Public Information Notice No. 01/116

Public Information Notice: IMF Concludes 2001 Article IV Consultation with the Arab Republic of Egypt

November 5, 2001

On October 31, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Arab Republic of Egypt.¹

Background

During most of the 1990s, Egypt made considerable progress in macroeconomic stabilization and structural reform. The fiscal deficit was greatly reduced, inflation fell to low single digits under a currency peg to the U.S. dollar, and debt service indicators strengthened substantially, aided by debt reduction from official bilateral creditors. On the structural front, progress was made in financial and trade liberalization, and privatization. These advances contributed to rising investment and stronger real GDP growth.

In the late-1990s, however, macroeconomic performance weakened as a result of a combination of policy and external factors. On the policy side, credit growth remained rapid and structural reform slowed; also, measures of the fiscal deficit were revised upward, though the deficit of the general government was still low at the end of the decade. At the same time, tourism experienced a temporary downturn, global financing tightened after the Asian Crisis, and the pound continued to appreciate as a result of the strengthening of the U.S. dollar to which it remained pegged. These developments together resulted in sizable official reserve losses, albeit from a high level and the reserve position remained comfortable.

Following monetary tightening in 1999/00, private credit growth slowed significantly from earlier unsustainable rates. This helped stabilize official reserves toward end-2000, but was associated with a marked slowdown in economic growth from 5 percent, on official data, in 1999/00 to preliminary staff estimates in the 3-3½ percent range for 2000/01. Consumer price inflation remains low, at 2.2 percent for the year to June 2001.

Updated fiscal accounts have been compiled using a new reporting framework developed over the past year with the authorities. On the revised accounts, the fiscal deficit is estimated to have averaged 3-4 percent of GDP in recent years for the budget sector alone. However, at the level of the general government, which provides the most comprehensive picture of the fiscal situation, and includes the outlays of the National Investment Bank (NIB) and the General Authority for the Supply of Commodities (GASC), as well as financing received from the Social Insurance Funds (SIFs), the deficit is provisionally estimated to fall to under 1 percent of GDP. At the level of the general government, after netting out government obligations to the SIFs, public debt amounted to 64 percent of GDP at end-2000/01. Within this total, foreign public debt, almost entirely to official creditors, amounted to about 26 percent of GDP; domestic public debt amounted to 38 percent of GDP, almost all of which was held either by the Central Bank of Egypt, or by commercial banks to meet liquidity requirements.

During 2000, seeking to strengthen the external position, the authorities departed from the de facto peg to the U.S. dollar adopted in early 1991. Following an initial depreciation, an adjustable currency band was adopted against the U.S. dollar in January 2001; this band was subsequently further depreciated and widened in mid-2001, resulting in a cumulative depreciation of about 25 percent relative to the U.S. dollar.

Balance of payments pressures eased in 2000/01. The external current account moved into broad balance in 2000/01, as non-oil imports fell by 10 percent in dollar terms and non-oil exports rose 7 percent. The deficit on the external capital account also narrowed slightly. Reflecting these developments, the decline in official reserves in 2000/01 was limited to US$0.9 billion (0.9 percent of GDP), compared to US$3 billion a year earlier (3.1 percent of GDP). At end-June 2001, net official reserves amounted to US$14.2 billion, or about three times the level of Egypt's short-term public external debt.

On the structural front, several key measures have been adopted in recent months. In the fiscal area, the general sales tax (GST) was extended to the wholesale and retail levels by parliament in May 2001 and implemented from July 2001. The authorities also signed in June 2001 an Association Agreement with the EU which, once ratified, will provide for a phased, multi-year reduction of tariffs on EU imports. In the financial sector, parliament approved in June 2001 a law promoting the development of a mortgage market, key in which are provisions for strengthening the potential claim of lenders over property collateral. Further, following a review of existing financial legislation, a draft money laundering law has been prepared to criminalize the activity, strengthen penalties, and establish a central authority to supervise and coordinate detection and enforcement efforts. Last, a number of smaller companies were privatized last year, together with a large cement company in September 2001.

Executive Board Assessment

Executive Directors commended the authorities for the progress made in strengthening Egypt's economy over the past decade by substantially reducing the fiscal deficit, bringing inflation to low levels, improving debt service indicators, and advancing structural reforms. At the same time, they noted that balance of payments pressures emerged in the late 1990s. These were linked to adverse shifts in the external environment as well as to a rapid growth of domestic credit. Directors noted that, although a reduction of private credit growth since early 2000 had helped to strengthen external performance and stabilize official reserves, it was also associated with the slowdown in economic growth. They further noted that the outlook for growth and external performance had deteriorated somewhat following the events of September 11. In light of these considerations, Directors agreed that the key challenge in the period ahead is to restore strong economic growth and robust job creation, while maintaining macroeconomic stability. This requires persistence in the implementation of structural reforms and sound financial policies.

