Egypt’s Flawed State Subsidies Need Effective Reforms
by Tarek Erfan Shafey
The Flawed Subsidies
As Egypt endeavors to grow its economy and improve the standard of living of its fast-growing, 102 million-strong population, the state needs to reform its wasteful, inefficient and counter-productive, universal subsidies on food, fuel, electricity and public transportation. In the state budget for FY 2021, state spending was USD 109 Billion, with the four subsidy categories, although they have been steadily reduced in recent years, still costing USD 5.4, 1.8, 1.7 and 0.6 Billion, respectively. They are a major cause of the still high budget deficit (7.2% of GDP in 2020–21), annual inflation (though now down to 4.3%, as an effect of COVID-19) and borrowing cost rates (typically around 10%). We discuss their impact and present a reform strategy to make them more equitable, efficient and beneficial to the national economy.
Among many disadvantages of Egypt’s subsidies, they are non-targeted and benefit many non-needing consumers, and hence inequitable and ineffective in protecting lower-income citizens from the strains of market forces. They also foster costly and harmful waste and overconsumption. Food staples such as bread, rice, sugar, edible oils and tea are subsidized to all at well-below market prices, leading to imports worth tens of billions of US Dollars in those items plus beef, and Egypt’s high rates of obesity, diabetes, and heart and other diseases. Moreover, other important food items such as beef, poultry, fruits and vegetables cannot be subsidized due to high costs or seasonal volatility, therefore the inflation caused by state budget deficits leads to even higher non-subsidized food inflation which hits the poor hardest.
Meanwhile, universal fuel and public transportation subsidies have led to more road congestion by private cars and very mediocre and widely unavailable public transportation. Having exported petroleum as recently as 2011 and natural gas until 2013, through years of excessive consumption Egypt squandered annual surpluses worth billions of US Dollars, and annually imported petroleum and gas worth billions of USD Dollars. Thanks to more recent gas discoveries; most importantly the giant “Zohr” field, gas self-sufficiency, industrial production and electricity availability and reliability have been restored after long and disruptive shortages, and some gas is now exported. Meanwhile, the environment-harming use of heavy oil fuels in place of gas, especially in thermal power generation plants, has largely stopped, and this has sharply reduced the petroleum import bill, improved the trade the trade balance helped lessen air pollution.
Egypt’s high, subsidy-driven budget deficits and low gross domestic savings rate (only 9.4% of GDP in 2019), as well as historically very high inflation and unhealthy, even often negative, real interest rates. It is now much lower due to COVID-19 but is subject to rebound risks due to several factors, prominent among which is a longtime policy bias in favor of keeping interest rates too low and being too tolerant of high inflation. have long acted as major investment impediments. China’s and Malaysia’s corresponding rate of 44% and 28.5%, respectively are much higher and typical of eastern and southeastern Asian countries, form the backbone of bank credit to domestic and foreign investors alike, and finance small and medium enterprises (SMEs). In Egypt, SMEs represent 80–90% of the economy and 75–80% of employment, so in order for them and investments to grow more strongly, Egypt needs to achieve much higher bank savings rates relative to GDP. This is best done via achieving sustainably and consistently healthy real (inflation-adjusted) bank interest rates. Through cutting spending on mega-projects and reforming the subsidy regime, the state needs to reduce its budget deficit in order to curb the inflationary money printing upon which it relies to pay public debt, to keep interest rates low, inflation lower and real interest rates healthy, hence spurring bank lending to the private sector.
Sustainable Subsidy Overhaul
Thorough reform is essential. Driven by budgetary pressures and conditional loan agreements with the always austerity-minded International Monetary Fund (IMF), Egypt has reduced fuel and electricity subsidies, but what is really needed is an overhaul of the subsidy regime. Paramount should be economic efficiency and market discipline in pricing, while also supporting deserving low-income citizens via direct, targeted and conditional cash support. A good model for Egypt is Brazil (“Bolsa Familia”, or family allowance) and a similar scheme in Mexico (“Prospera” or prospering), where food and energy are priced at market rates while a national conditional cash transfer regime, known as and disbursed to the mothers, rewards responsible low-income families who commit to preventive health care and a full education for their children. Such programs can be used to great effect in Egypt to combat the high incidence of child labor and reward responsible behavior such as smaller family sizes.
Indeed, children’s education and family planning are important national goals needing decisive measures. For families with up to two children, only two at most would be included in cash support for food, energy, transportation and children’s schooling. For larger families, four existing children would be supported, with stringent conditions. Free contraceptives would be provided, and should any more children be born or any child un-enrolled from school, the subsidies would be revoked for the entire family. Given the prevalence of market prices, the subsidy removal threat would be a potent disincentive to non-compliance with the new state policies, and much-needed money can be saved.
