Monday, 29 June 2015

Egypt fiscal cutback broadly on track

Higher growth and lower commodity prices are helping Egypt to reduce its budget deficit.

Egypt is rotating its economic policy towards a new model based on two arrows: lower government spending and higher investment. The move is prompted by Egypt’s backers in the Gulf—who seem unwilling to continue writing blank cheques—and the unsustainability of the old model—which saw the Egyptian government spending beyond its means. The Egyptian authorities and the International Monetary Fund are optimistic that the new model will lead to higher economic growth. And the latest numbers show that at least one of the arrows is on track to hit somewhere close to its mark.

According to the Ministry of Finance data, the budget deficit (the difference between the government’s spending and revenue) for the period July 2014 to April 2015 was 9.9% of GDP. The Ministry expects the deficit for the whole fiscal year, which ends on June 30, to reach 10.8% of GDP. This is quite a bit lower than the 2013/14 deficit, which was 12.8% of GDP, although still higher than the original deficit target (10% of GDP).

The expected deficit reduction will be achieved despite reduced support from the Gulf and the postponement in the implementation of capital gains tax. The former, which fell by $5.7bn compared to a year earlier, would have reduced the budget deficit by 1.9% of GDP if maintained at last year’s levels. The impact of the capital gains tax is less significant: it would have only reduced the deficit by less than 0.1% of GDP if it had been implemented.

So how was the deficit reduction achieved? First, higher growth has resulted in higher tax revenue for the government. Real GDP growth accelerated to 5.6% in the first half of the current fiscal year compared to 1.2% in the same period a year earlier. As a result, Egypt’s tax revenue increased by 22.6% over a year ago. Second, lower food and energy prices have helped the government to control its expenses.

Going forward, Egypt plans to continue tightening fiscal policy. The government has recently announced the deficit target for 2015/16 (9.9% of GDP), and Egypt’s five-year macroeconomic strategy expects the deficit to continue declining to 8.1% of GDP in 2018/19. There are risks to this outlook. Not least because commodity prices are expected to recover and may increase expenditure. In addition, too rapid a fiscal consolidation can sometimes be self-defeating: it can be detrimental to growth and hence to revenue and the deficit itself. But Egypt and its regional and international backers are intent on continuing firing the fiscal arrow.

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