From the August 2013 issue of Research Magazine • Subscribe!

Egypt’s Economy Is Driving Its Politics

Turmoil in Egypt has deep economic roots

Photo: Getty Images Photo: Getty Images

[EDITOR’S NOTE: The following column was written several weeks ago, before the situation in Egypt became marred in violence. Alexei Beyer has added an introduction to give the piece more context, given the seriousness of the current situation there.]

Egypt's military, which in early July suspended the Islamist-backed constitution and removed president Mohamed Morsi from office, had no desire to govern Egypt - just to control where the country is headed. So far it hasn't worked out the way it planned. A workable government has not been established and the country is facing the prospect of full-scale rebellion by the Muslim Brotherhood.

The next several weeks will be crucial not just for Egypt but for the entire Middle East. The Arab Spring, which raised hopes of democratization and openness in the Arab World two and a half years ago, is turning into a relentless slide toward civil war, sectarian strife, radicalization and chaos. Egypt is the most populous Arab country, with a strong military and pivotal strategic position. It has been an ally of the United States and the first Arab country to make peace with Israel. It is the linchpin of an increasingly troubled region; if the situation there deteriorates, the Middle East will likely face years of worsening turmoil. 

Shooting protesters and fighting street battles with the Muslim Brotherhood may not be the best way to reestablish social peace. The longer bloodshed continues, the greater will be the damage to Egypt's economy and investor confidence and, since poor economic performance has been at the root of popular discontent, the less chance there will be that the country will return to normalcy. 

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The Cairo stock ­market greeted the anti-government protests that began in late June and resulted in the ouster of the Muslim Brotherhood administration of President Mohammed Morsi with considerable enthusiasm. The EGX 30 index gained over 15% in just two weeks, rocketing 7% on July 4, the day after the Egyptian military stepped in to put an end to the stalemate between the government and protesters. While the danger of political turmoil endures, investors are willing to take a risk on the country’s future and Egyptian shares are remarkably cheap, especially in U.S. dollar terms.

As much as millions of Egyptians disliked living under the authoritarian rule of President Hosni Mubarak, it was the state of the economy that drove much of the popular discontent two years ago.

The economy nose-dived after the 2008 global financial crisis and had recovered only partially by 2011. Unemployment was running close to 10% overall, but the young people descended onto Tahrir Square in Cairo to protest faced even worse economic prospects. Many were educated and technically savvy, differing little from their counterparts in the West, but the sclerotic Egyptian economy simply couldn’t provide enough jobs. The youth unemployment rate stood at over 25%, and life prospects for the 58% of Egyptians who are under 25 years of age were not promising.

Bad to Worse

But since Mubarak was forced out, the economic situation has only become worse. The Islamist government was characterized by mismanagement. Unemployment has rocketed, surpassing 13% at last count. The situation for young people deteriorated further.

The Egyptian pound, which has been weakening since mid-2010, dropped sharply with the advent of the Morsi administration a year ago, losing more than 10% of its value since the start of 2013. Inflation, which was under control prior to the Arab Spring, measuring around 3%, took off. More recently, consumer prices have been rising at a double-digit rate, raising the specter of an inflationary spiral.

The weak Morsi government didn’t dare to boost taxes on its impoverished population, nor could it reduce costly fuel subsidies. Investors and tourists feared political instability. With the economy in shambles and no policy in place to tackle economic woes, it was no surprise that protests against the Islamist government intensified and that the decision by the Egyptian military to remove it enjoyed such strong support across the political and religious spectrum.

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.

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