Following the implementation of all of the International Monetary Fund’s (IMF) preconditions for the three-year, $12bn loan Egypt is bent on receiving, the government submitted a letter of intent to the IMF executive board two days ago.
A letter of intent outlines one or more agreements between the two parties before the conclusive agreement is finalised.
The IMF executive board is set to hold a meeting on 11 November to discuss, review, and decide on Egypt’s request for the three-year loan, the Central Bank of Egypt (CBE) said on Tuesday.
The liberalisation of the exchange rate and lifting subsidies among other decisions were the main conditions stipulated by the IMF for the loan to receive final approval. Egypt checked off the last requirements on 3 November when the CBE announced it would float the Egyptian pound, which was followed later that evening by the government’s decision to increase the prices of petroleum products.
Egyptian officials and experts have predicted that the IMF executive board will agree to the loan before the month’s end following Egypt’s displayed commitment to the preconditions.
The IMF delegation arrived in Cairo on 30 July for a two-week visit to discuss the possibility of a loan. The IMF loan is part of a financial agreement worth $21bn that will be dispensed over the coming three years to finance Egypt’s economic reform programme. Of the total amount, $3bn will come from the World Bank, $1.5bn from the African Development Bank (AfDB), $3bn from a planned international bond sale, and the rest will come from other sources.
Egypt resorted to negotiating with the IMF for the larger portion of the $21bn package to support its economic reform programme—part of the Sustainable Development Strategy: Egypt Vision 2030. The need for such loans is the result of an increasing budget deficit over the last six years, which ranges between 11% and 13%, according to Finance Minister Amr El-Garhy.
El-Garhy revealed that among the reasons to resort to the IMF is to show investors that Egypt is serious about its commitment to the implementation of its economic reform programme.
The deputy finance minister for monetary policy, Ahmed Kojak, said that the loan will reduce the size of domestic debt, given the interest rate of 17%. He noted that the ministry is seeking to reduce the ratio of public debt to 90% of GDP after it hit 97% of GDP.
Liberalisation of exchange rate and the bailout approval
The liberalisation of the exchange rate, as a result of floating the Egyptian pound, was the most important condition set by the IMF before the loan could be approved. While there is popular objection to such conditions, and the loan itself, the government has moved forward in its implementation scheme.
The flotation of the Egyptian pound means that the price of the national currency will ultimately be decided by the market’s forces of supply and demand.
There are a few states, such as New Zealand, Sweden, Iceland, and the United States, where central banks do not intervene to determine the exchange rate, and when they do, it is on a very minimalistic basis. The number of states in the IMF’s member pool that utilise such a system decreased in the period between 2008 and 2014 from 39.9% to 34%.
The number of countries that follow the fully managed float, which is a very limited intervention towards determining the exchange rate, also decreased in the same period, from 19.5% to 12.2%.
The CBE’s Thursday decision to float the pound came with a guiding rate of EGP 13 per US dollar, but that rate has fluctuated in banks through the inter banking system and efforts to combat the high price in the unofficial market.
What is the inter banking system?
The inter banking system is a financial system of trading currencies among banks and financial institutions, excluding retail investors and smaller trading parties.
The inter banking system in Egypt is represented in the trading of US dollars among local banks, with a commitment by each bank to announce prices across a network of electronic trading screens.
According to this mechanism, each bank must determine buying and selling prices of the US dollar, based on its dollar liquidity without intervention from the CBE.
The inter banking system for foreign currency trading was adopted in Egypt prior to December 2012, before the state decided to pose periodic tenders during which the CBE sold dollars to banks, in light of the fall of hard cash resources. It had been followed in previous years, and was governed by a price scope set by the CBE. Banks were not, at the time, free to set the price based on supply and demand, unlike the current system.
Lagarde before and after the flotation
On 8 October, before Egypt took the decision to float the pound, Christine Lagarde, managing director of the IMF, made it clear in a press statement that Egypt must complete some of the preconditions set by the IMF prior to obtaining the loan, including the liberalisation of the exchange rate.
However, after the flotation, Lagarde said: “I will recommend that the IMF board approve Egypt’s request in support of this ambitious economic reform programme that will help restore macroeconomic stability and bring Egypt’s economy closer to its full potential.”
What will happen to the deficit and external debt?
The effects of the flotation do not stop at prices, but also extends to the budget deficit and external debt.
Global head of research at Mubasher Financial Services Amr El Alfy said that the direct effects of the flotation include a high budget deficit due to the high cost of importing, such as wheat, on one hand, and the high cost of government debt services on the other hand. The CBE also decided to increase the interest rate by 3%, which coincided with the flotation decision and will directly affect the cost of government borrowing.
According to the state budget for the current fiscal year, it is expected that spending on benefits would be increased to EGP 292.52bn, compared to last year’s amount of EGP 244.012bn, accounting for 31.2% of expenses.
El Alfy forecasted that the budget deficit by the end of the current fiscal year will approach 13%, compared to the 9.8% targeted by the government.
Egypt is most certainly not the only country to have taken out a massive loan from the IMF or other financial institutions. Daily News Egypt highlights the cases ranked most successful and unsuccessful in dealing with a scenario like Egypt is grappling with now.
