Egypt’s Economy Is Driving Its Politics

Much at Stake

Egypt is at a crossroads. Being the most populous Arab country, Egypt is also the key to the future of the Middle East, which is currently split between stable, autocratic and extremely rich Gulf monarchies and the crescent of instability that now stretches from Iraq and Syria to Libya. The political climate everywhere in the region is highly volatile. Turkey, a NATO member and a paradigm of stability for nearly a century, has been a cause for concern for its allies for the past few years, despite posting healthy economic growth since the end of the 2008 crisis.

Iran is also far from stable. While many people in the West are concerned about the acquisition of a nuclear weapon by the country's theocratic regime, Vali Nasr, the dean of the Johns Hopkins School of Advanced International Studies, warned in a recent book that Iran may be in danger of becoming a failed state in the near future.

After two years of political uncertainty, Egyptians seem to welcome the stability inherent in military rule. They are also willing to give the new government, which is taking office with the backing of the armed forces, the benefit of the doubt. Interim leaders have already announced a timetable for a new election, to be held in 2014, but the real time pressure may be felt on the economic front: how to stop the rapid deterioration of the economy before the end of the year—or before popular discontent spills over once again.

The first order of business for the new government is to secure enough loans to prevent an outright economic collapse, a prospect the Morsi administration was staring in the face. Hard currency reserves have been depleted, going from $36 billion at the time of Mubarak's ouster to around $13 billion currently. The White House has already dismissed calls in Congress to cut or reduce America's $1.5 billion in annual aid to Egypt. While a comparable sum could be borrowed elsewhere, notably from Gulf States, Egypt must be cautious about adding to its foreign debt pile. External debt increased by one-third over the past year, to over $45 billion.

Debt is expected to measure 80% of GDP at the end of the year, according to Moody's. While the debt burden has already raised fears of an imminent default on Egypt's sovereign debt, the country needs to borrow a lot more money just to support the sagging currency. The new government is hoping to get the $4.8 billion loan from the International Monetary Fund that has been under negotiation during the Morsi administration.

Stemming the decline of the pound is crucial. Egypt imports most of its fuel and 70% of its food, and the drop in the pound since the start of the year has hit consumers extremely hard. Worse, even as the dollar, in which international trade in most commodities is denominated, continues to appreciate in world currency markets, commodity prices are entering a bubble stage, driven by loose monetary policy pursued by major central banks around the world.

Some unpopular measures are unavoidable, such as a sharp reduction in fuel subsidies. During the last fiscal year, which ran through June 30, the decline of the local pound boosted the cost of subsidies, which are consuming some 8% of the country's GDP.

Waiting for Growth

Economic growth has slowed to a crawl, which means that, given Egypt's rapid population increase, per capita GDP is actually slipping. But getting the economy to grow again may be tricky. Tourism is a major chunk of the economy, accounting for some 10% of the country's economic output, and is also the one sector that has spare capacity and can be boosted rapidly. Political instability has reduced the number of tourists over the past two years, and prices of accommodations have fallen—all the more so since the pound has been so cheap. But the obverse of this is that tourism has started to pick up steam since the start of the year. One gauge of the improvement was a 37% jump in the sale of buses in the January-March period.

But tourists watching the political turmoil of the past weeks are likely to think twice before booking Egyptian resorts for this summer's vacation. Moreover, the bulk of visitors to Egypt are coming from Europe, at a time when the eurozone is entering the fourth year of an economic slump. Britain, whose citizens vacationing in Egypt numbered 25,000 during the recent unrest, is not doing much better, and even Russia, another major source of visitors to Egypt, is going through difficult economic times.

Even under the best-case scenario of social peace and political stability, a country of 80 million mostly poor citizens is unlikely to earn enough income by managing hotels and running boats up the Nile. Its economy needs to be diversified and made more dynamic, capable of providing gainful employment not only to its 80 million current citizens but to the 20 million additional inhabitants it will have by 2025. It should be noted, moreover, that Egypt had just 20 million citizens in 1955. Not surprisingly, the Egyptian military, having removed Morsi from power, hastened to appoint a civilian administration and thus avoided assuming responsibility for the country's economic mess.