Page 1 of 2

IN THE SPRING OF 2002, THEN-LAWMAKER Mohamed Morsi took a visiting journalist on a tour of the university in his home district in the Nile Delta. Morsi was a professor of engineering there, and he lamented the widening gulf between the demands of Egypt’s youth and the economy’s ability to meet them. “When these students graduate,” he asked, gesturing to the young people around him, “where will they go? We have 200,000 graduates in the market, and there are no jobs.”

A decade later that number has risen to 750,000 and Morsi, now Egypt’s president, has done little to salve his country’s ailing economy. Instead, the veteran Muslim Brotherhood leader has polarized the nation by indulging his Islamist base while antagonizing secularists and liberals. He has aggrandized power at the expense of a dissolved Parliament and signaled ambitions to control the judiciary, prompting critics to compare him with Hosni Mubarak, the dictator toppled by a revolution two years ago. Morsi has also sowed confusion with ad hoc policy prescriptions and cabinet appointments, which analysts say have complicated talks with the International Monetary Fund for a $4.8 billion bailout package. While the two sides haggle, the country’s foreign exchange reserves have slipped to critical levels and the Egyptian pound has declined, to 6.51 to the dollar.

Discontent erupted in a wave of protests late last month, on the second anniversary of the revolution, that left dozens dead and prompted Morsi to declare a state of emergency in the provinces of Port Said, Ismaïlia and Suez, which straddle the Suez Canal.

“People of talent do not want to serve in this government,” says Angus Blair, president of Signet Institute, a Cairo think tank. “They see many negative factors and few positive ones. A lot of wealthy people have taken money offshore, and they’re worried about the fact that the government does not have a viable economic plan.”

The IMF expects Egypt’s economy to grow by 3 percent this year, up from 1.5 percent in 2012 but far short of the pace needed to reduce a 13 percent unemployment rate. More than three quarters of the jobless are between the ages of 15 and 29. In December, Standard & Poor’s cut the country’s long-term debt rating to B– from B and cautioned that another downgrade was possible without a comprehensive and compelling economic reform effort by Cairo.

Not all the news is bad. Qatar, like other Sunni Gulf monarchies an ally of Egypt’s Brotherhood-dominated government, has pledged a $5 billion lifeline to the country, money that may be tempting Morsi to believe Egypt can do without the assistance of the IMF — and its accompanying policy conditions. Qatar National Bank has agreed to buy a majority stake in the Egyptian unit of Société Générale for nearly $2 billion. Fitch Ratings, meanwhile, has praised the central bank’s new exchange-rate-setting regime for its transparency. The government recently announced a set of austerity measures that it contends will cut the budget deficit by nearly 15 percent.

Egypt is also blessed with a fertile underground economy. Recent government policies, however, suggest that an abundance of liquidity should not be taken for granted. In December the central bank imposed a $10,000 ceiling on foreign currency transactions while tightening restrictions on lenders’ long dollar positions to 1 percent of their capital bases, down from 10 percent. Inflation, always high in a country with badly neglected infrastructure and supply bottlenecks, is hovering around 7 percent and expected to enter double-digit territory this year given sustained political uncertainty and chronic food and fuel shortages. In December the government warned that its subsidies bill, which amounts to nearly 10 percent of gross domestic product, would increase by 10 billion pounds ($1.6 billion) in the fiscal year ending June 30 as a result of the currency’s sagging value and fluctuations in commodity prices.

Egypt’s liberal elites have failed to cohere into an effective opposition to offer solutions to the country’s economic woes. That leaves Morsi and his Islamist allies with a virtual hegemony over domestic politics, but so far they have failed to use their clout to revive the economy.

“I’m surprised by Morsi’s lack of competence and statesmanship, the inability to appear more than the guy from the movement,” says Issandr el-Amrani, a Cairo-based journalist, commentator and consultant. “The impression is that one hand doesn’t know what the other is doing and that even if he has a policy he may not be able to execute it.”

At times the Morsi administration appears to be splitting at the seams under the weight of its challenges. In November massive political demonstrations erupted after Morsi — Egypt’s first freely elected president, though with only 51 percent of the vote — issued a decree granting himself emergency powers. Since then more than a dozen prominent government officials have resigned, none of them Brotherhood members.

