Tuesday 18, September 2018 by Bloomberg

Saudi reforms could cause crisis for Egypt

 

In August, as the Turkish lira crisis set off anxieties of financial turmoil in other developing economies, the Egyptian pound held firm.

That was thanks to painful reforms the government of President Abdel-Fattah El-Sisi began in 2016. Allowing the currency to trade freely, along with a rise in tourism and in remittances from Egyptians working abroad, had helped to stabilise the Egyptian economy, prompting S&P Global Ratings to raise the nation’s credit rating.

Now, Egypt’s reforms face an unexpected challenge from the reform agenda of its most important political and economic allies, Saudi Arabia. The knock-on effect of Crown Prince Mohammed bin Salman’s plan for economic modernisation could force El-Sisi to deepen spending cuts and seek more expensive borrowing. The way out for the president is to make bolder changes, to cut the Egyptian economy loose from the restricting ties to the state, and its all-powerful military.

On 11 September the Saudi Government began to enforce strict labour-market regulations, to boost employment of its own nationals at the expense of foreign workers. The hiring restrictions, part of Prince Mohammed’s Vision 2030 programme, were announced in January, and there has been a steady exodus of foreigners ever since. According to Saudi government statistics, the number of foreigners employed in the kingdom fell from 10,883,335 in the fourth quarter of 2016 to 10,183,104 in the first quarter of 2018.

There is no breakdown of the nationality of foreigners who’ve been forced out of jobs, but it’s fair to guess that Egyptians make up a high proportion. Surveys by the Egyptian Government show that Saudi Arabia is the leading destination for emigration, and by some estimates there are 2.9 million Egyptians in the Kingdom.

The remittances that expat Egyptians send home from the Gulf, especially from Saudi Arabia, are a major source of foreign currency and domestic economic stability. According to 2017 data compiled by the World Bank and Standard Chartered PLC, more than 70 per cent of remittances to Egypt come from members of the Gulf Cooperation Council, and nearly 40 per cent from Saudi Arabia alone.

For now, the remittance flows from Saudi to Egypt are holding firm—they have averaged $2.93 billion a year since 2002. There are two likely reasons: first, Egyptian workers who have lost their jobs are sending home final payments, and second, workers who still have their jobs are sending more money home than usual to support their families through a period of high inflation in Egypt. But as more workers depart from Saudi Arabia, the flows will inevitably slow.

For El-Sisi, this is a double whammy. His government desperately needs money and can ill afford a sharp decline in remittances, and the Egyptian economy, with official unemployment at 10.6 per cent in early 2018, can hardly accommodate the expats coming home. It’s a double-whammy for the returnees, too—they face a scarcity of jobs, and a soaring cost of living.

Egypt’s predicament is a reminder that although regional economic integration in the Middle East has never been particularly strong, which prevents some kinds of contagion, such as currency crises, the national economies of the region are connected in other ways: Poorer states are dependent on wealthier ones for oil and gas subsidies, direct financial support, and for the employment of millions. When the domestic priorities of a wealthy state change, the impact on dependent states can be as damaging as any currency contagion.

For Egypt, the pressures of returning laborers come at an especially inopportune moment. The El-Sisi government has recently reported a gradual increase in employment numbers, from 12 per cent just a year ago. Wages have grown, too. Egypt has made some headway in cutting its budget deficit, mostly with external financial support. In the 2017/18 fiscal year that ended in June, Egypt was able to bridge its deficit and refinancing largely through increased international borrowing, both from multilateral lenders and commercial banks.

But this massive effort covered just over half the year’s budget deficit of 9.8 per cent of GDP. Even without the impact of the new Saudi employment rules, the current fiscal year was going to be tougher: Analysts at HSBC Corp. predict that the Government will need to raise more than $100 billion in additional budget support from international loans, bond issues or local bank loans. Financial support from regional allies like Saudi Arabia will be crucial.

The Egyptian government has been trying to reduce its dependency taking a machete to subsidies on fuel, utilities and public transport. Transportation costs are already up more than 50 per cent over last year. Electricity price increases implemented in July are expected to raise the average power bill per household by more than 25 per cent. Inflation has been holding steady at close to 14 per cent, after steps by the central bank to devalue the pound last year.

Looked at another way, El-Sisi is making many of the tough, unpopular decisions that bin Salman needs to make in order to achieve the goals of his Vision 2030 plan; unlike the crown prince, the Egyptian president cannot soften the blow by increasing government spending and cash support to citizens.

El-Sisi was counting on Egypt’s wealthy Gulf allies to help keep the economy afloat while he slashed away at spending. But he can’t manage the fiscal priorities of his benefactors. If Saudi Arabia gets more serious about its own reforms program—curbing its tendency to hand out largesse, at home and abroad—that will mean still more pain for Egyptians. Already, many of the grand plans by Saudi Arabia and the UAE to invest in new cities, infrastructure, and housing development in Egypt are being scaled down. Saudi development of the Red Sea coast could also mean a threat to Egyptian tourism operations.

If El-Sisi is serious about weaning the economy of its dependence on subsidies, he must act now to end the cycle of borrowing-spending-cutting-borrowing. Thus far, his reforms have been designed mainly to balance the government’s books to the satisfaction of outside lenders. He must aim higher, for genuine liberalization. That would require El-Sisi, a former general, to reduce the unhealthy domination of the economy by state and the military. He must promote the development of an independent private sector capable of creating both unemployment and revenues for the state. It won’t happen in time to absorb the hundreds of thousands of workers now returning from Saudi Arabia, but the goal should be to remove the necessity for so many to leave Egypt at all.

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