Egypt threatened by full-blown economic crisis

CAIRO (Reuters Breakingviews): Egypt finds itself without a government at the worst possible economic time. Amid deadly clashes, and with elections likely to be delayed, its financial situation cannot be ignored and requires immediate action. The pound is under pressure, investors are wary. Social spending is beyond the country’s means. Taking action now could limit the fallout. But without a proper government, the odds this will happen are low.

The economy has huge vulnerabilities. The budget deficit is will reach 10 percent of GDP in 2011. Waning tourism, shrinking foreign direct investment, and the central bank’s costly defence of the pound all have depleted Egypt’s foreign reserves by 40 percent, to $22 billion, this year. Egypt now has only three months worth of imports in liquid reserves and is under increasing pressure to let its currency devalue.

The immediate priority is to go back to the International Monetary Fund and take the $3.2 billion 12-month facility mindlessly turned down in the summer. Even that aid is now looking like a paltry sum compared to the size of the crisis. Egypt has low external debt, but its over reliance on domestic banks has driven T-bill yields up to 14 percent. And 22 percent of total government spending already goes to serving interest payments.

Subsidies -- mostly on cheap fuel -- soak up a further 33 percent of total spending. That is greater than spending on health or education, and benefits the rich disproportionately. Phasing out subsidies would show investors that Egypt is prepared to tackle its deficit and the population that the government is willing to start honouring its “social justice” commitment.

Egypt also needs to reform its taxes. The country currently has no tax on capital gains. Income tax doesn’t amount to more than 20 percent for most top earners -- lower than the global average, according to the Carnegie Middle East Center. Corporate tax is also capped at 20 percent for most companies. Egypt may have many low-tax neighbours but many long-term investors might be willing to pay for their access to a big market.

Subsidy and tax reforms aren’t new ideas in Egypt. But with the economy now seen as broken, the important decisions that can’t wait for a full political transition might be easier to agree.