Explanatory Memorandum to COM(2024)461 - Providing macro-financial assistance to Egypt - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2024)461 - Providing macro-financial assistance to Egypt. |
|---|---|
| source | COM(2024)461 |
| date | 15-03-2024 |
1. CONTEXT OF THE PROPOSAL
• Reasons for and objectives of the proposal
The European Union (‘EU’) and Egypt have agreed to deepen their relationship and develop a strategic and comprehensive partnership for shared prosperity, stability and security, based on joint interest and mutual trust and building on the already existing positive agenda in EU-Egypt relations. The Strategic and Comprehensive Partnership will cover specific areas of cooperation outlined in the Joint Declaration, clustered across six pillars of intervention, namely: political relations; economic stability; investment and trade; migration; security and law enforcement cooperation; demography and human capital. The implementation of cooperation in these areas will unleash the full potential of the EU-Egypt relationship.
Underpinning the partnership will be a financial package consisting of short- and longer-term support for the necessary macro-fiscal and socio-economic reform agenda, as well as increased amounts available to support investments in Egypt and targeted support for the implementation of the different strategic priorities.
This financial package will be provided in a challenging economic situation where Egypt continues to have sizeable and unmet financing needs. In this context, the Egyptian authorities requested support through macro-financial assistance (‘MFA’) from the EU on 12 March 2024 after an International Monetary Fund (‘IMF’) staff level agreement on an augmented Extended Fund Facility of USD 8 billion was announced on 6 March 2024.
After showing some resilience during the pandemic, partly thanks to reforms in the context of successive IMF programmes since 2016, Egypt’s macro-fiscal situation has deteriorated noticeably over recent months. Over the past two years, external pressures have intensified and Egypt’s debt has increased further, also reflecting a more sluggish implementation of reforms agreed on in the October 2022 Staff-Level Agreement with the IMF. The repercussions of Russia’s war on Ukraine and the Hamas terrorist attacks across Israel on 7 October 2023 have led to protracted capital outflows and lower services exports, notably from tourism and Suez Canal proceeds. This is particularly challenging amid Egypt’s difficult fiscal situation with growing public debt and persistent deficits, as well as a chronic current account deficit. The major rating agencies downgraded Egypt ratings since April 2023, eventually sending the country’s sovereign debt rating to below-investment grade after the outbreak of the Gaza conflict. Egypt continues to face very significant challenges, including high inflation, the state’s entrenched economic footprint, inefficiencies in the foreign exchange market, and the spillovers from the conflict in Gaza, which further weakened Egypt’s economic stability and put pressure on the country’s external and fiscal position while increasing the country’s overall vulnerability to external shocks.
Against the backdrop of the deteriorating regional stability and Egypt’s important role in the region, the conclusion of a staff-level agreement on a new IMF programme and after an in-depth assessment of the economic situation in Egypt and in the context of the Strategic and Comprehensive Partnership between Egypt and the EU, the Commission is submitting to the European Parliament and the Council a proposal to provide a new MFA of up to EUR 4 billion to the benefit of Egypt, as part of an overall MFA package of up to EUR 5 billion in loans.
The proposed MFA would help Egypt cover part of its overall external financing gap, which is estimated at around USD 17.7 billion in the context of the new IMF programme over the period of 2024-2027.
The disbursement would take place in three instalments, with the release of each instalment, including the first one, strictly linked to satisfactory progress with the implementation of both the IMF programme and in relation to a number of additional policy measures to be agreed between the Commission and the Egyptian authorities and listed in a Memorandum of Understanding (‘MoU’). The MoU could, in principle, include reforms to promote the role of the private sector in the economy, monetary and exchange rate policy reforms, continued Public Finance Management (PFM) reforms and social support mechanism enhancements.
As further elaborated in the Commission Staff Working Document accompanying this proposal, the Commission considers, based also on the assessment of the political situation made by the European External Action Service, that the economic preconditions for the proposed MFA operation are satisfied, while progress in relation to the political pre-conditions will be monitored continuously so as to ascertain that compliance with the criteria moves in a satisfactory direction.
• General context
Growth slowed down on the back of both domestic and external factors. Following a strong post-pandemic recovery of 6.7% during fiscal year (FY, July-June) 21/22, real GDP growth eased to 3.8% in FY22/23 and continued to ease to 2.6% year on year during the July-September 2023 quarter. High inflation, uncertainty surrounding the exchange rate and sluggish reform implementation weighed on consumption and investment. The previously strong services exports have come under pressure as the conflict in Gaza dampens tourism and the Houthi attacks in the Red Sea brought down Suez Canal proceeds. Non-oil private sector activity, gauged by the Purchasing Managers’ Index, remained contractionary in January 2024 as order books weakened and output declined. Business expectations deteriorated under ailing client demand. By December 2023, unemployment receded slightly to 6.9%.
