What challenges lie ahead for Egypt’s economic reforms?

What challenges lie ahead for Egypt’s economic reforms?

As Egypt prepares to receive the second tranche of a $12 billion IMF loan, the country is facing continued political and economic challenges. While economic reforms are starting to yield results, the combination of inflation, popular discontent and security threats could affect the government’s ability to woo back foreign investors.

News of the approval of a three-year $12 billion IMF bailout plan last November was greeted positively by investors as a sign of the government’s commitment to fix the country’s battered economy, reduce public deficit and control inflation. The first weeks of 2017 have nonetheless exposed the challenges ahead. In January, inflation reached its highest level since February 2005, with a 28% increase in consumer prices. Combined with the continued threat of terrorism, the situation is likely to undermine confidence in Abdel Fattah al-Sisi’s already unpopular government and hamper its ability to implement reforms.

Egypt is facing a combination of security and economic risks

Egypt’s economy is battling a number of structural problems, mainly low growth rates and high deficit. The country’s external debt reached $60 billion in the first quarter of 2016/2017. As part of the IMF bailout plan, the country agreed to implement a series of sensitive reforms. Egypt’s central bank allowed the currency to float freely, leading to a sharp devaluation of the pound and soaring food and fuel prices. The last months of 2016 were marked by public loss of confidence in the government and regular protests over its inability to control inflation.

On the political front, the threat of terrorism continues to harm Egypt’s reputation as a safe place for foreign investments. Egypt’s security environment remains volatile and is characterised by a combination of high scale and acute attacks, as evidenced by the attack on a Coptic church on 11 December 2016 in Cairo, and regular clashes between military forces and Islamist militants in the Sinai Peninsula. The ISIS-affiliated Sinai Province terrorist movement has stepped up its activities and is staging regular attacks against military checkpoints and security facilities.

The short-term challenges for business and Egypt’s security environment

The second tranche of the IMF is expected to be delivered within weeks, pending a review at the end of the month. Although experts predict that the bailout plan will have positive long-term effects on the Egyptian economy, the government’s reforms raise challenges in the short-term. The devaluation of the pound has increased the costs of production for businesses, as fuel and raw material prices have gone up. Inflation is yet to reach its peak and businesses will continue to feel its crippling effects in the short term. Inflation and weak currency, combined with the introduction of VAT, have also placed pressure on consumers.

The government is likely to face growing popular discontent over soaring prices in the coming months. While it has so far cracked down on public protests, spiralling inflation could spark more social unrest in the coming weeks. Al-Sisi came to power in 2014 promising to restore political stability after the turbulence of the Arab Spring. However, growing anti-government sentiment and the potential risk of popular unrest could affect Egypt’s stability and erode investor confidence.

Domestic and geopolitical threats remain primary concerns for investors as Egypt struggles to project the image of a safe country to do business in. The terror threat has already had a strong impact on several business sectors, notably tourism. Tourism has represented a driving force for Egypt’s economy for years but has faced difficulties since the Arab Spring. The downing of a Russian aircraft by the Egyptian branch of ISIS over the Sinai in October 2015 dealt a further blow to the tourist industry. Tourists are regular targets of terrorist attacks, alongside military personnel and government officials. The recent string of attacks, including the death of eight soldiers on 16 January and the bomb attack on an armoured vehicle in the Sinai on 17 February reflects the government’s failure to stabilise the country’s security environment.

The government’s response

Moody’s latest sovereign outlook for the Levant and North Africa (published in January 2017) gave Egypt the highest economic strength assessment in the region while highlighting the challenges associated with domestic security conditions. The beginning of February has also seen an increase in the value of the pound – a sign that investors are regaining trust in Egypt’s prospects. The political factor is likely to be decisive in maintaining or destroying investor support.

Investors will be monitoring the government’s response closely in the next few months. If anti-government sentiment grows, the government could react by toughening its stance towards public protests, a situation which could result in heightened political risks. Much will also depend on the government’s ability to push through further reforms to secure the full IMF support package while mitigating the short-term effects of inflation. Priorities also include strengthening the country’s security environment, reforming its oil and gas industry and implementing infrastructure projects to attract investment. Egypt’s government is hoping that its structural reforms will act as incentives for foreign investors and bring the awaited economic boost.

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