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A Crisis of Confidence

2:28 PM, Apr 17, 2012 • By DAVID SCHENKER
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From failing European economies to staggering murder rates in Central America, there’s no shortage of crises on the agenda as the International Monetary Fund holds its annual spring meeting in Washington this week. Of all the problems within the IMF’s purview, however, the ongoing economic deterioration in Egypt may be the most acute. Compared to the problems in Europe, the Egyptian economic meltdown is relatively inconsequential, yet the regional implications could be profound. While not specifically on the agenda, the crisis in Egypt may very well overshadow the conference.

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The attention is well warranted. With 83 million people, the Suez Canal, and a peace treaty with Israel, stability in Egypt matters. Recognizing this, the IMF has spent the past year trying to cajole a financially struggling Egypt to accept a $3 billion loan. Despite the best of intentions, though, the loan program is at most a stopgap measure.

The situation in Egypt is increasingly dire. Political uncertainty and an absence of physical security have scared away tourists and investors alike as local capital has taken flight. With unemployment and inflation up, consumer confidence is down and the mood is dour. In March, 88 percent of those polled said they were pessimistic about Egypt’s economic prospects—an astounding increase from 11 percent just a month earlier in February.

News on the macroeconomic front is little better. Since the February 2011 revolution, the state’s foreign reserves have dwindled from $36 billion to less than $15 billion and are falling at a rate of $600 million a month. Cairo has been using its reserves to defend the pound but a continued drop in reserves will result in currency devaluation or hyperinflation, a devastating prospect for a state where more than 40 percent of the population lives on less than $2 a day.

Short on cash and with precious few sources of revenue, Cairo is borrowing from domestic banks at interest rates in excess of 15 percent to help cover its $23 billion budget deficit. It also borrowed $1 billion from the Egyptian military. The military-appointed transitional government has also looking abroad for assistance. Regional donors include Saudi Arabia, which has delivered about a billion dollars, and says it will honor its pledge to donate another $2.75 billion.

As for Western institutional lenders, Egyptian populism and politics have made their money all but untouchable. Shortly after the uprising, the interim Egyptian government gave in to anti-American sentiments—70 percent of Egyptians say they no longer want U.S. assistance—and declined a $3 billion IMF loan. More recently, the FJP declared its opposition to an IMF loan so long as the transitional government remains in power. This has served as an effective veto on IMF action, since the fund requires “broad political support” for its loans.

After the presidential elections this summer and the seating of a new—presumably Islamist—government, the FJP has hinted that it will relent and drop its opposition to the loan. But this alone will not solve the state’s economic woes. Going forward, the key will be to restore domestic and international confidence in the Egyptian economy, no mean feat given the volatile political environment.

Consider the Egyptian stock market, which lost half its value in 2011. In early 2012, the FJP reached a modus vivendi with the military’s ruling Supreme Council of the Armed Forces (SCAF) and stocks rebounded. But rising Islamist-SCAF tensions have reversed this trend. The day after the FJP nominated a presidential candidate the EGX 30 stock index dropped almost four percent.

Of equal concern to foreign investors, as well the tourism industry, are the social changes the Islamists say they intend to affect. One concern is a potential ban on bikinis and alcohol that would permanently cripple Western tourism in the Sinai. But the FJP and their ultra-conservative Salafist cousins—who control 27 percent of parliament—have a broader legislative agenda that includes instituting sharia and the penalties associated with it—like cutting the hands of recidivist thieves—lifting the legal ban on female genital mutilation, and mandating that Muslim women wear hijabs.

Despite these potentially damaging social policies, the Muslim Brotherhood has been continuously reassuring skeptics of its commitment to a free market economy. Months ago, Hassan Malik, one of the organization’s chief local financiers and policy advisors, said it in the most impolitic way possible. The economic policies of the Mubarak regime, he said, “were on the right track, but were marred by rampant corruption and nepotism.”

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