June 21, 2018 / 5:46 PM / in 3 months

Egypt taking risks with sharp subsidy cuts, economists say

* Gamble aimed at stabilising economy, luring investment

* But rise in living standards may take time to arrive

* Fears austerity may stoke inflation, cut consumption

* Egypt recovering from years of post-uprising turmoil

By Patrick Werr

June 21 (Reuters) - Egypt’s sharp cutting of fuel subsidies last week, part of an IMF-backed economic reform programme, is a gamble that Cairo hopes will stabilise the economy and attract private investment, ultimately raising living standards.

But the risk is that the pay-off may be slow in coming. Some economists worry that recent austerity measures, which have angered Egyptians, could also spark unexpectedly high inflation, that would crimp consumption, put off a quick recovery and deter potential investors.

The government on Saturday raised the prices of a wide range of subsidised fuel products, including petrol, diesel, fuel oil and natural gas, causing immediate price hikes.

Egypt, halfway through the three-year IMF programme, had raised electricity prices by an average of 26 percent only four days earlier. On June 2 it put up the price of piped drinking water by 46.5 percent and on May 10 the price of metro tickets by as much as 350 percent.

Mohamed Abu Basha, head of macroeconomic analysis at Cairo-based investment bank EFG Hermes, said too many reforms at once might fail to quickly revive the ailing economy.

“Typically in fiscal consolidation the risk is that you enter a period of stagnation,” Abu Basha said. “You do a lot of reforms but they weigh too much on the economy’s capacity to grow.”

The price of popular 80-octane petrol rose 51 percent to 5.50 Egyptian pounds ($0.31) a litre, which still covers only 57 percent of the cost of production, according to a research note by investment bank Beltone Financial.

Economists nonetheless give the government of President Abdel Fattah al-Sisi high marks for pushing through long-delayed reforms in the face of mounting public discontent.

One of the top-trending Arabic Twitter hashtags for Egypt on Thursday was “Sisi must go” (irhal ya Sisi) with more than 86,000 tweets.

“In the grand scheme of things, whatever harsh austerity measures are being put in place today, they lay a very strong foundation for private-sector-led growth over the coming five years,” said Hany Farahat, senior economist at Egyptian investment bank CI Capital.

He said the government of the most populous Arab state needed to take corrective measures after the fiscal laxity, excess spending and monetary instability that characterised the years prior to the IMF agreement.

A popular uprising in 2011 toppled longtime leader Hosni Mubarak, who was eventually succeeded by Islamist president Mohamed Mursi. Sisi, as army chief, overthrew Mursi in 2013 after mass protests against his rule.

“No investor will come to Egypt,” Farahat said, “if there is a risk of over-spending or over-borrowing, which risk pressure for devaluation of the currency and an outflow of capital.”

In the years after the uprising, authorities were politically hobbled in their attempts to control spending. The 2012-13 budget deficit soared to an unsustainable 13.7 percent of GDP, financed in part by expanding the money supply.

“Before the IMF programme they were printing money. And now since the IMF is on board this stopped happening for sure,” Farahat said.

Fuel subsidies ate up more than 10 percent of total budget in the financial year that ended on June 30, 2017, according to ministry of finance figures.

FOREIGN INVESTORS STILL SHY

Egypt’s GDP grew by 5.4 percent year-on-year in the first quarter of 2018, according to the planning ministry.

But foreign investors are still shying away, apart from those focusing on the more resilient energy sector.

Non-oil foreign direct investment fell to about $3 billion in 2017 from $4.7 billion in 2016, according to Reuters calculations based on central bank statistics.

The economy has been given a boost in recent months by a recovery in tourism and by increases in natural gas production and revenue from the Suez Canal.

Inflation shot up to a high of 35 percent after the austerity measures that accompanied the November 2016 IMF pact. These included a rise in fuel prices, a 13 percent value-added tax and a devaluation that cut the Egyptian pound value by half.

“(A risk is) that the second-round inflation effect is higher and longer lasting this time than last because companies need to get some margin back, which would put consumption, interest rate cuts and investment recovery in doubt,” said an economist based outside of Egypt who wished not to be named. ($1 = 17.8600 Egyptian pounds) (Reporting by Patrick Werr Editing by Mark Heinrich)

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