A new constitution, written by a committee dominated by the Brotherhood and passed in a December referendum, has been condemned as illiberal by opposition leaders. Earlier that month Morsi slammed the door on a pledge to raise taxes in return for an IMF rescue plan, straining relations with the Fund.

In December state television announced that Egypt’s central bank governor was stepping down, only to deny the report a few hours later. The episode coincided with the resignation of the country’s vice president and prompted speculation that the news was leaked to focus Morsi’s attention on the economy.

While the government stumbles, Egypt burns. Absent a clear vision for the economy and the political will to impose it, say analysts, the country’s budget deficit could balloon to some 15 percent of GDP in the current fiscal year, well above the official 9 percent target. The burden of an already onerous public sector will deepen thanks to a 10 percent increase in civil-servant compensation, which Mubarak decreed at the 11th hour in a desperate bid to remain in power. Add to that the pound’s relentless depreciation, which has increased the cost of a vast array of government subsidies on food, fuel and other basic goods.

In a January cabinet reshuffle, the president appointed senior Muslim Brotherhood members to three key posts, a move interpreted as a gesture to Egypt’s ultraorthodox Salafi parties, which have emerged as both tactical allies and political rivals to the more moderate Brotherhood. He also named as his Finance minister Al-Morsi al-Sayyed Hegazy, an obscure economist and expert on Islamic banking. Analysts say Hegazy, who holds a Ph.D. from the University of Connecticut, was tapped to transform Egypt’s capital markets into a fountainhead of sukuk, or shari’a-compliant debt products. Such issues are a growth market worth competing for: Last year sales of sukuk in the Middle East quadrupled in value, to $18.5 billion, or about half the global total for such instruments.

Islamic banking has assumed totemic significance under the Morsi regime. The president and his advisers, nearly all of whom hail from the Brotherhood, have aggressively promoted interest-free debt as a means of financing everything from the redevelopment of Egypt’s aging infrastructure to an ambitious land reform program. Nonetheless, a proposed law that would help Cairo transform itself into a shari’a-compliant investment hub has been blocked by Al-Azhar University, not on spiritual grounds but on nationalist ones: Al-Azhar scholars, who routinely render decrees on the doctrinal fidelity of draft laws, object to a provision that would allow foreigners a share of revenue from projects in which they are invested.

Critics of the government’s shari’a-centrism assert that there is no guarantee Gulf investors would be any more willing to ignore Egypt’s downside risks than Westerners are. Instead, they urge the government to develop dollar-based credit markets for the sake of greater liquidity and lower prices. “If we want to defend our currency, we need to borrow from outside the region,” says one Egyptian financial specialist, who requested anonymity. “Why borrow in local currency at a cost of 700 to 800 basis points when you could borrow dollars over a period of ten years? This is an important discussion we’re not having.”

The departure of Mumtaz al-Saeed, Hegazy’s predecessor as Finance minister and a key negotiator in the IMF talks, may further estrange both sides in what has been a slow and jerky process. Al-Saeed, a ministry veteran who was lured out of retirement to join the Morsi government, had hammered out the main elements of an assistance package with Fund officials last fall, but the two sides postponed a formal agreement because of the street violence triggered by news of Morsi’s emergency powers. A key plank of the proposed IMF package was an increase in taxes on cigarettes, alcohol, food, fuel and other consumer goods, which the Fund and many Egyptian economists regard as crucial for reducing the deficit.

Talks between the ministry and the IMF broke down in December after the president, responding to intense grassroots resistance — much of it led by Brotherhood leaders — reversed his commitment to the proposed tax hike just hours after it was announced. Stunned by Morsi’s reversal, IMF officials insisted on a new reform blueprint. Fund officials have complained that the government’s figures “just don’t add up,” says one analyst close to the negotiations.

Adding to the confusion, the analyst says, was that the Egyptian Tax Authority was never informed that a sales tax was forthcoming. “The government is in an absolute mess,” he says. “The IMF is both frustrated and annoyed.”

Business owners, meanwhile, seem convinced that Morsi will ultimately concede to a tax increase under IMF pressure — his reversal was verbal, they point out, not by decree. As a result, many have moved preemptively to protect their margins. Vodafone Group’s Egyptian unit raised the price of its prepaid phone cards by 15 percent, encouraging some retailers to follow suit.

