Subsidy Reform: Towards a New Economic Trajectory

Ministry of Finance

December 2014

2

Outline

I. Introduction

II. Background

III. The Vision Behind Reform

Subsidy reform: Serving overall economic policy goals

IV. Sustaining the Reform Momentum

Moving from Vicious to Virtuous Cycle

Policy Options

V. Policy Lessons

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I. Introduction

For more than a decade, subsidy reform has been a top priority on the economic agenda of successive

governments. However, moving forward with implementation has usually been fraught with

political risks and fear of popular backlash.

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II. Background

Although the Jan 25 revolution heightened economic risks associated with elevated budget deficit and government debt levels, the accompanying political instability made the decision to adjust energy prices increasingly challenging : Vicious cycle.

Significant decline in economic growth Notable jump in unemployment

9.4 9.0

11.8 12.6 13.2

2008/2009 2009/2010 2010/2011 2011/2012 2012/2013

Unemployment rate (%)

4.7 5.1

1.8 2.2 2.1 2.2

2008/2009 2009/2010 2010/2011 2011/2012 2012/2013 2013/2014

Real GDP Growth rate (%)

Source: Ministry of Planning (MoP) Source: Central Agency for Public Mobilization and Statistics (CAPMAS)

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II. Background

During the three fiscal years leading to June 2014, the budget deficit has been persistently in the low double digit, whereas the total subsidy bill peaked to reach 9.4 percent of GDP, of which more than two thirds were allocated to inefficient oil subsidy

High and growing budget deficit

72 98

134 167

240 255 6.9

8.1

9.8 10.6

13.7 12.8

0

50

100

150

200

250

300

0

2

4

6

8

10

12

14

16

2008/2009 2009/2010 2010/2011 2011/2012 2012/2013 2013/2014

(%)

Overall Fiscal Deficit (EGP Billion, RHS)

Overall Fiscal Deficit(% of GDP, LHS)

94 94 111

135

171 188 179

9.0

7.8 8.1

8.6

9.7

9.4

7.7

0

2

4

6

8

10

12

0

20

40

60

80

100

120

140

160

180

200

08/09 09/10 10/11 11/12 12/13 13/14 14/15Budget

In LE Billion As % of GDP

High and growing subsidy bill

Source: Ministry of Finance (MoF) Source: Ministry of Finance (MoF)

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Meanwhile, Egypt was undergoing a critical transition stage, ending by the adoption and implementation of a well-defined political roadmap.

Milestone Due date Action

• First draft of the constitution prepared by 10-person expert committee

August 2013

• Draft constitution prepared by 50-person expert committee representing all segments of society

December 2013

• Referendum on the constitution January 2014

• Presidential Elections June 2014

• Parliamentary Elections March- April 2015 Still to

come

II. Background

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Finally the return to political stability with the ratification of the new constitution and the election of a new president several factors come together to make the long overdue subsidy reform possible:

A combination of a strong political will, popular consensus about the high cost of subsidy, and a candid political outreach to the public and the business community.

II. Background

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“It is no secret that Egypt is currently undergoing extremely difficult economic ... Conditions …We will not avoid confrontation (of our problems) under any circumstances or over any political compromise. I have undertaken the mission and will accept nothing short of success.

Success however has a price, which we should all have to pay. You, the people have a fundamental role to play; by sensing and rising up to the responsibility.” (President El Sisi- June 30th, 2014)

Source: State Information Service

لن نتهرب من المواجهة .. وإننا لن نفعل كما حدث في الماضي ... التي يمر بها الوطن... ال يخفى عليكم صعوبة األوضاع االقتصادية »إال أن هذا النجاح له ثمن يجب أن نقبل . فلقد قبلت المهمة ولن َأرضى للنجاح بديال بإذن هللا.. تحت ذريعة االعتبارات والمواءمات السياسية

استشعارًا .. دور وطني وفعال للمواطن المصري.. دوِركم أنتم.. مصحوباً بدور أساسي ( الدولة)يتعين أن يكون دور ... جميعــاً سداده 2014يونيو 30الرئيس عبدالفتاح السيسي، -« للمسئولية وارتقاًء إلى مستواها

الهيئة العامة لإلستعالمات: المصدر

II. Background

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On the 4th of July, a decision was taken to increase the prices of a wide range of energy products, with total savings equivalent to one third of the expected subsidy bill of FY 2014/2015.

