It's the economy, stupid: Egypt's new 'pharaoh' not fairing so well

Published December 12th, 2012 - 11:13 GMT
The cabinet was neither consulted nor informed about the president’s sudden decision to suspend the new tax law
The cabinet was neither consulted nor informed about the president’s sudden decision to suspend the new tax law

A dramatic U-turn by Egypt’s embattled president Mohammed Mursi over a proposed tax hike has raised serious questions about the decision-making process within the government, casting doubts over the administration’s competence and ability to craft a coherent economic policy. It has also brought into question the fate of a crucial International Monetary Fund (IMF) loan Egypt is awaiting, set to be ratified by the fund’s board next week. 

Experts derided both the government’s unilateral decision to raise taxes at a time of political crisis and the president’s swift retraction of the measures in the face of public uproar. 

Some feared the president’s volte-face indicated a desire to pass the Islamist-penned constitution first and then subsequently institute a tax hike. Others said his quick retraction undermined his leadership and exposed a lack of political maturity. 

Official sources in the prime minister’s office told the independent al-Masry al-Youm newspaper that the cabinet was neither consulted nor informed about the president’s sudden decision to suspend the new tax law, announced only hours earlier. The announcement to suspend the law – less than 24 hours after it was issued - was initially made on the president’s Facebook in a 2 a.m. online post early on Monday that bewildered observers. 

The unnamed source is quoted as saying there was “panic”’ within the government that the cancellation of the tax rises would jeopardize an IMF package, expected to be approved on Dec. 19. The agreement would unlock nearly $5 billion in financing from the fund as well an additional $14.5 billion in external funding attached to it. 

Separately, Ahmed el-Wakil, head of the Federation of Chambers of Commerce, a key industry body, told the newspaper that the group was not consulted by the cabinet ahead of the tax hike and warned that the president’s suspension of the tax increases could lead to the cancellation of the IMF loan. He called on all political parties “to put their political and ideological differences aside and reach a consensus in order to save the country from economic collapse.”

Amr al-Mounir, board member of the Egyptian Tax Association, told Al Arabiya in an interview that despite sending a number of suggestions and recommendations to the government on tax reform, they were not consulted in latest decisions. 

On Sunday, attention was abruptly diverted from the ongoing constitutional crisis to the state of the economy following the surprise announcement of a raft of changes to the tax law. The new measures called for an increase in sales taxes on a range of consumer goods and services as well as higher taxes on income and property. Some of the changes, like an overnight spike in the price of locally produced cigarettes, would hit the millions of low earners most severely. 

After widespread outcry, president Mursi - who is locked in a fierce standoff with opposition forces over the constitution – halted the decision saying that he didn’t want to impose “additional burdens on Egyptian citizens without their choice or consent” and called for a public societal dialogue on the matter. 

The president’s Islamist Freedom and Justice Party had earlier rejected the “surprise” tax raises and called for the measure to be presented to parliament once it was formed next year. 

The president’s spokesperson said in a press conference Monday afternoon that President Mursi has stopped ‘decisions issued by the finance ministry regarding the tax law” to allow for more discussion. He also said the fear of price increases was “unjustified” and that most of the decisions would be implemented in July 2013. Economists expect the bulk of austerity measure to be ‘back-loaded’ with most cuts and tax increases kicking in next year. 

The legality of the president’s retraction remains unclear given that the amendments to the tax law (Law Number 102 of year 2012) were printed in the state newspaper, making them official. 

Analysts also point to a disconnect between the cabinet, led by Prime Minister Hisham Kandil, whose priority is securing the IMF loan, and the presidency, which is staking its credibility on passing an Islamist drafted constitution, set to be put to a referendum vote on Dec. 15, despite opposition to it. 

Absent from this equation is the average Egyptian, who has borne the brunt of the economic stagnation following Egypt’s disastrous transition. Roughly 40 percent of Egyptians live below the poverty line and there is growing discontent with the administration’s progress on the bread and butter issues, many of which led people to revolt against the Mubarak regime.

Economists agree that painful reforms are an unavoidable part of any economic program given the state of Egypt’s finances. But by raising taxes as a stand-alone measure - removed from a comprehensive economic package – the government is taking the “easy option” to reduce its budget deficit - a key requirement to receiving the IMF financing. 

Experts say this reveals a lack of vision and creativity. A tax hike would be better received if presented within a comprehensive package of measures to increase productivity and growth. 

“There would have been less of an outcry if this had been part of a package to boost growth,” Angus Blair of the Cairo based think-tank Signet Institute said. “I’m disappointed that one of the first key acts is to raise taxes. That doesn’t induce growth.” 

Wael Ziada, head of research at investment bank EFG-Hermes, said the latest misstep highlighted the government’s “extremely poor policy communication” with the public. He said the president’s U-turn reflected “the broken channels of communication between the branches of the power.”

Ziada said it was misguided of the government to kick off its economic plan with a tax increase and to attempt to pass such a measure in the midst of the political crisis polarizing the country. 

“It is very difficult with the political congestion and the significant polarization to pass taxes or economic measures of that nature,” he said. The success of tough economic policies depended in large part on the timing of their implementation, he added. 

Successful implementation of the government’s economic plan is a key requirement to secure IMF financing and the latest U-turn highlights the difficulty of winning support for unpopular economic reforms, particularly at a time of deep division. 

Egypt’s trajectory towards IMF approval hinges on implementing key “prior actions”: removal of subsidies on high class 95 octane fuel, which came into effect last month; expansion of the tax base through progressive income taxes, approved in November; and adoption of a more flexible exchange rate for the currency, which, according to the text of the government’s economic plan, the central bank is pursuing, albeit with the added proviso of “avoiding sharp fluctuations in exchange rates.” 

Beyond that, the two main components of the economic plan consist of cutting government spending by reducing subsidies on fuel and electricity (already in progress) and increasing revenue through raising taxes on income, capital gains, goods and services. The latest move was a fulfillment of that aspect of the program. 

In the wake of the political crisis trigged by president Mursi’s Nov. 22 decree, the IMF said that when its board met in Washington on Dec. 19 it would need to ensure that the economic outlook for the country has not changed and, perhaps more pertinently, that the government is capable of successfully implementing its economic reform program. 

The IMF said it will also require assurances from other donors - such as the United States and the European Union - that their share of financing will also be forthcoming. Some members of the European parliament have called for a suspension of economic aid to Egypt following the president’s decree. 

Before the latest backtrack on taxes, economists had cautioned that the recent turmoil could threaten the loan. And while many believe the IMF’s approval is very much a done deal, some say it could still be delayed. 

“Prior to this incident [retracting the tax increases] the probability of delay would have been zero,” Ziada of EFG said. “After this incident, you cannot say the probability is zero.”

The climb down on taxes sent shares on Egypt’s benchmark index down 1.5 percent on Monday, with losses since the constitutional decree exceeding 9 percent. The cost of government borrowing increased at an auction of Treasury bills and the Egyptian pound remained at its lowest level against the U.S. dollar in 8 years. In the 18 days since the constitutional decree, the currency dropped 0.9 percent versus the dollar, a loss almost equal to the 1 percent decline since the beginning of the year.

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