A signed agreement may now have to wait until after upcoming elections that would restore Egypt’s lower house of Parliament, a delay that would be as politically expedient for Morsi and the Brotherhood as was the removal of al-Saeed. Not only did the minister’s departure distance Morsi from a reviled policy, it created an opportunity to bring in Hegazy, whose Islamic-banking credentials appeal to orthodox Muslim voters.

“They’re appeasing the electorate rather than being serious about reform,” says Mustansir Barma, head of economic research at the American Chamber of Commerce in Egypt. “The problem is that populist demands don’t sit well with the country’s economic reality.”

In response to a series of written questions from Institutional Investor, Masood Ahmed, who directs the IMF’s department for the Middle East and Central Asia, says the Egyptian government requested a delay in the negotiations while it grapples with the country’s uncertain political outlook and “deteriorated” economic circumstances. The Fund, Ahmed writes, is eager to work with Cairo on a rescue package that is “homegrown, addresses Egypt’s fiscal and external deficits, and helps restart growth, while protecting the most vulnerable.” A judicious plan would, among other things, eliminate or reform wasteful programs such as energy subsidies while raising revenue by “increasing moderately the progressivity of income taxation” and establishing a broad-based value-added tax, he says.

The IMF must be satisfied that Egyptian authorities “fully stand behind their policy program and have the capacity to implement it,” Ahmed says.

It is uncertain how, given the Islamist proscription against interest charges, the fundamentalist orientation of Morsi’s administration might be reconciled with the conditions IMF officials may attach to a rescue package. Nor is it clear that the Egyptian economy can wait for the elections, tentatively scheduled for April. Since negotiations for a bailout fund were suspended, the pound has lost 7 percent of its value against the dollar, compounding inflationary pressure and fanning concerns of a downward spiral of the currency. Interest rates on Egyptian sovereign debt, which over the past two years had eased to about 13 percent from the 17 percent level investors were demanding during the twilight of the Mubarak era, are once again creeping upward.

“The only hope is a deal with the IMF,” says Magda Kandil, executive director of the Egyptian Center for Economic Studies and a former IMF adviser. “That’s why a gradual approach on some of these reforms may be necessary. The sales tax could be agreed to but delayed, for example. The same with the removal of subsidies. Some compromise is needed.”

The twin specters of sustained political uncertainty and economic stagnation are fanning fears of an exodus of Egypt’s affluent and enterprising elites — secularists and liberals in general and Coptic Christians in particular — who feel disenfranchised and vulnerable in an age of Islamization. Recently, a Coptic community center in the resort city of Fayoum was torched, an all-too-common occurrence that residents say law enforcement officials have done little to investigate, let alone prevent. And Morsi did not help reassure anxious Copts when he dispatched his prime minister to attend the enthronement in November of their new pope, Tawadros II, rather than appear at the event himself.

The Copts, should they flee, would be the last of Egypt’s non-Muslim constituencies to abandon the country to what appears to be an increasingly parochial fate. Until the postwar era, when strongman Gamal Abdel Nasser nationalized the economy and segregated Egypt from foreign influence, the country’s economic and political culture was influenced by Jews and Christians from Europe — Armenians, French, Greeks, Italians, Maltese — as well as Arabs, Iranians and Turks from the Muslim world.

“The golden era of Egyptian cosmopolitanism is long gone,” says journalist el-Amrani. “But what some people fear today is that what happened under Nasser is happening again. Can Egypt, which relies on tourism and imports much of its agriculture and fuel, really afford to isolate itself?”

The clock is ticking. Though Egypt has managed to elude a political as well as an economic collapse, the combination of rising inflation and sustained joblessness could provoke a reckoning in the revolution’s third year. Over the next several weeks, the country needs to repay more than $1 billion in external debt obligations, nearly half of which come due by the end of February. Its foreign exchange reserves have been diminished to about $15 billion, or three months’ worth of exports, down from $36 billion in late 2010. Annual direct foreign investment, nearly $13 billion at its peak several years ago, has dwindled to a fraction of that. Egyptian hotels reported that the November protests against Morsi’s expanded authority caused cancellations to soar as high as 70 percent of their bookings for the crucial year-end holiday period, hitting hard currency earnings at a time when the economy needed them most.

“Confidence continues to get hit on a regular basis since key problems are not being tackled and the government is not offering hope for change,” says Signet Institute’s Blair. “The probability of a major crisis as opposed to a minor one has risen.”

Single Page    1 | 2