Inflation has remained high, amid a volatile parallel exchange rate, which diverged substantially from the virtually stable official exchange rate throughout most of 2023 and early 2024. Consumer price inflation stood at 29.8% year on year in January 2024, following an annual average of 33.8% in 2023. Importantly, food price increases moderated somewhat but were still high at 47.9% in January, where corresponding spending accounts for roughly one third of the consumer basket. Already before the current crisis, around 30% of the population was in poverty, thereby particularly affected by the higher food price inflation. While official reserves inched up slightly to USD 35.3 billion or around 7½ months of imports in January, and total net foreign assets of the financial system reached a negative position of USD 27.2 billion in December 2023, both are expected to improve on account of inflows from the USD 35 billion United Arab Emirates (UAE) investment announced on 23 February 2024, and the new flexible exchange rate regime. As the official exchange rate was fixed at around 31 Egyptian pounds per US dollar since the last devaluation in February 2023 until March 2024, foreign exchange shortfalls gave rise to an increasing parallel market with rates fluctuating between 50 and 70 EGP/USD. When the SLA with the IMF was signed on 6 March 2024, the authorities enacted a flexible currency regime and the EGP settled at around 50 EGP/USD. The Central Bank of Egypt (CBE) accompanied the move to a flexible exchange rate with a sizeable interest rate hike of 600 bps in an attempt to curb inflation.
The public finance situation remains very challenging. The fiscal deficit deteriorated over spiralling interest payments while public debt remains high. The overall budget deficit had remained broadly stable in FY22/23 at around 6% of GDP. However, the first half of FY23/24 (July-December 2023) has seen a 75.3% year-on-year increase in the deficit in nominal terms as expenditure growth outpaced revenue growth, notably owed to a doubling in interest payments which now eat up as much as 97.8% of total budget revenues during the same period. For FY23/24 as a whole, the IMF projects interest payments to reach 87.2% of total budget revenues. The overall budget deficit is projected at 6.3% of GDP in FY23/24. Public debt stood at 95.9% of GDP at end-FY22/23, up from 88.5% the FY before and the highest since 2017, and is projected to rise to 96.4% this FY.
The current account improved but regional crises pose risks. At the same time, the UAE investment deal will probably raise imports. Following a deficit of 3.5% in FY21/22, the current account deficit narrowed to 1.2% last FY and improved by another 12% year on year in nominal terms during the July-September quarter of 2023. While tourism and Suez Canal proceeds provided strong support, goods exports eased. Remittances declined strongly as Egyptians abroad avoided the overvalued official exchange rate. Strong import compression helped keeping the overall deficit contained. High-frequency data suggest that the usually strong income earners tourism and Suez Canal proceeds have since been hit particularly hard by the conflict in Gaza and the Red Sea attacks and corresponding downside risks remain substantial. The unification of the previously fragmented exchange rate system is likely to help lure remittances back into official channels. At the same time, implementing the UAE investment deal on the ground in early 2025 will probably push up imports.
In FY22/23, Egypt nearly reached its goal of USD 10 billion in FDI inflows, up by 12.3% over FY21/22. This included public asset sales under the new state ownership policy. The UAE investment deal will provide a further boost to FDI, although it remains unclear whether the state-directed investment by the Emirati sovereign fund will also induce market-driven investment from elsewhere. Portfolio investment flows, previously a significant although volatile source of hard currency, have not yet returned to Egypt after the massive outflow that started when Russia’s war on Ukraine began, reflecting a key vulnerability for Egypt. The so far existing backlog of domestic reforms, including the long overdue exchange rate unification and, most recently, uncertainty due to the war in Gaza are likely to have deterred capital inflows further. Moody’s lowered Egypt’s sovereign credit outlook from stable to negative in mid-January 2024, citing the risks from growing interest service, the exchange rate rebalancing and mounting external pressures. Earlier in October 2023, Moody’s, S&P and Fitch all downgraded Egypt’s sovereign debt to below-investment grade due to record inflation, a chronic foreign currency shortage and the government’s growing public debt.
