Democracy of bread: The subsidy system is a burden on the budget

Subsidies have played a significant part in the Egyptian economy since the era of President Gamal Abdel Nasser in the 1950s and 1960s – a time in which numerous Middle Eastern autocracies sought the approval of the populace through the provision of food and other essentials at below-market prices. Sardonically described as the “democracy of bread” by Tunisian scholar Larbi Sadiki, the practice of subsidisation did not end with the arrival of the more free-market-inclined Anwar Sadat; rather, the 1973 rise in global commodity prices cemented their position in balance sheets so securely that, despite a number of attempts to reduce them over the years, they represent a significant part of it to this day.

URGENT ATTENTION REQUIRED: However, while an average growth rate of 4% between 1992 and 2011 (peaking at 7.3% in March 2008) allowed the regime of Hosni Mubarak to push the difficult question of subsidy reduction down the political agenda, the deteriorating economic situation since the January 2011 uprising has propelled the issue to front and centre of a more open public economic debate.

The country’s major political blocs agree that the problem of subsidy reliance needs to be tackled soon, and few disagree with the premise that, with borrowing costs at historic highs, there is wisdom in investing in infrastructure and large projects rather than short-term social firefighting. Nevertheless, an important question remains unanswered: how can subsidies be reduced without drawing the ire of a recently empowered population that has fought for greater social justice?

DAILY STAPLE: Nearly 70% of Egyptians possess ration cards that allow them access to subsidised bread and other staples, and estimates suggest that half of the population rely on their daily bread quota for the majority of their calorie intake. The price of subsidised baladi bread, the round, unleavened loaves which are a daily staple for much of the population, has remained unchanged since the assumption of power by Mubarak in 1981. Yet Egypt imports around half of its wheat – or an estimated 10m tonnes in the 2010/11 fiscal year, according to the UN Food and Agriculture Organisation. The rise in international wheat prices in recent years has placed significant pressure on the national food import bill, with the 2010/11 wheat bill totalling around $3.5bn.

While the subsidised bread programme has come to symbolise the social contract between the national government and the people, it has become a significant burden on the budget.

FUEL: Worse, still, is the nation’s fuel bill. Expenditure on a variety of fuels accounts for around 70% of total spending on subsidies. Despite the fact that Egypt is a net gas exporter, it imports a number of fuel types – including around 50% of the butane which is widely used in canister form by Egyptian households. These are available from state depots for around LE3 ($0.50), yet are more readily available on the black market for anything up to LE80 ($13.40).

The lower security in the wake of the 2011 uprising led to a marked increase in illegal butane trading, which in turn resulted in the reduced availability of subsidised stock. The subsequent protests which accompanied each butane crisis served as a reminder of the politically sensitive nature of the subsidy question. Government statistics show that Egypt also imports around 10% of its petrol and 40% of its diesel, which are made available to the population at a subsidised rate. As with butane, the price differential between the government supply and black market rates makes illegal trading in vehicle fuel an attractive proposition. Such activity was blamed for petrol shortages in the first quarter of 2012, which saw petrol stations close down or restrict customers to quotas of 20 litres per car.

More egregious in the eyes of many economists is the fact that energy-intensive industries, such as cement, fertiliser, steel, glass and ceramics, also benefit from subsidies on fuel oil, gas and electricity – as well as indirectly from the fuel subsidies enjoyed by the transportation sector. As a result of its largesse in relation to the nation’s fuel bill, the government estimated that total spending on energy subsidies for 2011/12 reached $16bn; thanks in part to rising global energy costs, this represents a 40% increase on the previous fiscal year.

THE POLITICS: With the nation spending close to 10% of its GDP on subsidies, most of Egypt’s fractious political community agree that the subsidy issue is one of the most pressing challenges facing the government. Pressure to address the problem has come from outside too, although the structural adjustment agreements reached with the IMF that targeted the subsidy system for reduction have had little effect over the long term. Egyptian leaders, and the successive governments that have served them, have learnt that attempts to change the system are likely to provoke a hostile reaction from the populace. In 1977 President Anwar Sadat attempted to remove the flour, rice and cooking oil subsidies; the result was a near-revolution that saw hundreds of thousands of protesters descend on the capital and the hasty re-implementation of the subsidy system.

More recently, the two transitional governments which were formed after the 2011 uprising have publicly acknowledged the need to address the energy subsidy system, in particular. In January 2012 the government of then Prime Minister Kamal Ganzouri announced that it would raise the prices paid by steel, cement and ceramic companies for their subsidised energy, although no timeline for this alteration was established and no price changes had been made by the time that parliament was dissolved just ahead of the presidential election of 2012.

However, the completion of the presidential elections and the possibility of a period of increased political stability have raised hopes that the subsidy question will soon be tackled by the newly elected government with its mandate from the people.

THE CURE: The Freedom and Justice Party (FJP), the Muslim Brotherhood’s political arm and the principal beneficiary of the parliamentary elections of late 2011 and the presidential elections of mid-2012, has stated its intention to re-calibrate the subsidy system. In the run-up to the presidential elections it raised the idea of connecting more households to the natural gas network to reduce the subsidy on imported butane, while revising the wider subsidy network so that it is weighted towards those most in need. The FJP’s desire to refine, rather than abolish, the subsidy system is in agreement with a long-held view of many within the financial community.

“Five products are heavily subsidised, some more skewed towards consumption by the more affluent end of the population, some towards the domain of the poor population. But if you add it together and analyse it, only 20% of the LE120bn ($20.08bn) [total subsidy bill] is in the domain of what you need to do to protect social justice, vulnerable groups and so on. I think that you have plenty of fiscal space with which you could have created not only the support of subsidised fuel, but also to extend the umbrella of support which people have demanded post-revolution – better housing, education, quality of living, roads, security, stimulus packages to help small and medium-sized enterprises get better access credit, production subsidiaries and tax incentives,” Magda Kandil, former executive director and director of research at the Egyptian Centre for Economic Studies, told OBG.

To date, successive governments have failed to exploit this potential fiscal space, but the announcement of the 2012/13 budget in May 2012 revealed the possibility that the beginnings of such an undertaking might be in train. While food subsidies, considered untouchable for their importance to millions of the poorest in Egypt, will rise in the proposed budget, fuel subsidies will be cut by around 27% if its measures are enacted. Total fuel subsidy spend will therefore fall from LE95bn ($15.9bn) in 2011/12 to LE70bn ($11.7bn), representing 48% of the total subsidy bill of LE145.8bn ($24.4bn).

The budget announcement also included a change in the distribution system, proposing a coupon model for octane petrol, diesel and butane gas in a bid to limit profiteering practices. Energy-intensive industries, which have hitherto enjoyed subsidised fuel and electricity despite selling their product on both foreign and domestic markets at going international rates, will have their subsidies removed by the end of the 2012/13 financial year if the provisions of the budget are implemented. This alone will have a sizeable impact on the total subsidy spend; in the 2011/12 financial year the government spent more than LE10bn ($1.7bn) on subsidised fuel oil that was destined for the industrial sector.

Clearly, subsidisation will remain a sizeable element of the budget for some time to come, and political uncertainties threaten any process of fiscal reform, but for the first time in years the prospect of a more efficient subsidy system is a realistic one.