Egypt’s economy has been plagued by high inflation, a budget deficit reaching 11% of GDP, and a severe shortage of foreign currency exacerbated by falling tourism and Suez Canal revenues. Running out of time and options to save the economy, Egypt turned back to its old friend, the IMF, and came to a preliminary agreement for a US$ 21 billion loan package, of which US$ 12 billion will be financed by the IMF. The funding will likely restore confidence in Egypt’s struggling economy, though the path to recovery will be filled with reforms that will impact Egypt’s consumers and operating environment. To unlock funds from the IMF and other lenders, Egypt must commit to measures including devaluation, subsidy cuts, and new taxes. Here are the changes businesses should plan for in the following 12 months:
1.Value-Added Tax (VAT)
Egypt’s parliament just approved a new VAT at a rate of 13% and is aiming to implement the new tax in September 2016. During the 2017/18 fiscal year, the VAT is planned to increase to 14%. The tax will be applied to each stage of the production chain and to the final retail stage. However, some commodities and services will be exempt from the tax, including essential foods, dairy products, medicine, and petroleum products. The VAT will generate a reliable stream of revenue that the government will invest in priority sectors like education, healthcare, and infrastructure.
Businesses can expect consumers to become more price-sensitive following implementation of the VAT, and revenue targets should be adjusted. Businesses should also determine whether their products will be part of the tax exemption list and ensure that local partners’ preparations for the VAT are aligned with their broader pricing strategy and product positioning in the market.
2. Egyptian pound devaluation
Another devaluation of the Egyptian pound is imminent. The Central Bank devalued the pound from 7.83 to 8.88 EGP in March 2016, but this move failed to give confidence to international investors, and the black market value has now reached almost 13 EGP to US$ 1. FSG expects a devaluation to occur in 2016, though it is uncertain whether Egypt will choose gradual devaluation or immediately float the currency. If managed correctly, the devaluation will boost private-sector confidence, stimulate exports, and relieve pressure on foreign exchange reserves.
To plan for devaluation, businesses should align their Egypt teams and HQ on how they plan to utilize existing local currency accounts before devaluation significantly reduces their value in dollar terms, for example, by considering local investments. Additionally, establishing a flexible pricing structure will allow businesses to respond rapidly to currency volatility.
3. Subsidy reform
The government announced plans to end fuel subsidies within the next three years, and intends to increase prices to 65% of their actual cost in the 2016/17 fiscal year. Currently, fuel is sold between 53% and 58% of its actual cost. While there is urgency and political will, Egypt’s poor track record in following through with subsidy reform raises questions as to whether prices will increase by the magnitude the government claims. In 2014, fuel prices were raised by 78%, but were reduced again in 2015/16 due to domestic outrage. This time, however, it is likely the government will raise prices by smaller increments to tread carefully around domestic reaction.
Subsidy reform presents both challenges and opportunities for businesses. In terms of challenges, businesses could see operating costs rise and consumer budgets tighten. In terms of opportunity, cuts in social spending mean the government will reroute fiscal resources toward investment, especially in infrastructure. Businesses should monitor upcoming public projects, and ensure their local partners are equipped with the necessary skills, focus, and support to capture new opportunities over the coming year.
Stay invested for the long term
There is no doubt Egypt will go through many changes in the next 12 months. However, the magnitude of those changes is likely to be limited due to domestic pressures; the path to recovery requires the government’s careful navigation around a population suffering from unemployment and reliance on subsidies. Nonetheless, Egypt’s proposed reforms are a positive step toward recharging Egypt’s lackluster economy. Egypt will remain an attractive market for MNCs due to its favorable demographics, so it is important that businesses determine Egypt’s long-term potential and make the necessary strategic investments today. Aligning internal strategy around a slow timeline for economic recovery will allow MNCs to mitigate the risks of a short-term volatile environment, while capturing long-term opportunity.
This post was written by FSG Analyst, Dalia Naguib