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Egypt´s Brewing Crisis: Subsidies (WSJ) WALL STREET JOURNAL) By MATT BRADLEY CAIRO, EGYPT 03/23/12)Source: http://online.wsj.com/article/SB10001424052970204059804577228984285910816.html WALL STREET JOURNAL WALL STREET JOURNAL Articles-Index-TopPublishers-Index-Top
Cairo Faces Public Wrath if It Reforms Bloated and Corrupt System, but Alternative Is a Budget Morass

CAIRO—Egypt´s interim government has just months to tear apart the country´s bloated subsidy system before the nation faces a budget crisis, economists and government officials say.

Pressure to address the issue mounted Thursday, when an International Monetary Fund representative left Cairo with few signs that politicians are nearing a deal for a much-needed $3.2 billion loan. Delays could deepen Egypt´s troubles: The country´s subsidy system will cost substantially more if IMF-backed reforms aren´t made before a widely anticipated fall in the value of Egypt´s currency.

Egypt´s generous subsidies on food and fuel are widely seen as unsustainable.

The interim government, grappling with a hollowed-out economy following last year´s revolution, has propped up the Egyptian pound by purchasing the currency in the market. Those operations have drawn down the country´s once-robust stock of foreign reserves—which the government also uses to buy the imported fuel and wheat it offers its population on the cheap.

Economists believe Egypt will have no choice than to abandon its support of the pound, making devaluation imminent. A weaker pound will lead to higher prices for imported food and fuel, further burdening Egypt´s tight budget and raising fears that the government could be forced to abruptly drop subsidies on which tens of millions of Egyptians rely.

Subsidies already absorb at least 28% of Egypt´s budget outlay of 476 billion Egyptian pounds ($79 billion). About two-thirds of that goes toward fuel and energy, with the rest aimed at reducing food prices, particularly for wheat.

Politicians here have for decades lacked the political will to cut the subsidies, which critics say have also created corruption and waste. But the programs now appear to be a time bomb for an administration without the political capital to carry it out. That leaves the interim government facing a dilemma: It can reform the subsidies regime and face public wrath, or have a budget disaster.

The country´s interim military leadership hasn´t commented on the subsidy regime, leaving public statements to the civilian government it appointed. Officials, speaking anonymously, acknowledge that the subsidy system is rife with inefficiency and offers an open window for graft.

"There is wide social agreement on removing and reforming subsides," said a high-level policy maker in the Egyptian government. "Nobody has been brave enough to take this decision."

Secretary of State Hillary Clinton on Friday plans to waive congressional democracy-promotion conditions to allow the release of up to $1.5 billion in aid to Egypt, a senior State Department official said, despite concerns the country is backsliding on commitments it made to democratic governance. These funds won´t have an impact on subsidies since they can only be used to pay U.S. defense and security companies for contracts with Egyptian military.

Elected politicians have yet to fully embrace the IMF´s overtures to extend a $3.2 billion loan that Egypt´s military rulers rejected in July. IMF representatives are expected to reconsider the country´s loan application at the end of March. Before that, Egypt´s finance ministry is due to release an economic strategy to which it says subsidy reductions will be central.

Egyptian financial officials hope that IMF assent to the loan will entice foreign investors and inspire Arab Gulf states to pitch in with billions of dollars worth of aid promises that were never fulfilled.

But the loan´s prospects were dealt a further blow Thursday. The Muslim Brotherhood´s Freedom and Justice Party, which enjoys a nearly 50% plurality in Egypt´s lower house of Parliament, is opposed to the loan because the government hasn´t adequately explored other means of raising money domestically, said Brotherhood spokesman Mahmoud Ghazlan. This week, other Brotherhood leaders had said the group is open to the loan.

Egypt is the largest per capita wheat consumer and largest wheat importer in the world, relying on foreign supplies for about 60% of domestic consumption. Much of that wheat goes toward an Egyptian dietary staple, a round pita bread called aish, or "life." For the 40% of Egyptians who live on less than $2 a day, subsidies provide a cushion.

While a sliding pound would significantly raise the cost of feeding this nation of more than 80 million people, reformers consider bread prices largely untouchable. When then-President Anwar Sadat attempted to lift the subsidies in 1977, the country descended into nationwide riots.

Egypt also imports about 14 million tons, or about 40%, of its petroleum and fuel products each year. Already, prices are rising: Public expenditure on energy is likely to increase by 25% to 120 billion Egyptian pounds during the next fiscal year thanks to a global rise in energy prices, Egypt´s Minister of Petroleum said recently.

Egypt´s blanket fuel subsidies ostensibly allow all Egyptians to purchase butane, a cooking gas, for about EGP2.8, just under 50 cents, compared with an international price of nearly $13 for a 12.5- kilogram cylinder. In reality, most Egyptians pay about $5 for an underfilled cylinder of about 10 kilograms. Fuel importers blame the markups on multiple layers of middlemen and corrupt side-sales.

This week, the government blamed "leakage"—a euphemism for smuggling the subsidized gasoline out of the country, where can be sold at a markup—for fuel shortages that have recently caused motorists to line up at gas stations throughout the country.

Economists say the prime beneficiaries of across-the-board energy subsidies are wealthy Egyptians, who pay the same rock-bottom prices for gasoline, cooking fuel and electricity as do the country´s poor, but who each consume much more in their cars and homes.

Economic policy makers´ calls to cut such spending have gained urgency. Instability sparked by last year´s uprising against then- President Hosni Mubarak has sent foreign investors and tourists scurrying. Egypt´s industrial production has plummeted.

Economic growth for the 2011-12 fiscal year, which runs through June, is expected to be 1%, according to Capital Economics, a London-based research firm. That marks a significant decrease from about 5.1% in 2009-10, according to the Ministry of Finance.Net foreign direct investment in Egypt declined to $440 million during the first quarter of the 2011/2012 fiscal year, compared to $1.6 billion during the same period in 2010/2011.With foreign-currency inflows curtailed, Egypt has spent more than $20 billion of the $36 billion foreign- exchange reserve it held before the revolution began in January 2011. The defense of the pound has aimed to avoid the kind of inflation that could produce more instability after a year of street rioting that has left more than 1,000 people dead.Egypt´s foreign reserves offer little more than three months of import cover, economists say. They say the country´s Central Bank will be compelled to allow the Egyptian pound to weaken within the next several months.

Even the rosiest predictions expect the pound to fall to at least 7 Egyptian pounds to the dollar from its current exchange rate at just above 6 Egyptian pounds.

Though Egyptian finance officials project a budget deficit of about 8.6% of gross domestic product, many economists expect the shortfall to exceed 11% of GDP even before factoring in the higher subsidy costs. A diminished pound could send the local-currency cost of energy subsidies up by as much as 30% to 40%, said Magda Kandil, the executive director of the Cairo-based Egyptian Center for Economic Studies, a liberal-minded think tank.

The government is currently reviewing plans to shift the blanket subsidy system to a direct-payments regime, under which the state gives poor consumers cash handouts to cover for higher prices. Pilot programs for a "smart card" plan, in which poor Egyptians could purchase low-cost fuel and bread with an electronic card, have been operating in Egypt for the past several years. Write to Matt Bradley at matt.bradley@dowjones.com (Copyright © Dow Jones & Company, Inc.) 03/23/12)


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