As regards fiscal policy, Directors noted that it would be important to avoid exacerbating the current economic slowdown to provide adequate room for growth of private sector credit and agreed that the broadly unchanged fiscal stance projected for 2001/02 appears appropriate. Directors noted that downside risks to economic growth from recent developments could have repercussions for fiscal policy, and recommended that automatic stabilizers be allowed to work fully at the present time. They indicated, however, that attempts to foster stronger economic growth through discretionary fiscal policies could adversely affect confidence and prove counterproductive. A few Directors indicated that some consolidation may be warranted over the medium term to reduce the public debt ratio.

Directors supported the authorities' commitment to continuing exchange rate flexibility, which would allow Egypt to ride out periods of market turbulence while avoiding further significant declines in official reserves from the currently relatively strong position. They indicated that flexibility would be particularly important in the period ahead to help Egypt to weather any external shocks that might emerge following recent events. Directors underlined the importance of ensuring that the foreign currency market remains liquid, and urged that the currency band be adjusted, as needed, in response to market conditions to ensure that external competitiveness is maintained.

As regards monetary policy, Directors welcomed the slowing of private credit growth, which has reduced pressures on the exchange rate. Looking forward, they supported the intention to guide monetary policy using a range of indicators, given uncertainties about money demand, and encouraged efforts to strengthen the tools of monetary policy and to further develop financial markets, particularly through greater interest rate flexibility. Directors welcomed recent progress in strengthening banking supervision and commended the authorities' decision to participate in the Financial Sector Assessment Program in early 2002. Directors also commended the authorities' intention to strengthen the criminalization and detection of money laundering, noting the importance of strong safeguards in this area.

Directors noted that Egypt's rapidly rising labor force will require significant further progress with structural reform to foster strong output and employment growth. Key goals should be to broaden the activities of the private sector, eliminate impediments to international trade and investment, and reduce official bureaucracy and red tape. On privatization, Directors welcomed the government's plans to offer the remaining nonfinancial public companies for sale by end-2002. They noted, however, that privatization of the state-owned banks-already considerably delayed-was not envisaged in the near term, and encouraged the authorities to give this a high priority.

Directors commended the recent signing of the Association Agreement with the European Union. At the same time, they emphasized the importance of multilateral tariff reduction in order to secure the full benefits of trade liberalization. In this context, Directors encouraged the authorities to move toward a much lower and more uniform tariff structure. The authorities were encouraged to accept the obligations of Article VIII, Sections 2, 3, and 4 of the Articles of Agreement.

Directors viewed the authorities' agenda for tax reform as timely given prospective declines in some revenue categories over the period ahead. They welcomed the extension of the general sales tax (GST) to the wholesale and retail levels, as well as the authorities' intention to further amend the GST to move in the direction of uniform rates, more limited exemptions, and a stronger rebate system. Directors also welcomed the intention to seek parliamentary approval later this year for reforms of the personal and corporate income tax system, and noted that progress in significantly reducing exemptions to income taxation and customs tariffs will be key. They supported efforts to strengthen tax and customs administration, noting the high priority of these reforms, and stressed the need for strengthened public management as well.

Directors welcomed Egypt's successful debut Eurobond issue in June 2001, noting that further integration into global markets would require strong economic policies and institutions. In this connection, they noted the importance of comprehensive, high-quality macroeconomic data, and welcomed recent progress in strengthening Egypt's database, including by developing more comprehensive and internally consistent fiscal accounts. Directors also welcomed completion of the fiscal module of the Report on the Observance of Standards and Codes. Directors noted that further efforts are needed to strengthen and clarify reporting on National Investment Bank (NIB) operations, and encouraged the timely completion of the ongoing audit of the NIB. The authorities were urged to publish the updated fiscal accounts, together with supporting fiscal documents, including the audited year-end treasury statements, after parliamentary approval. In regard to other macroeconomic data, the initial work toward compilation of a monthly index of industrial production was commended, and further improvements in the real sector database were seen as important. Directors encouraged the authorities to subscribe to the General Data Dissemination System and the Special Data Dissemination Standard.