When the long-anticipated IMF agreement is finally signed, will Egypt really be hit with a huge surge in inflation? It doesn’t have to be so.
Already inflation is sizzling. In August it reached a seven-year high of 15.5 per cent before falling back to 14.1 per cent last month, still an extraordinarily high number. The fear is that the measures the government is putting into place before it requests a US$12 billion loan from the IMF make even higher inflation inevitable.
The prime minister was quoted this week as saying the IMF deal could be signed by the end of the year.
Among the new measures are the three additional percentage points that the valued-added tax, put into law last month, will add to the tax bill for much of the economy. In the plan the government submitted to the IMF earlier this year, the price of fuel will also be increased to reduce Egypt’s enormous spending on subsidies. Not only will this push up the price of petrol and diesel, the argument goes, it will also trigger a series of other price increases as truckers and tractor, bus and taxi drivers pass on the additional cost to their customers.
Yet another planned measure is a major devaluation of the currency. The argument here is that this will make imports more expensive and these costs will also be passed on to consumers. Add to this recent increases in water and electricity bills.
It is important to differentiate between inflation, which is a general increase in prices throughout the economy, and a relative increase in the prices of some commodities.
A devaluation will affect only those imports such as poultry, meat, fish, wheat, corn, edible oil, milk, beans, lentils, tea and butter that are on the central bank’s priority list and are bought at the official price of 8.88 pounds to the US dollar.
Almost everything else must be bought at the black market rate of about 16 pounds to the dollar, assuming importers even know which back alleys to look in to find these dollars. The prices of these items may actually go down if a devaluation increases the amount of foreign currency on offer.
The problem, of course, is in the transition period. If everyone raises their prices in the expectation that inflation will soar, a good chunk of the country’s products may well go unsold, leading to a nasty economic slowdown that would continue until prices cool.
This may be why the government has asked companies to keep their prices down and to limit profit margins on commodity sales to 5 per cent: it wants to limit price increases during the adjustment period to head off any slowdown as much as possible.
This leads to the question: will the government be able to keep money supply under control once an IMF deal is signed?
The problem is the huge deficit, which has forced it to borrow directly from the central bank, or, in other words, essentially to print money.
According to preliminary finance ministry figures, the government spent 110 billion pounds (Dh45.5bn) at current rates in July and August but collected only a measly 46bn pounds in revenue. The rest had to be either borrowed or created. There are not that many places where Egypt can turn to these days for loans.
In the year to August, Egypt’s M2 money supply rose by 18 per cent to 2.15 trillion pounds. This means that an additional 333bn pounds are sloshing around the economy looking for goods and services to buy. And not many more goods and services were created during that year: the IMF estimates Egypt’s economy grew by 3.8 per cent in the year to end-June. The result is inflation.
Presumably, the government will be able to use some of the billions it will receive under the IMF deal to plug the deficit without resorting to money creation. If the IMF seal of approval restores confidence in the country’s finances, new lenders from abroad may also be willing to buy Egyptian T-bills, helping to plug the gap.
There will most probably be a bump in inflation, but as the budget deficit decreases over time, inflation will also decline. In its October World Economic Outlook, the IMF projected that Egypt’s inflation rate next year will rise to 18.1 per cent, or 2.6 percentage points above its peak in August. With a bit of clever management, the government should be able to keep inflation even lower than that.
Patrick Werr has worked as a financial writer in Egypt for 26 years
business@thenational.ae
Follow The National's Business section on Twitter
