JEDDAH: Addressing capital imbalances will be a crucial matter for any government in Egypt, as public finances will no longer be contained this year after some years of hard work, Credit Agricole said Friday in its analysis on Egypt's "The Point of No Return". The report said any government which comes to power will have to revert to some form of additional short-term subsidies. More importantly, Egypt's budget deficit is bound to increase as the cost of borrowing rises and the government embarks on additional distribution tactics. The report said that for the next three years, Egypt's gross public debt to GDP will remain around 70 percent. However, "we now think this scenario is no longer viable and we expect that public debt will revert to 85 percent this year and 97 percent by 2014." Fiscal policy will be another major challenge for the government. In all likelihood, there will be no rationalization of fuel subsidies and improving tax-evasion mechanisms will not be carried through this year, the report said. Replacing the sales tax by a comprehensive VAT is expected to be postponed and measures to close loopholes in the income tax system will not be addressed this year. Moreover, the proposed property tax will also not be enacted, restraining the revenue options of the state. "We expect that the budget deficit this year could reach 12.3 percent from an estimated 8.2 percent. Infrastructure expenditure by the government to help kick-start the economy, hinted at by the new minister of finance, would place an additional burden on the budget and fiscal consolidation. Banks will be under pressure to finance the budget, but risk - due to private sector output falling due to a decline in investments - will create unavoidable short-term challenges," Credit Agricole said. On current account balance and fiscal balance, the report noted that over the short term, the Egyptian pound (EGP) would fall by 20 percent, which would require the central bank to intervene on several occasions. The main instigator of the fall will be the decline in capital inflows and rise in outflows. The forecast decline is more than the 6 percent the EGP depreciated between September 2008 and March 2009. It subsequently appreciated due to resumed capital inflows. The drawdown in reserves would be a crucial factor in supporting the EGP, but increased political tensions, a run on local banks as well as expected dollarization of some of the deposits will impact the short-term currency outlook. The government will be caught 'between a rock and a hard place' as it could fast exhaust its foreign currency reserves to pre-2002 levels. Moreover, the report said current account risks over the short to medium term as growth is expected to fall amid significant depreciation of the EGP and falling service receipts, tourism and remittances. A small decline in demand-driven imports could offset some of the current account pressures but it will not be enough. FDI, which reached more than $13 billion in 2008 from below $1 billion pre-2004, would be impacted given that investor confidence is expected to fall precipitously. Additional pressure on the EGP could arise due to a possible reintroduction of a parallel market in the US currency, Credit Agricole said. A parallel market rate, which had a premium of 15 percent in late 2003-04, could return as confidence declines and trust in the EGP falls. "This could be a major macroeconomic disturbance to our short- and medium-term scenario. A liquidity crisis is not implausible. We do not expect the Suez Canal to cease operating as the army will safeguard its smooth functioning. Any doubt about safe passage through the Suez Canal would be a significant destabilizing event for Egypt and would open the door to outside military intervention," the report noted. A depreciating currency would lead to higher import costs, especially food imports such as wheat. Global food commodity prices are on the rise and that is likely to translate into additional burdens for the local economy. Inflation will continue to be the "untameable beast" that the government failed to stabilize despite concerted efforts. Food inflation of around 17 percent - which accounts for 44 percent of the inflation basket - is a major issue for the government, citing the 1977 bread riots that broke out in Cairo when the government tried to stop subsidizing it led to the army's intervention. As the government refrained from instituting a cut to the subsidy, food riots broke out yet again in Cairo in 2008 and the army once again played a crucial role in reinstating order, the report added. The government would not be able to combat inflationary pressures effectively as high fiscal deficits would only add fuel to an existing fire. Food inflation will remain a considerable worry as supply shocks could occur in several food categories due to the ensuing crisis. The government will have to address inflation, which remains at elevated levels, Credit Agricole further said. In view of the political and economic conditions currently prevailing, Credit Agricole lowers Egypt's real GDP outlook for 2011 from 5.3 percent to 3.7 percent with additional downside risks lingering in the short term.
