Egypt, like many Arab neighbors, has long relied on subsidies to ward off social instability. The large subsidy regime has become increasingly untenable as Egypt nears insolvency, and this year the government has begun to address several main subsidies to bolster the overall health of the economy. Since the 1920s, Egypt has relied on a complex subsidy system that totaled $29 billion in the 2011-2012 fiscal year and currently accounts for 29.6 percent of government expenditures (around 13 percent of Egypt's gross domestic product). Making foundational changes has proved too difficult for previous governments because poor Egyptians were wary of price hikes, and previous governments favored short-run social stability to maintain power rather than long-term economic stability.
Egypt's energy subsidies also show the influence the business class and the military have on policymaking. The energy subsidies tend to be regressive, since subsidized gasoline and electricity benefit wealthy Egyptians, who often have several cars, TVs and air conditioning units per household, more than they benefit the poor, though the poor still view the subsidies as a lifeline.
The government's current efforts are focused on reducing consumption of bread, gasoline, diesel, natural gas and electricity, as well as stopping domestic smuggling of fuel to areas of the country where shortages are common. Cairo is attempting these preliminary moves toward much larger reforms now because unlike previous permanent governments, the interim government does not need to maintain broad public support since it will step down in June after the May 26-27 elections. Before the election, the interim government may make minor changes to the subsidy system to help enable the future president to continue the reforms, but social stability and increased national security will be essential for a future overhaul of the expensive subsidy regime. This will likely prove difficult for a military-backed government with a vested interest in the current subsidy system. The new government will need time to consolidate power before it can attempt more wide-ranging and politically risky, but economically critical, reforms.
The current subsidy reform scheme will bring some relief to Egypt's unstable financial position, but Cairo will likely remain reliant on external aid. However, displaying a willingness or ability to implement austerity is a positive indicator to the international community, which is uneasy about lending to Cairo. Recent aid from the Gulf states has done little to stabilize Egypt's economy — a feat that would require a dramatic restructuring of state economic assets and the subsidy scheme that has underwritten the foundation of the Egyptian military state for decades. Now, diplomatic sources indicate that the Gulf countries are becoming uneasy about the prospects of an open-ended financial commitment to Egypt, and with a lack of clear options, Cairo has to demonstrate to the broader international community that it is both willing and able to institute economic adjustments.
Previously, former President Mohammed Morsi explored a card system for gasoline and diesel and raised the price of premium fuels and butane canisters, but the inability to adhere to the IMF's strict conditions for subsidy reforms precluded the Morsi government from securing a $4.8 billion IMF loan and millions of dollars in other supplementary loans. Egyptian policymakers also understand the need to attempt changes while their current financial safety net remains in place and during the relative stability while al-Sisi campaigns, rather than risk imposing reforms after the election. While Egypt's reforms may signal some positive signs to Egypt's lenders and international institutions like the IMF, Egypt's social and political framework cannot yet support the kind of sweeping reforms necessary to reduce Egypt's dependence on foreign aid.
Specific Subsidy Reforms
Bread
The government spends about $3.15 billion each year subsidizing bread and is now trying to implement a smart card rationing system to reduce by 20 percent waste in the system caused by excess consumption of bread and the smuggling of flour to the black market. President Anwar Sadat attempted to remove the bread subsidies in 1977 as suggested by the World Bank, but hundreds of thousands of poor Egyptians rioted, and the subsidies have continued to the present day. Many people now profit off the current system by selling subsidized flour to private bakeries that sell bread at prices above the rates set by the government. Others buy subsidized bread and feed it to livestock because it is cheaper than animal feed. To reduce this exploitation, a pilot smart card rationing system began in Port Said on April 20 and, depending on how successfully the government enforces the new system, may be implemented nationwide by July.
Under the new system, state-run bakeries will purchase 100-kilogram (220-pound) bags of flour at the market price of 286 Egyptian pounds per bag, instead of at the subsidized price of 16 Egyptian pounds, eliminating the incentive for flour to be sold on the black market. These bakeries will then make bread and sell it to the government at 0.34 Egyptian pounds (about 5 cents) a loaf. The government will then sell up to 150 loaves of bread a month to citizens for 0.05 Egyptian pounds a loaf — a state-regulated price that has remained unchanged since 1989 and is one-seventh of the actual cost of the bread. Currently, people are able to buy unlimited amounts of bread, which is why waste and overconsumption is common. Officials hope that they will be able to import 10 percent less wheat next season due to reduced exploitation of the bread subsidy. Egypt currently imports 10 million metric tons of wheat per season.
