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Abu Dhabi, UAEMonday 17 December 2018

Austerity bites hard in Egypt – but still it's progress 

For all of those out there wailing and beating their breasts over the allegedly disastrous austerity measures that Egypt took in November to get an IMF loan, can we remind ourselves of the state of the country just a year ago?

Would we really want to go back to the economy was then?

In the past few weeks, Egypt made a new round of spending cuts and tax increases on the top of the measures taken in November, when it let the Egyptian pound fall by more than half against the US dollar, raised fuel prices and added three percentage points to the value-added tax (VAT).

This past month felt almost as painful.

The government increased fuel prices, including a 43 per cent rise in the price of 92 octane and 55 per cent in that of 80 octane, the two most popular grades. It then hiked VAT by another 1 percentage point, bringing it to 14 per cent, and raised the price of electricity by around 42 per cent for household consumers.

To add insult to injury, the central bank raised overnight interest rates by two percentage points in May and another two points this month, triggering complaints that this would lead to more inflation, which was already running at about 30 per cent. (Increasing interest rates actually reduces inflation, but that is another story.)

Long-suffering Egyptians on the street have been screaming blue murder.

A main argument against the IMF reforms has been that by letting the pound plummet, Egyptians now have to pay much more for imports, something that causes great hardship to the poor. Part one of the formula is that a strong currency is great because people can buy dollars cheaply. But there are two sides to the formula, and a good part of the population wants to ignore part two: people with dollars do not want to buy pounds if the currency is overvalued.

A year ago, the lack of dollars was paralysing the economy. Let us take a walk back to the summer of 2016.

In July 2016, supplies of state-subsidised baby milk formula were running short, aggravated in part by the government's lack of dollars to import it. Mothers were forced to stand in queues, occasionally breaking down in tears.

By October, sugar became a problem as well. Supermarkets and shops ran out, long queues began forming outside government cooperatives, and prices doubled over a few weeks. This was also due to the currency shortage. Rather than devalue the pound, the central bank had sent a large, cumbersome bureaucracy in to decide what kind of goods could be imported and how to allocate its ever decreasing supply of foreign currency. But somehow it forgot to add sugar to the list of priorities, and private traders were not able to get dollars to import.

And there was also a rice shortage.

Oil and gas were also a problem: the government was unable to pay money it owned to international oil companies, which caused them to suspend their exploration and development of new gasfields.

Currency controls had all but brought trade to a halt. Exports had slowed to a crawl because traders would not buy Egyptian goods as the artificially high pound made them too expensive. Imports dropped because importers were unable to get dollars. Investment dropped because no one wanted to put their money in the Egyptian pound when everyone knew a devaluation was inevitable. Wealthy Egyptians were finding increasingly ingenious ways to smuggle their cash out of the country.

In August 2016, the government approved a law imposing prison sentences of three to 10 years and fines of up to 5 million Egyptian pounds (Dh1m) for trading foreign currency outside the official exchange rate, even though the central bank did not have enough foreign currency to meet local demand. The government had already closed down dozens of exchange bureaus, which a year later have still not been allowed to reopen. The more the government cracked down on the black market, the weaker the Egyptian pound became.

Officials were flying around the world to convince anyone with the means to give or lend it foreign currency to help it delay the inevitable devaluation. Saudi Arabia, the UAE, Kuwait, China, Japan, South Korea. Anyone who might listen. The "Sheherzad" economic policy, one Egyptian financier noted wryly in a reference to the legendary queen in the One Thousand and One Nights collection of Arabic tales who must tell an exciting new story each night to avoid being put to death by the king.

The problem was that with the collapse in the price of oil the Arabian Gulf oil states had been squeezed and were no longer in the mood to send cash.

In the meantime, Egypt's budget deficit was widening, and interest payments on its borrowing were taking up an ever greater portion of spending. The deficit for the financial year that ended June 30, 2016, was a staggering 12.2 per cent of GDP. The government had long before resorted to printing money to finance the deficit, which in turn caused inflation to surge and the currency to weaken ever further.

Egypt's economic situation a year ago was absolutely dismal and getting worse by the day. No government goes to the IMF out of desire. It is an embarrassing and politically disruptive step to take.

But if it had not done so, Egypt's economy by now would truly have been a disaster.