from From the Potomac to the Euphrates and Middle East Program

Be Afraid, Very Afraid: Egypt’s Economic Nightmare

April 10, 2014

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It would not be an overstatement to say that over the last decade Egypt has become a slow-rolling train wreck.  The fact that it has picked up steam in the last three years should be even less of a surprise.  Egypt analysts, policymakers, journalists, and legislators have become inured to the country’s increasingly violent politics, authoritarianism, and economic dysfunction. The violence that is now spreading out from the Sinai Peninsula and the force that the state has used to confront it is not likely to bring about a collapse of the Egyptian state, but the economy could.

Egypt is perilously close to becoming insolvent, meaning a default on its debts. As I argue in a recent Council on Foreign Relations Contingency Planning Memorandum, despite Gulf assistance, the combination of the country’s economic needs, the legacies of Cairo’s incoherent economic policies of the past along with their continuation today, the political challenges to economic reform, and the potential for exogenous shocks all make a solvency crisis a significant possibility.  This might sound surprising to the casual observer of Egypt.  The economy was a subject of intense coverage in the months preceding the July 3, 2013 coup, but has receded from view as Saudi Arabia, the United Arab Emirates, and Kuwait stepped in with an initial $12 billion infusion of aid that was followed recently with another $8 billion.  The money from the Gulfies was supposed to stabilize the Egyptian economy, but the numbers do not lie.  The country’s foreign currency reserves—between $16-$17 billion—are close to where they were in late 2012 and the first half of 2013, which means Egypt is hovering just above the critical minimum threshold defined as three months of reserves to purchase critical goods.  A portion of those reserves are not liquid and with a burn rate estimated to be $1.5 billion per month, it is easy to understand why Egypt is one exogenous shock—think Ukraine, which is a major producer of wheat and Egypt is the world’s largest importer of it—or political crisis away from default.  The Saudi, Emirati, and Kuwaiti money has merely kept the Egyptians above water.  The expansionary fiscal policies and stimulus that the Egyptian government is pursuing help in the short-run, but they also produce additional near-term debt.  This is not a good place for Egypt to be with government debt at 89 percent of GDP and overall debt at more than 100 percent of economic output.  Much of this has been financed through domestic borrowing—67 percent of Egyptian bank assets are claims on the government.

Underlying Egypt’s economic mess are incoherent and contradictory policies that are difficult to change given the compelling political rationale for pursuing them.  The rigidity of Egypt’s system of subsidies, for example, is a critical component of the social safety net and an important means of political control.  One of the reasons Hosni Mubarak had a poor track record keeping his promises to the IMF was the fact that he witnessed, from his perch as vice president, the 1977 “Bread Riots” that shook the regime. The presumptive next Egyptian president, Abdel Fattah al Sisi, has spoken of sacrifice, but like his predecessors, he will find that once he is firmly in the chair it will be politically difficult to impose the hardships associated with necessary economic reforms.

The question is: What to do about a potential Egyptian solvency crisis?  Unfortunately, there is not a lot the United States can do until the Egyptians make the hard choices about economic reforms.  Still, Washington can offer the Egyptians loan guarantees, relieve the debt Egypt owes to the United States, encourage the Egyptians to pay down debt with foreign assistance, and establish an international consortium to help the Egyptians deal with its energy infrastructure and resources problem.  Even if the United States, Egypt, and allied countries pursue these policies and initiatives, a solvency crisis remains plausible.  Under those circumstances, Washington would have to support the military both politically and diplomatically given the inability of civilian leaders and ministries to deal with the political and economic fallout from a default.  This is not to suggest that the armed forces is particularly well-equipped in this area, but it is the only state organization that is likely to remain coherent under dire circumstances.  The United States would also have to lead a major international effort to marshal even larger sums of financial aid that Cairo is receiving now to refloat the Egyptian economy.  Resumption of food aid to Egypt would also likely be necessary.

An economic problem the magnitude of a solvency crisis will only intensify the pathologies that Egypt is already experiencing—violence, political tumult, and general uncertainty.  Economic decline would create a debilitating feedback loop of more political instability, violence, and further economic deterioration. It’s a scary scenario that deserves attention and preparedness, but there does not seem to be much urgency to try to address it anywhere.  Gulf money appears to have lulled people into the sense that the Saudis, Emiratis, and Kuwaitis will stave off disaster.  It’s a false sense of security.