Oil Price Adjustments (2014/2015) Electricity Price Adjustment Plan (14/15-18/19)

34%

71%

47%

116%

43%

0%

20%

40%

60%

80%

100%

120%

140%

EnergyIntensiveIndustries

OtherIndustries

LowConsumptionHouseholds

HighConsumptionHouseholds

CommercialUse

%C

ha

ng

e i

n P

rice

Electricity Average Price Increase over 5 Years

II. Background

Source: Ministry of Petroleum Source: Ministry of Electricity and Renewable Energy

155%

114%

64%

42%

27%

0% 0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

Diesel NaturalGas

Kerosene Gasoline Fuel Oil LPG

% C

ha

ng

e i

n P

rice

Petroleum Products Average Price Increase leading to savings of LE 46 bn in 14/15 (2% of

GDP)

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III. The Vision Behind Reform

This decision to cut one-third of the energy subsidies at once was a bold step backed by unwavering political commitment and a comprehensive vision determined to put the economy back on track, while also setting the stage to ensure that Egypt’s future growth would be more inclusive

Energy price adjustments are geared towards reducing the budget deficit and helping to achieve fiscal consolidation and recalibrating the budget structure.

Together, they serve the following goals:

Promoting Economic Growth

Restoring Macroeconomic Stability

Enhancing Social Equity

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Reform has been placed within a clear medium term plan. This will create a more visible and stable macroeconomic environment, conducive for both domestic and foreign investment.

Gradually adjusting energy prices will provide the right signals to ensure the optimal allocation of resources and help shift investment decisions to more labor intensive industries.

Subsidy Reform: Serving Overall Economic Policy Goals

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Energy subsidies are well known to be regressive. The new system directly creates more equity, while bringing about important economic, employment and fiscal gains.

Social Spending vs. Subsidies Inequality in Fuel Subsidies

80.1%

59.2%

38.1%

22.3% 19.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Gasoline Natural Gas Electricity LPG Kerosene

Amount of Fuel Subsidies received by the Wealthiest 20% of Society

Expenditure

on Health, 31.6

Expenditure on

Education, 73.1

Electricity Subsidies,

8.6

Petroleum Subsidies,

120.0

0

20

40

60

80

100

120

140

160

180

LE

Bil

lio

n

Expenditure on Energy Subsidies (Electricity and Petroleum Materials) exceeds Expenditure on

Health and Education in FY12/13

Source: Ministry of Finance (MoF) Source: Central Agency for Public Mobilization and Statistics (CAPMAS)

Subsidy Reform: Serving Overall Economic Policy Goals

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Subsidy Reform: Serving Overall Economic Policy Goals

Simultaneously, the government is embarking on a wide-ranging social package.

● Wage Adjustments:

1. Second round of minimum wage increase (to reach 1200 EGP)

2. Increasing salaries for teachers and medical professionals

● Doubling the number of beneficiaries from the Social Solidarity Pensions (from 1.5 million to 3 million)

● Increasing the purchase price of wheat from farmers (EGP 420/bushel)

● Overhaul of ration card subsidies in favor of a better targeted food subsidy scheme

● National Housing Projects:

1. Launch of 1 million low-income housing units to be implemented over five years across various governorates (224 thousand units complete)

2. Launch of 150 thousand middle-income housing units to be implemented over four phases.

In the medium term, a constitutional mandate, will require the expansion of health, education and scientific research expenditure to be increased by 3 – 4 percentage points of GDP.

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III. Sustaining the Reform Momentum: Moving from Vicious to Virtuous Cycle

Fiscal Consolidation

Gradually Building Credibility

Creating Consensus for

Reform

Further Implementation

of the Reform Agenda

Better Macroeconomic

Environment

Enhanced Delivery of social

Services

More Inclusive, Job Creating Growth

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IV. Sustaining the Reform Momentum: Policy Options

a) Medium-term Strategy for Energy Sector Reform

Rolling out the smart card system (envisaged before the end of the fiscal year)

Revisiting the energy mix (Renewable energy, Wind/Solar)

Expanding production (new players: public, private, PPP)

Further price movements to reduce subsidy and rationalize consumption

b) Redirection of Spending to Social Programs

Improving the quality of expenditure on Health/Education/R&D

Expansion of existing cash transfer programs (Takafol and Tadamon Programs)

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14.0

16.0 17.3 17.9 17.6

13.7 12.8

10.4 8.5 6.8

5.9 4.7

9.9 9.3 8.7 7.9

0

5

10

15

20

25

2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19

(%)

Overall Fiscal Deficit Projections (as % of GDP) over the Medium-term

Baseline Scenario Reform Scenario (Excluding H, E and R&D) Reform Scenario

The government has deliberately opted for a gradual, balanced and sustainable path.

IV. Sustaining the Reform Momentum

Source: Ministry of Finance (MoF)

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V. Policy Lessons

There is no optimal time for reform: Social and political costs are inevitable - political will is indispensable.

Reform creates winners and losers. Losers of this reform will have a strong interest to impede it.

Good communication is crucial : Timely, frequent and frank outreach to the public will help dampen resistance and create apt environment for implementation.

A balanced socioeconomic approach is necessary for the sustainability of reform. Initially, the government could start with quick fixes or low hanging fruits. In the medium to long term, it is necessary to embark on more far-reaching and inclusive development programs.