Timing of Egypt Turmoil Couldn't Be Worse for Economy

Egyptian protesters hurl stones toward Egyptian riot police during clashes at Tahrir square. Photograph by AFP via Getty Images

Political turmoil in Egypt entered its fourth day Monday, after President Mohammed Morsi’s surprise power-grabbing decree galvanized the opposition and set off rounds of street violence, at a time when the nation needs unity to make difficult economic decisions.

Egypt’s economy was already in trouble, with foreign reserves having fallen 40 percent since the uprising and growth projected to be less than 2 percent this year. Tourism and direct foreign investment have dropped, while unemployment has climbed. Economists say the government needs to tighten spending and devalue the currency—unpopular moves even without angry demonstrators already in the streets.

“Morsi needs political support to institute unpopular economic policies, such as cutting subsidies on fuel or potentially allowing the pound to depreciate against the dollar or the euro,” says Elijah Zarwan, a Cairo-based senior policy fellow at the European Council on Foreign Relations. “The more polarized the situation gets, the more each side escalates, the harder to imagine the kind of consensus-driven compromise that stands the best chance of enduring and producing the political stability that Egypt needs to get its economy back on track.”

Late Thursday night Morsi issued the constitutional declaration stating the president can issue “any decision or measure to protect the revolution,” which is final and immune to appeal in the courts. His declaration also barred the judiciary from dissolving the upper house of parliament or the body tasked with writing the new constitution, both of which are dominated by Islamists. The powers would be in place until new parliamentary elections are held and the constitution is ratified, which are expected only in the spring.

The response was immediate: The fractured opposition united and violent protests—often against the headquarters of Morsi’s political party—erupted across the country. On Sunday the first casualty of the violence was identified in the press as 15-year-old Islam Hamdi Abdel-Maqsood, killed as protesters tried to storm the party offices in the Nile Delta city of Damanhoor.

Both sides announced rallies, scheduled for Tuesday, for and against the decree, ratcheting up pressure on the government and setting the country on another collision course.

The effect of the turmoil on the economy was immediate. In the first day of trading since the decree, Egypt’s benchmark EGX30 stock index dropped 9.59 percentage points on Sunday. The losses were among the biggest since President Hosni Mubarak’s ouster in an 18-day uprising in January 2011.

The crisis could not have come at a worse time, with economists prescribing strong medicine to attack the country’s rising deficits and economic woes.

“We think that Egypt needs a fiscal tightening of 3 percent of GDP to put public finances on a stable footing,” says Neil Shearing, chief emerging markets economist at Capital Economics in London. “Delivering this is going to be extremely difficult against a backdrop of continued civil unrest. The currency remains a difficult issue, too. The pound looks extremely overvalued at present and probably needs to fall by 20 percent or so in order to restore lost competitiveness. But this implies a loss of purchasing power and will be unpopular. Given all the other challenges, devaluation could well be kicked further down the road and dealt with at a later stage.”

One piece of good news was the government’s announcement last week of a preliminary agreement with the IMF for a $4.8 billion loan, but this too comes hand-in-hand with steep reforms. As part of the agreement, Egypt should overhaul its energy subsidies, resulting in steep increases in the price of cooking gas and petrol, which would be a deeply unpopular move that again risks bringing people back out into the streets. There is already opposition to the IMF deal, which has been hotly debated since Mubarak’s ouster, and analysts worry that continued political turbulence would either stall the loan or reduce Morsi’s willingness to institute the kind of reform the Egyptian economy needs.

“It feels at the moment like it’s two steps forward and one step back,” says Shearing. “The IMF deal was a major positive development—the sums of money involved won’t cover Egypt’s entire external finance needs over the next couple of years, which is close to $20 billion, but it will go a long way toward reversing the immediate threat of the balance of payment crisis, which is very real. If nothing else, the events of the past week illustrate that progress over the next year will be extremely bumpy. Clearly, local politics still matter enormously.”

With three senior advisers already resigning over the decree, Morsi appears to be trying to defuse the situation, and he sought a meeting with senior judges on Monday. A statement on Sunday night from the president’s office said Morsi was committed to “engage all political forces in the inclusive democratic dialogue to reach a common ground.” Protesters, meanwhile, look to be in it for the long haul and have set up an encampment in Tahrir Square, the heart of the uprising that toppled Egypt’s last dictator.

“I think we’ve started to see the first steps toward a compromise that will restore stability in the short term, but that even at the end of that, I think the experience has hurt Morsi in terms of the support of a large segment of the population that was willing to reserve judgment and even among many people who voted for him because they didn’t want to elect a dictator, and it’s going to be difficult for him to recover that support,” Zarwan says.

Finding allies for unpopular economic reform will now be even more daunting, says Zarwan. “Unless he can pull some pretty fat rabbits out of his sleeve fairly quickly, he’s not going to find that kind of broad-based support.”

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