The Egyptian economy faces persistent economic challenges that have only worsened with the unrest that has followed the Arab Spring. The fledgling Muslim Brotherhood government in Cairo must balance the needs of a powerful military establishment with the needs of a fractious populace. Strikes, protests and sporadic violence have become a daily occurrence in the Middle Eastern country of more than 80 million people, and various government announcements have been quickly reversed. In this unstable environment, investor confidence has plummeted, damaging the country's financial position and bringing Egypt to the edge of complete instability.
Egypt's negative financial account has exacerbated the outflow of foreign exchange previously driven by the country's large trade deficit, and foreign reserves are dwindling. Without foreign reserves, Cairo would be unable to pay for foreign currency-denominated imports and would be unable to maintain the value of the Egyptian pound. The government has two realistic options: Find outside financing to make up the difference, or ask the population to accept higher costs for a range of goods and services. In the current environment, the first option will be difficult. But the second option carries profound political consequences and could worsen already significant unrest.
The nature of Egypt's economic challenges is neither new nor surprising. Egypt's large population and limited arable land outside the Nile Delta historically have made capital accumulation and development a challenge. These challenges have grown as Egypt's population increases and oil production falls. Cairo knows it needs to enact a range of cost-cutting reforms while negotiating with the International Monetary Fund for a $4.8 billion credit line that would help stabilize its currency and restore the confidence of global investors. This policy will meet with some success. But it is highly likely that Egypt will have to rely heavily on the time-tested use of its strategic position in the Middle East to secure foreign aid and investment.
Real Sectors, Real Problems
Questions about the future of energy subsidies dominate the Egyptian economic conversation. Egypt used to export a significant amount of oil, but oil production has slumped while subsidized consumption has continued to rise. Although Egypt remains a net exporter of crude oil by a small margin, the country is a net importer of refined petroleum products. Despite these developments, long-standing subsidization policies are politically very difficult to get rid of without a significant backlash from the public.
Egypt, however, can no longer afford them. Energy subsidies make up 72 percent of total subsidies and one-fifth of the government's total budget. Though they are expensive, completely ending the subsidies would increase prices of energy-related goods and services by around 30 percent, which would trigger inflation in other sectors. The complete removal of subsidies is probably out of the question.
Changes can be made to mitigate the impact of reduced subsidies. Blanket price subsidies benefit higher income private consumers the most, since they have the money to own cars, run air conditioners, etc. These consumers were targeted in late 2012 when the government removed subsidies for high-octane gasoline. The changes, however, were made obsolete almost immediately as high octane consumers switched to lower octane gasoline.