• Consistency with existing policy provisions in the policy area
• Consistency with other Union policies
The EU and Egypt have developed a close political and economic relationship over the years, formalised through the conclusion of the Association Agreement, which entered fully into force in 2004 This relationship was recently given new impetus through the February 2021 adoption of the Renewed partnership with the Southern Neighbourhood ‘A new Agenda for the Mediterranean’ and the subsequent adoption of the EU-Egypt Partnership priorities 2021-2027) in June 2022 at the 9th Association Council. The partnership priorities set the political framework until 2027 and cover three broad areas: (i) modernizing Egypt’s economy in a sustainable way, (ii) strengthening cooperation on foreign policy issues, (iii) ensuring stability through cooperation on security and counterterrorism, migration and promotion of human rights. The EU-Egypt Multi-Annual Indicative Programme (2021-2027), the EU’s programming document for Egypt, is also based on the Partnership Priorities.
Egypt's economic ties with the EU are also well developed. The EU remains Egypt's first trading partner in terms of both imports and exports and one of the biggest investors in Egypt. In 2022, Egypt reduced its trade deficit with the EU owing to stronger exports in particular of oil, gas and fertilisers. In line with the EU Trade Policy Review Communication of February 2021, the EU is open to working with Egypt on modernising bilateral trade and investment relations, including by ensuring the trade and competition provisions of the EU-Egypt Association Agreement are implemented in full, in a manner that enables it to reach its full potential.
Cooperation is set to deepen further under the Strategic and Comprehensive Partnership for shared prosperity, stability and security that was confirmed at the tenth meeting of the Association Council on 23 January 2024. It will cover specific areas of cooperation, including political relations, good governance, human rights and fundamental freedoms, macroeconomic stability, sustainable investment and trade, energy, water, food security and climate change, migration, security and human capital development.
Countries that are covered by the European Neighbourhood Policy are eligible for MFA (if fulfilling different conditions). The EU MFA would complement the grants mobilised under the Neighbourhood, Development and International Cooperation Instrument – Global Europe (‘NDICI-GE’) and other EU programmes. By supporting the adoption, by the Egyptian authorities, of an appropriate framework for macroeconomic policy and structural reforms, the EU’s MFA would enhance the added value and effectiveness of the EU’s overall financial interventions, including through other financial instruments.
2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY
• Legal basis
The legal basis for this proposal is Article 212 of the Treaty on the Functioning of the European Union (‘TFEU’).
• Subsidiarity (for non-exclusive competence)
The subsidiarity principle is respected as the objectives of restoring short-term macroeconomic stability in Egypt cannot be sufficiently achieved by the Member States alone and can be better achieved by the European Union. The main reasons are the budgetary constraints faced at the national level and the need for strong donor coordination in order to maximise the scale and effectivenes of the assistance.
• Proportionality
The proposal complies with the proportionality principle: it confines itself to the minimum required in order to achieve the objectives of short-term macroeconomic stability and does not go beyond what is necessary for that purpose.
As mentioned above, the proposed MFA operation in this decision would be the second part of an MFA support package of overall up to EUR 5 billion, divided into a short-term MFA operation of up to EUR 1 billion1, and the present regular MFA operation of up to EUR 4 billion. As identified by the Commission based on the estimates of the IMF in the context of the Extended Fund Facility, the amount of the proposed two new MFA operations corresponds to 56.7% of the estimated residual financing gap for the period FY24/25-FY26/27. This is consistent with standard practices on burden-sharing for MFA operations (for a country with an Association Agreement, the upper limit would be 60% according to the Council conclusions of 8 October 2002), taking into account the assistance pledged to Egypt by other bilateral and multilateral donors.
• Choice of the instrument
Project finance or technical assistance would not be suitable or sufficient to address the macroeconomic objectives. The key value added of the MFA in comparison to other EU instruments would be to alleviate the external financial constraints and to help create a stable macroeconomic framework, including by promoting a sustainable balance of payments and budgetary situation, and an appropriate framework for fostering broad-based structural reforms. By helping to put in place an appropriate overall policy framework, MFA can increase the effectiveness of the actions financed in Egypt under other, more narrowly-focused EU instruments.
3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONS AND IMPACT ASSESSMENTS
• Stakeholder consultations
MFA is provided as an integral part of the international support for the economic stabilisation of Egypt. In the preparation of this proposal for MFA, the Commission services have consulted with the IMF and the World Bank, which have already put in place sizeable financing programmes and are preparing new ones. The Commission consulted the Alternate Economic and Financial Committee on 12 March 2024, where an endorsement for the draft proposal was provided. The Commission has also been in regular contact with the Egyptian authorities.
