The fiscal route to a fairer Egypt

Egypt has taken significant steps over the past two years to rebuild political stability and restore confidence in its economic potential. The first two stages of the political roadmap announced in July 2013 – the ratification of a new constitution by referendum in January 2014 and presidential elections in May 2014 – were smoothly and successfully conducted. The final phase to elect a new parliament should be concluded before the end of 2015.

The return to normality that these developments represent after an extended period of political stress and uncertainty has opened up a new chapter of opportunity for the country. Critically, this has given the current government room for manoeuvre to enact the tough structural reforms that have long been recognised as necessary to develop a strong economy – but that no previous government has had the will to see through.

Moving fast

In the space of little over a year since its appointment, the government in which I serve has slashed energy subsidies as a first step in a medium-term plan to eliminate them almost entirely (save for fuel products and electricity targeted to the poorest income segment); begun to liberalise the electricity sector to encourage private sector investment in both conventional and renewable energy; repaid nearly $3bn in arrears to foreign oil and gas companies; overhauled a creaky food subsidy system to vastly improve the quality and choice of commodities provided to the public while substantially reducing leakages and proving targeting mechanisms; introduced amendments to the income tax code to make the tax system more equitable and to improve tax buoyancy; implemented a new progressive property tax system; taken steps to contain the public sector wage bill; resolved nearly 300 investor disputes; begun ambitious mega projects with the participation of private companies; and passed or amended a number of laws (with many more legislative reforms still in the pipeline) to enhance the local investment environment. These examples represent only a handful of examples of what is contained in the government’s ambitious reform agenda.

In my view, that agenda is best summed up as a comprehensive package of policies, programmes and projects intended to achieve multiple and complementary objectives: to correct Egypt’s macroeconomic imbalances; to create an internationally competitive and private sector-led new economic platform; and, most importantly, to ensure that growth is inclusive, generates good jobs and ultimately delivers a better standard of living for our 90 million citizens. Indeed, this government has not shied away from acknowledging that while Egypt won accolades from international observers during its last period of robust growth during the mid-2000s, little was done then to improve the lives of ordinary Egyptians.

Fiscal importance

Getting fiscal policy right is the linchpin for the entire reform programme. It is the first line of defence to tackle our large fiscal deficit and reduce the heavy public debt burden (currently more than 90% of gross domestic product [GDP]). Without a credible fiscal consolidation effort, hard-won confidence in Egypt’s prospects would quickly dissipate.

At the same time, we are utilising fiscal policy as a tool to strike the balance we need between sound and sustainable growth on the one hand and social justice on the other. As I have frequently stated, no economic measure is to be enacted without a corresponding social measure – and vice versa. In practice, this means that any austerity measure must be compensated by a social policy to cushion its impact on the poor and vulnerable, while any social measure will be accompanied by an economic offset to ensure that it is financially sustainable.

In drafting the latest budget, I have emphasised that fiscal policy is being deployed not only for traditional revenue-raising and expenditure-cutting purposes but also to realise broader public aims. Tax policy has therefore been geared to enhance revenue buoyancy as well as to boost the factors of production. For example, the 10% dividends tax introduced in July 2014 should incentivise companies to retain more of their profits and thereby build up capital. Firms will then be better positioned to expand operations while reducing their borrowing needs.

Tax incentives

Likewise, a primary driver behind the amendments to the existing Goods and Services Tax [GST] – beyond raising revenues that will contribute to the medium-term fiscal adjustment – is also to bolster investment incentives. The new regime will create a broader and more equitable tax base by capturing services that are currently not taxed and by unifying the rate of taxation on goods and services. Moreover, there will be a speedy tax-refund mechanism for capital inputs (now taxed at 5% rather than 10% previously) that will improve businesses’ cashflow.

We expect these tax advantages to encourage informal economic actors to join the formal sector, as well as to help small enterprises to become larger and more competitive, and in the process to generate more jobs. We are concurrently preparing a simplified tax regime for small and medium-sized enterprises that combines their sales and income taxes, reducing the bureaucratic hassle factor for them.

Equally important, we are carefully designing the amendments to the GST to mitigate adverse impacts on the poor by maintaining exemptions on the staple goods and services (including public health and education) that they consume. My ministry expects that the impact on inflation stemming from the introduction of the new GST will not exceed 2% to 3% in the worst case, and will be one-off, dissipating after the first year of implementation.

We have expressly drawn other revenue measures with social equity considerations in mind. The property tax – implemented for the first time in 2014 although passed back in 2008 – is one example: 50% of the proceeds of the tax are being redirected toward improving conditions in urban and rural slums.

Spending wisely

On the expenditure side, the energy subsidy reform and the bold measures we have implemented to contain the wage bill relative to GDP are already creating fiscal room for the government to gradually shift spending to productive uses and targeted cash transfers. This began in fiscal year 2014/15, when the budgetary allocation for health and education exceeded energy subsidies for the first time in many years. This was a deliberate policy choice that we had budgeted for well before the sharp decline in global oil prices after October 2014 further reduced the weight of energy subsidies in the budget. We have also launched the 'Takaful' and 'Karama' programmes, which distribute cash directly to designated beneficiaries in Egypt’s poorest districts.

Additional space has been carved out in the current fiscal year budget to allow for an increase in the government’s capital expenditures to E£75bn [$9.58bn], up by 25% over the previous fiscal year. This is a start, although the budgeted amount still falls far short of Egypt’s needs. Given its financial limitations, the government is increasingly turning to public-private partnerships and other vehicles to encourage the private sector to play a bigger role in service delivery and infrastructure investment.

In addition, ongoing reforms to improve competitiveness and fix supply-side bottlenecks (such as resolving the power shortage, improving the food subsidy system, upgrading and building roads, ports and other infrastructure) are expected to boost productivity and dampen inflationary pressures. These measures will protect the people’s living standards, particularly the purchasing power of the poor, who are the most vulnerable to the so-called 'inflation tax'.

Encouraging response

While it is still early days, the Egyptian economy’s initial response to the government’s policy initiatives has been promising. Growth reached 4.7% in the first nine months of fiscal year 2014/15, compared with only 1.6% during the same period in the previous year – and following several years of annual growth hovering at 2%. We project 5% growth during the current fiscal year driven by rising foreign direct investment inflows, the continuing recovery of tourism, various new infrastructure and agricultural reclamation projects, and the start-up of the second phase of the Suez Canal axis development project, which will create a new zone of economic activity encompassing industrial parks, logistical areas, tourist resorts and other projects.

In effect, the various policies, programmes and projects are stretching out the Egyptian economy: making it bigger, more efficient, more vigorous and more productive. The economy’s production frontier is literally being pushed out. Nonetheless, we know that there are still big challenges ahead and risks that continue to face Egypt’s future outlook. Resistance to reforms from vested interests as well as capacity constraints in some instances have caused delay to implementation of selected measures. But the challenges are manageable as long as the government remains focused on the reform track that it has determinedly embarked upon.

Hany Kadry Dimian is Egypt's minister of finance.