Will Sisi succeed in taking on Egypt’s subsidies?

Will Sisi succeed in taking on Egypt’s subsidies?

To make Egypt a more attractive home for investment, President Sisi made tackling unsustainable food and energy subsidies a top priority. A year later, it is still unclear whether Sisi’s government can follow through on reforms that have stymied leaders for decades.

As Egypt’s leaders struggle to bring the country’s finances under control, one budget item in desperate need of reform is subsidies. For years, international investors, IMF economists, and domestic analysts have called for changes to the unsustainable system of handouts.

It is easy to understand why. Since the 2011 revolution, spending on subsidies has consistently represented over a quarter of all annual government expenditures, which is more than Egypt spends on health services and education combined.

Almost 90 percent of Egypt’s subsidies are spent on energy and food. According to Egypt’s Finance Ministry, the state-run Egyptian General Petroleum Corporation (EGPC) and the General Authority for Supply Commodities (GASC) received LE 126 billion and LE 35 billion in fiscal year 2013-14, respectively.

The money is used to pay for commodities that are then sold to retailers and distributors at below-market prices. For consumers, this translates to low-cost staples like bread and fuel.

The problem with these subsidies have been well documented. Energy subsidies in particular tend to benefit well-off Egyptians more than they benefit the poor. Dalibor Rohac, writing for the Cato Institute, estimated that, “in urban areas, the top quintile of the income distribution receives eight times as much in energy subsidies as the bottom quintile.”

Energy subsidies also reduce costs for energy- and capital-intensive industries like steel and cement whose firms can sell products for an inflated profit, attracting more investment and further distorting the market. Energy subsidies also promote consumption, straining Egypt’s dilapidated power grid and leading to shortages.

Holding the price of goods below market price has also led to the growth of black markets. Bakers who are sold cheap flour are often accused of under-producing subsidized bread and selling the remaining flour at a higher price. Similarly, Egyptian truck drivers can fill their tanks with subsidized gas and then drive to the Libyan border where it is sold at four times the price.

Subsidization has also required a complex bureaucracy to distribute resources, creating opportunities for abuse. Writing for Muftah, journalist Peter Volkmar found that, “by the time subsidized wheat reaches the market, for example, about a quarter has been lost to theft and spoilage.”

But while Egypt’s subsidies have been in place since World War II, they came under renewed scrutiny in the aftermath of the 2011 revolution when government deficits ballooned to more than 10% of GDP.

A fresh approach to subsidies 

President Abdel Fatah al-Sisi came to power in May 2014 with a pledge to stabilize the nation’s economy. His platform included subsidy reform, which aimed to calm investors by shrinking Egypt’s deficit and stemming the outflow of foreign currency reserves. According to the Egypt’s Ministry of Finance, projected spending this fiscal year will constitute around 11 percent less on food and 21 percent less on energy subsidies than in FY 2013-14.

In July of 2014, the government allowed the price of energy for households and businesses to increase by as much as 80%, with the goal of allowing prices to continue rising by about 20% every year until 2018. The government may be able to wean consumers off of subsidies even sooner if the global price of oil remains low.

Sisi has also announced a new program to reduce spending on food subsidies. Families would be issued plastic “smart cards” allowing them to buy five loaves of bread per family member each day. Bakers would also be paid for the loaves that they sell, rather than sold subsidized flour, making it harder to deal on the black market.

A more radical reform is to simply eliminate subsidies entirely and instead distribute cash directly to the poor. This is already being tried in some impoverished villages in rural Egypt, where families receive cash in exchange for sending their children to school and undergoing regular medical checkups.

Christopher Blattman, an economist at Columbia University, advocates for these types cash transfers as a replacement for traditional development policy on the grounds that they are more efficient and cost effective. In Egypt, the administrative costs are so high that replacing subsidized bread with cash transfers could cut program costs in half.

Will Sisi succeed?

After a year in office, the success of the president’s reforms appears to be mixed. According to the Finance Ministry’s monthly bulletin, spending on energy subsidies fell about 10% during July 2014 to May 2015 compared with the year before.

Minister of Supplies, Khaled Hanafi, told Reuters that the new cards for bread subsidies had been deployed in 17 of Egypt’s 29 governorates, and that consumption had fallen between 15% and 35% in those areas.

Yet, although the government is still on track to meet its budget target by the end of the fiscal year, payments to the grain-importing GASC increased by almost 28 percent and total spending on subsidies increased by more than 15 percent.

Data limitations make assessing the success of Egypt’s subsidy reforms difficult. Nevertheless, President Sisi has been recognized for his efforts. Ahead of the March 2015 conference at which international corporations and Gulf neighbors pledged to invest billions into Egypt’s economy, Sisi commissioned an IMF report that praised Egypt’s early progress on subsidy reforms.

Sisi does deserve credit for tackling a burden that held back Egypt’s economy for decades. Yet, absent more fundamental reforms that decentralize power, reduce regulation, and eliminate corruption, Egypt’s economy will not realize the full benefit of subsidy reform.

About Author

David Wille

David Wille works for a research center affiliated with George Mason University, where he is pursuing an MA in economics. Prior to graduate school, David was a retail banking research analyst at a Virginia-based consulting company and was a Fulbright Scholar in Egypt until 2011. He writes about the political economy of the Middle East.