Phasing Out Energy Subsidies as Part of Egypt’s Economic Reform Program: Impacts and Policy Implications

By the end of the 2015/16 fiscal year, a long-standing mix of high government deficits, an overvalued exchange rate, a growing current account deficit, and declining gross international reserves had resulted in low economic growth and severe shortages of foreign exchange in Egypt. The fiscal deficit had reached around 12.5 percent of gross domestic product as a result of increasing government spending on subsidies and interest payments combined with lower revenues. The current account deficit reached around 6 percent of GDP in 2015/16 as tourism revenues, foreign direct investment, and remittances had all declined over the previous years. The GDP growth rate had dropped to 2.2 percent in 2012/13. And while GDP growth had recovered to 4.3 percent in 2015/16, this growth rate was still below the average rate of 5.5 percent that prevailed from 2004 to 2010 and was insufficient to reduce poverty and unemployment.

Facing these severe economic challenges, the government of Egypt (GOE) put in place a comprehensive economic reform program to restore macroeconomic stability and promote inclusive growth. The reform program includes the floating of the exchange rate, the phasing out of energy subsidies, and the introduction of a value-added tax (VAT) as its main elements. With the aim of improving the business climate and boosting investors’ confidence, the GOE has also formulated a new investment law to ease the establishment of new companies and encourage more investment. In the same context, the Central Bank of Egypt has eased restrictions on foreign currency transfers to facilitate the repatriation of profits for foreign companies operating in Egypt. To protect the poor and vulnerable from the anticipated (negative) impacts of such a comprehensive reform program, the GOE also expanded its social safety net by reforming and scaling up food subsidies and introducing a cash transfer program. The GOE has moved food subsidies from a ration card to a voucher-based system and increased the food subsidy allocations in 2017/18, increasing the monthly allowance per card from EGP 15 to EGP 21 for about 71 million beneficiaries. In March 2015, the GOE also introduced a cash transfer program, Takaful and Karama, to provide income support to poor families with children, to the elderly poor, and to people with disabilities. While there are signs that the economy is rebounding and Egypt’s economic outlook is becoming more favorable, it is less clear how the reform program has affected households, especially those of the poor. The objective of this chapter is to estimate the impact of the economic reform program on households based on simulations using prereform data, with a specific emphasis on the energy subsidy reform. We focus on the energy subsidy reform for several reasons:

● The energy subsidy reform is an ongoing process that is planned to continue until at least 2020, when domestic energy prices should reach world market levels.70 As such, the findings from the simulations done in this chapter are not only useful for estimating the distributional impacts of the reform steps taken between 2014 and 2017 but may also help decision making regarding the size of the expected impacts that are still to come.

● The devaluation was a one-time shock to the economy, rather than an ongoing policy reform process. As such, while we capture the devaluation as part of our scenarios, we put less emphasis on this issue in our discussion of results.

● We do not specifically examine the impact of VAT, as the shift from the preexisting sales tax to a VAT is more a shift in tax systems rather than a new tax. It is not expected to have large distributions implications. In addition, the absence of detailed data on the new and old tax rates by specific product and their matching to data in the social accounting matrix (SAM) would make it extremely difficult to assess such a shift in an economy-wide framework.

● Finally, we include the impact of scaling up the food subsidies and the introduction of the cash transfer program in our analysis to estimate how those programs may have helped households mitigate the impacts of the energy subsidy reforms, especially poor households.