Economies that failed in their borrowing plan
The two most famous models in this regard are Argentina and Greece. Argentina faced a severe financial crisis in 1997-1998; therefore, the country resorted to the IMF to obtain a loan to get rid of its economic troubles. Nevertheless, the tough conditions imposed by the IMF, marked by fiscal austerity and the emphasis on its monetary policy, are at the forefront of the country’s post-loan failure. In the case of Argentina, after obtaining the loan, it failed to pay off its outstanding debts and reserve the value of its currency.
On the same front, Greece followed similar footsteps with its IMF loan; however, the loan couldn’t boost development as much as being able to increase the external debt of the country, which amounted to a rate of 175% of the GDP.
Brazil is another economy that failed in implementing the IMF’s unfair terms. The country obtained a $30bn loan from the IMF in 1999 after several years of economic crisis under the administration of Lula da Silva.
Following years of effort extended towards implementing the IMF’s terms, the Brazilian economy deteriorated, thus da Silva threw away these terms and followed new reformist policies set by Brazil itself. This included opening up new relations with the European Union, the development of investment laws, and promoting the sectors of agriculture and tourism. In 2010, Brazil ranked in seventh place globally in terms of economic strength, achieving a growth rate of 7.5%.
Tanzania also failed in making use of the IMF’s loan to absolve itself of its debts. The IMF tried to change the country from a socialist country to a capitalist country by buying government services instead of providing free services to citizens. As a result of these policies, enrollment in schools declined from 80% to 66%, causing the rate of illiteracy to increase to nearly 50%. Moreover, GDP per capita declined from $309 to $210 between 1985 and 2000.
In this regard, the Russian model for dealing with its IMF loan cannot be forgotten. Russia obtained a loan in the 1990s worth $20bn; however, it did not implement the reforms it was requested to.
Malaysia’s experience with the IMF is not considered a wholly successful or failed experience, since Malaysia backtracked on the loan before it agreed to it in 1997. This was under the pretext that the IMF’s conditions were misleading, according to Mahathir Mohamad, the country’s prime minister from 1981-2004. Mohamad managed to achieve development through enhancing the country’s infrastructure by reducing poverty and decreasing the country’s debt.
The Malaysian experience proved very successful in facing the economic crisis in 1997. In 2001, the United Nations Development Programme (UNDP) reported that out of the most important global exporter countries in technology Malaysia ranked ninth, ahead of Italy and Sweden. In 2007, Malaysia ranked in 34th place in GDP, according to the IMF, and in 2004 it ranked in 18th place globally in the size of its exports.
Economies that succeeded
Nevertheless, there were success stories with IMF loans, such as Jordan, which resorted to the IMF in 1993 due to the economic crisis that emerged from the war with Israel. This led to a large economic recession, and the unemployment rate increased to as high as 35%. Between 1993 and 1999, the IMF granted three loans to Jordan. After that, the country took on huge reforms that included privatisation, taxation, foreign investment, and facilitated trade policies. Jordan managed to reduce its public debt and join the World Trade Organisation and sign a free trade agreement with the US.
Tunisia is another successful model of a country that received loans from the IMF more than once, most recently in the first half of 2016, when it received a loan worth $2.8bn. This loan intended to support the framework of the country’s four-year economic reform programme. In 2013, Tunisia obtained a $1.7bn loan for two years from the IMF on the condition that the country achieve some economic reforms.
Experts predict Egypt’s failure in dealing with the loan
Khaled Abdel Fattah, a finance and investment expert, said that the solution to the economic problems and financing gap plaguing Egypt currently require “political will” through the use of experts and economists to determine broad solutions. Going to the IMF, Abdel Fattah believes, is not the solution.
Abdel Fattah added that the IMF has destroyed states, and it has not proved that it has helped an economy to improve. He said that Brazil’s ultimate success following its loan was the result of political will, not the IMF loan.
He noted that the IMF has worked with successive governments in Egypt for years, and asked what the fund had actually done for Egypt during those years. He noted that over the years, during the IMF’s assistance, the economy has only collapsed further, unemployment has worsened, and the state’s assets have been sold.
An economic expert told Daily News Egypt that Egypt will repeat the experience of Greece and Argentina, especially following Egypt’s decision to put in place austerity measures, float the national currency, and reduce subsidies on petroleum projects.
He added that Egypt would not resist the popular anger and harsh criticism as a result of those actions, with evidence of the calls for demonstrations on 11 November. Even if the government succeeded in silencing the crowd, it may not be able to follow up on the implementation of such policies, he said.
What Egypt needs to take advantage of the loan
Cairo-based senior economist at Arqaam Capital Reham El-Desoki told Daily News Egypt that there are two ways to make use of the loan. The first is providing liquidity for economic crises and the second is using it for developing projects and new investments. People in Egypt envisage the IMF as a demon and are afraid of it, but Egypt’s commitment to repaying the loan is the basis of the deal and the IMF should not have to interfere with any governmental policies, said El-Desoki.
Professor of economics at Cairo University Alia El-Mahdi said that to achieve progress in using such a loan, Egypt needs political will led by the president, as he would be the reason behind the success of the deal.
El-Mahdi noted that the conditions set by the IMF are necessary, attributing this to necessary amendments in the tax system, subsidy reductions, and floating the Egyptian pound.