An important consideration in Egypt’s male-dominated society (especially among the working class) is that the family subsidy be awarded to the mothers, who are known to be more responsible in their behavior, careful about finances and caring of their children than the fathers, who may well waste the money on cigarettes, narcotics, having extramarital affairs, or (in the case of Muslims, who predominate in Egypt) marrying second or third wives. Social workers would need to visit the families and make it clear to the man that should he forcibly try to take the subsidy money from his wife, he will be sternly punished by rulings in family courts. Those quick-procedure courts are needed in Egypt, where regrettably many wives are bullied and abused by their husbands and need fast-moving and decisive legal protection.
While subsidies are being removed, pricing still needs careful planning to maximize both equitability and economic efficiency. Regarding food, the state would continue to produce staple baladi bread for lower-income citizens, but at market prices, and allow other food prices to settle at market rates (which would be benign given the improved macro-economy) and with strict state oversight for consumer protection. Cash for lower-income citizens would curb food waste and overconsumption (including rural families feeding baladi bread to farm animals), while also allowing those families to sensibly balance their food expenditure on various items, and save money for spending on other important items such as their clothing, homes, health and children’s education.
Regarding fuel and electricity, market-based and scaled pricing systems are needed. Only lower-income families would receive cash support, while progressively higher prices for electricity and gas would be charged to homes, non-profit educational and health care entities, government entities, stores and commercial establishments, and finally, energy-intensive and high-profit hotels, hospitals and factories. This would sharply reduce overconsumption. Regarding petroleum, the (albeit since partially reversed) fall in global oil prices in early-mid 2020 gives Egypt scope to price 92 and 95-octane gasoline at market rates with reasonable price hikes, restrict 80-octane gasoline and diesel subsidies by using “smart” electronic cards, and introduce cash subsidies for lower-income consumers.
There is also much room for higher output of oil, gas and especially electricity from renewable energy such as solar and wind power, and biogas. Egypt’s 40-year potential, estimated at 120 Gigawatts (GW) of solar power, 48 GW of wind power and 1.5 Trillion cubic feet (Tcf) natural gas equivalent of biogas, allows long-term exports of oil and especially natural gas and electricity, with earnings in many billions of US Dollars. Among many other benefits, that would transform Egypt’s economy and allow much higher spending on, and strong progress in, education and public health.
Regarding public transportation subsidies, a World Bank study in 2018 observed that Egypt’s policies waste plentiful fuel, distort road traffic demand in favor of private cars, increase that demand considerably, and cause low public transportation availability, quality, punctuality, reliability and comfort. As the study noted, repeated public opinion surveys showed that many moderate-income passengers and higher-income private car owners would be willing to pay more for a much-improved system and use it regularly, with elderly and women passengers in particular also citing the need for improved comfort and security. The conditions are hence in place for pricing public transport at market rates with cash support to low-income users, which would greatly reduce the state burden and allow major investments in lower and middle-level public transportation. Looking ahead, upmarket public transportation can be privatized but well-regulated, and the necessary consumer demand and willing business investors exist for that to happen.
Conscious of the situation, Egypt has since August 2016 implemented a USD 12 billion loan agreement and maintained close collaboration with the IMF, with resultant economic support loans from the World Bank and the African Development Bank. In return, Egypt has introduced reforms aimed at foreign exchange rate flexibility, introduced a Value Added Tax (VAT) of 14% to raise revenues, started reforming the inefficient public sector, and eased business-impeding capital controls. Businesses also need easier access to credit and less red tape. Before the COVID-19 outbreak, the macro-economy had responded relatively well, but major drawbacks of the reform are the higher incidence of poverty, at 32 % in 2019, up from 28% in 2015, and the major hit to the middle class and its real income and purchasing power, all of which were worsened by COVID-19, despite efficient and well-targeted fiscal and monetary stimulus.
With Egypt now constitutionally required to spend 3%, 4% and 1% of GDP annually on health care, education and scientific research, respectively, it is essential to sensibly spend the money saved via subsidy reforms. Public schools and universities are inadequate, with many mediocre in quality, so major investments are needed in public education facilities and quality improvement, with moderate tuition fees for efficient cost recovery and cash subsidies to deserving lower-income families, along with competitive and full scholarships to students who demonstrate both high merit and financial need. The health care system is in even worse condition, with modest-income citizens priced out of the exorbitant private hospitals, dependent upon very unreliable public health care, and suffering considerably as a result.
Three mandatory national schemes are recommended: 1) Universal health insurance modeled on Canada’s efficient system, 2) Retirement pensions for all employees, modeled on the USA’s “Social Security”, and 3) Employer-backed unemployment insurance. Health insurance would provide free, state-paid health care for all citizens, and be funded by individual insurance premiums on middle and high-income state and private sector employees, plus taxes on private sector companies, upscale health care providers, and especially tobacco, alcohol and building materials firms. Finally, the state needs to outsource, via Build-Operate-Transfer (BOT) and similar private investor partner schemes, certain, well-selected infrastructure such as power stations, water desalination and treatment plants, and certain, high-cost airports, road highways and bridges. Ultimately, effective subsidy reform and prudent spending can greatly serve Egypt.