Fuel
Smart cards are also being used to regulate the consumption of fuel because the subsidies have led to some fuel supplies being sold at higher prices on the black market. These cards track the supply and sales of fuel to identify where in the supply line smugglers are siphoning off fuel and how much is actually bought by consumers. This will allow the government to ration fuel, which sells for 1.85 Egyptian pounds per liter (98 cents per gallon) for 92-octane gasoline and 1.1 pounds per liter (61 cents per gallon) for diesel. The price of 92-octane gasoline has remained constant since 2006, except for the imposition of a sales tax in 2008. To better track fuel deliveries, the government has already distributed 2 million smart cards to gasoline stations and tanker trucks to create a database to better understand fuel distribution. Another 4.5 million cards are being distributed to consumers to track where and in what quantities gasoline is bought. Once the government is better able to understand where subsidized fuel is being transported to and consumed, it will likely amend the fuel subsidies, which will push the overall energy subsidy bill to more than $18.5 billion in the 2013-2014 fiscal year. Although the government has not yet announced how it will do this, it is anticipated that a yearly allotment will be assigned to consumers, and consumption over that allotment will be at unsubsidized prices.
Electricity
In addition to bread and fuel cards, Egypt is working to reform its use of electricity ahead of looming shortages this summer. Finance Minister Hany Dimian said in March that energy subsidies would exceed their $19 billion budget by 10-12 percent in 2015 unless reforms are made. Immediate reforms must decrease consumption and waste. Current electricity subsidies have encouraged overconsumption by wealthy consumers. Introducing reforms as the government braces for power shortages is difficult because the government must make a tough decision on whether to favor people or production, i.e., farms and factories, when diverting limited electricity.
To better allocate the supply, the government has said it plans to increase electricity prices for the wealthiest 20 percent of consumers before the presidential elections in May. The government is still in negotiations over how much the price of electricity will increase in total, but it will gradually increase over the next three to five years. Fifteen percent of the savings are scheduled to go to the poor and to social programs. The government also has asked 80,000 mosques that are under the control of the Ministry of Religious Endowments to refrain from using air conditioning except during prayer times until May 15. The ministry pays for the electricity these mosques consume.
Natural Gas
The government has also said it will double the price of natural gas that runs directly from the grid into households and businesses in an attempt to reduce consumption, which is expected to soon outpace domestic natural gas production. This price increase will have a modest effect on the energy subsidy budget because only wealthier households are linked directly to the grid, and most Egyptians rely on butane gas canisters for cooking. Current prices for households are 0.20 Egyptian pounds per cubic meter. This will rise to 0.40 Egyptian pounds per cubic meter for households that consume up to 25 cubic meters a month and 1 Egyptian pound per cubic meter for consumption between 25-50 cubic meters a month. This new, tiered pricing structure is expected to save $114-$143 million a year, depending on consumption levels.
Likely Outcomes
These modest efforts at food and energy subsidy reform are a positive sign for Egypt's economic struggles and are not likely to generate enough public opposition to prevent them from being implemented. However, it will take several years to enact larger reforms that will totally phase out wasteful subsidies and progressively apply only needed ones. Amid high levels of public support and a seemingly unrealistic level of optimism for stability and economic growth, al-Sisi is expected to win the elections in May. If he does, he will have to manage a period of political consolidation in order to have enough power to sustain the reforms.
During this time, al-Sisi will face difficult decisions about whether and how to continue slowly removing the untenable subsidies to increase investor confidence, while confronting the threat of social unrest from the poor over higher prices as well as from the military, which has a vested economic interest in the current subsidy system. Implementing the necessary structural adjustments in the economy will test the limits of al-Sisi's support.
It is critical that these reforms continue, helping Egypt alleviate a roughly $30 billion trade deficit and public debt around 90 percent of gross domestic product, and working to foster future economic stability for a growing population of 85 million people. Without favorable portfolio investment (which collapsed after the 2011 revolution), loans from benefactor countries or a long-term guarantee of financial assistance from the Gulf Cooperation Council, future economic stability will prove difficult because of Egypt's looming insolvency crisis.
If the government does not make gradual, voluntary cuts to the standard of living through subsidy reform, Egypt will eventually be forced to do so as a sharp shock to the economy, which would likely be destabilizing. However, as the most populous country in the Arab world, and with the international significance of the Suez Canal and the shared border with Israel, Egypt can be reasonably assured of enough minimal support from the international community to keep its core political and military institutions intact. Nonetheless, Egypt's attempts at economic reform should be viewed as an admission of the difficulty of its situation, rather than signs of meaningful change and improvement.
