EXTERNAL DEPENDENCIES ANALYSIS: Egypt’s attempts to reform highly subsidized oil and grain markets reveal key trade vulnerabilities. Egypt’s dependency on imported oil and cereals (despite its own production) leaves it exposed to price shocks and political upheaval just as it is trying to implement difficult reforms.
Since Egyptian President Abdel Fattah al-Sisi took power, Egypt has attempted to reform government subsidies in its key oil and grain markets. Egypt spends a considerable portion of its budget on providing cheap fuel and bread to its people. These reform attempts, however, put stress on markets that already have high existing trade risks.
Egypt produces lower quality oil, exporting a considerable amount despite rising domestic demand. The subsidies boost demand by lowering the market price, leading to an increased reliance on imported oil. Egypt also depends on foreign wheat and grain, with almost 40 percent of its imports of cereals coming from Russia and Ukraine last year. Given the conflict between those two nations, that trade source now looks a lot more vulnerable.
Subsidy overhaul
In the beginning of July, Egypt’s government increased fuel prices across the board, ranging from a 40 percent increase for high octane fuel to 78 percent for lower grades. While many protested the new prices, the government defended the measure as necessary to free up money.
Earlier this year in April, the government began a more modest attempt at reducing its bill for bread subsidies through a new smart card system. Egyptians using the smart card would accrue credits if they bought less bread than their quota under the current subsidy scheme. This should make bread subsidies more efficient, reducing the cost for the government.
By distorting prices, subsidies often artificially raise demand and promote energy intensive sectors over other industries. More importantly, from a fiscal point of view, subsidies expose governments to price shocks. When the price of goods shifts, the government’s bill changes with it.
Oil market
Sisi’s attempts at reforms could put further strain on an energy sector that already has been under stress. Since 2010, Egyptian oil consumption has outpaced production, creating a persistent shortfall and a trade deficit of $1.7 billion in the oil sector. This does not seem to be a trend that will be quickly reversed as production has steadily declined since the 1990s, except for a slight pickup in 2008-09.
With lower domestic production, refinery utilization in Egypt dropped as well (estimated at 63 percent). Refined petroleum must be imported from abroad and Egypt has turned principally to oil from Saudi Arabia, Kuwait, and Turkey. Those three countries make up over 53 percent of Egypt’s oil imports and, importantly, almost two thirds of that import flow is made up of refined petroleum and petroleum gases.
On the export side, Egypt ships a substantial amount of crude oil to Italy and India for use and refining there. Almost 90 percent of Egypt’s crude exports goes to those two countries. While that import flow represents a relatively negligible share of their imports, both Italy and India export refined petroleum back to Egypt.
Precisely because Egypt imports so much oil, the government’s move to reform subsidies should be welcomed. By IMF estimates, Egypt spent 31 percent of government revenue on oil subsidies in 2011. Partly due to the effect of subsidies, the Egyptian General Petroleum Corporation owes $7.5 billion to foreign oil/gas companies, leaving the sector under-invested.
In light of this, the current low price of oil is good news for the Egyptian government. Lower prices abroad make subsidies less expensive, albeit only as long as this prices prevail. Higher foreign prices would mean larger debts and more money diverted from other areas of the government’s budget to maintain a low domestic price.
Reform does come with a cost however. Increased energy prices will impact the cost of other goods and services, from taxi fares to the cost of shipping. This could act as a check on growth in the short-term, which has disappointed over the past couple years.
Grain drain
Imported wheat is vital for keeping the price of bread low in Egypt. The US Department of Agriculture estimated Egypt’s harvest from last year at 8.5 million tonnes, half a million tonnes short of the annual requirement for the subsidized bread program.
In 2013, Egypt imported $4.7 billion in cereals, with 26 percent of its supply coming from the Ukraine. As most of this comes through the Black Sea, the effect of the Ukrainian conflict started rippling out to Middle East buyers like Egypt earlier this year. Now, Egypt looks set to import more Russian grain, but the tensions in the region could make this grain more expensive.
With GDP growth of around 2 percent the past two years, Egypt hopes to simultaneously boost growth while also trimming its budget. It will be a tough balance to strike. Although the cost of subsidies drains government revenue, the low prices are relied upon by many Egyptians.
If the government does not help alleviate the shock of higher fuel and bread prices, the increased cost might cut too deeply into Egyptian’s wallets and hurt growth. But tackling subsidies now will allow Egypt to improve its trade balances in the oil and grain markets, insulating the country from price shocks in the future.
The External Dependencies Analysis (EDA) project makes country vulnerabilities stemming from their main trading relations explicit, and shows to what extent these might impact their current and future behaviour. With the EDA, GRI provides a new comprehensive tool for businesses, analysts and investors to grasp dynamics that are key to political risk analysis.
Note: Trade Data comes from GRI’s External Dependency Analysis based on data derived from the International Trade Center.