• Collection and use of expertise
In line with the requirements of Regulation (EU, Euratom) 2018/10462 (‘Financial Regulation’), the Commission services will carry out in time for the implementation of the assistance an Operational Assessment (OA) of the financial and administrative circuits of Egypt in order to ascertain that the procedures in place for the management of programme assistance, including MFA, provide adequate guarantees.
• Impact assessment
The EU’s macro-financial assistance is an exceptional emergency instrument aimed at addressing severere balance-of-payment difficulties in third countries. Therefore, this MFA proposal is exempted from the requirement to carry out an Impact Assessment in accordance with the Commission's Better Regulation Guidelines (SWD(2015) 111 final) as there is a political imperative to move ahead quickly in a situation requiring a rapid response.
More generally, the Commission's MFA proposals build on lessons learned from ex-post evaluations carried out on past operations in the EU's neighbourhood. The present MFA operation, and the economic adjustment and reform programme attached to it, will help alleviate Egypt's short-term financing gap while supporting policy measures aimed at strengthening medium-term balance of payments and fiscal sustainability and raising sustainable growth, thus complementing the augmented programme to be adopted by the IMF Executive Board. These policy conditions should address some of the fundamental weaknesses shown over the years by the Egyptian economy and economic governance system. Possible areas of policy reform measures could, in principle, include reforms on private sector empowerment, monetary and exchange rate policy reforms, continued Public Finance Management (PFM) reforms and social support mechanism enhancement, also building on reforms agreed under the first part of the MFA package and complementing other efforts supported under the Comprehensive and Strategic Partnership.
• Fundamental rights
Countries that are covered by the ENP are eligible for MFA. A pre-condition for granting MFA is related to respecting effective democratic mechanisms, including a multi-party parliamentary system and the rule of law, and guarantees respect for human rights, where in the present case Egypt should continue to make concrete and credible steps towards respecting these criteria.
Human rights challenges in Egypt remain significant, particularly in relation to the protection of fundamental freedoms, governance and the rule of law. However, in the last few years, the political leadership in Egypt has taken several steps putting greater emphasis on the importance of the respect for human rights; it abolished the state of emergency (apart from areas in the Sinai), launched the first ever National Strategy for Human Rights, relaunched the Presidential Amnesty Committee, releasing over 1000 political prisoners and embarked on the National Dialogue. Further, Egypt has intensified its engagement on human rights with the EU, allowing for the first time the visit of the EUSR for Human Rights to Cairo in 2022. Egypt has also recently started engaging in international fora and it is cooperating with the UN OHCHR in an EU funded project that aims to establish an EU-UN partnership, joining synergies to reinforce a culture of human rights in Egypt. Egypt has further declared in its National Strategy for Human Rights its intention to reform the law on pre-trial detention, ameliorate detention conditions, limit the number of crimes punished by death and enhance the culture of human rights across all government institutions. Effective implementation is needed, progress having so far been made in the institutional track.
In light of the above it can be assessed that Egypt has taken some relevant steps towards fulfilling the criteria. At the same time, effective progress on implementation needs to continue, notably in the framework of Egypt’s own National Strategy for Human Rights. Progress will be monitored continuously throughout the implementation of the MFA so as to ascertain that compliance with the criteria moves in a satisfactory direction.
4. BUDGETARY IMPLICATIONS
Being the second part of an MFA package of overall up to EUR 5 billion in loans, the proposed MFA operation for Egypt of up to EUR 4 billion is foreseen to be disbursed in three instalments of broadly the same size, to be released between 2025 and 2027. Provisions will be provided under the External Action Guarantee at a provisioning of 9%, which will be programmed under the NDICI-GE, for a total amount of EUR 360 million (budget line 14 02 01 70 “NDICI – Global Europe - Provisioning of the Common Provisioning Fund”).
The loans shall be granted in the form of amortising loans with a grace period and subsequent capital repayments in equal tranches over a longer period. Such loan structure will be beneficial for both the beneficiary, in that it facilitates repayments, and the budget, by spreading contingent liabilities over a long time frame.
5. OTHER ELEMENTS
• Implementation plans and monitoring, evaluation and reporting arrangements
The European Union shall make the MFA available to Egypt for a total amount of up to EUR 4 billion, provided in the form of medium- to long-term loans, which will contribute to cover Egypt’s residual financing needs in 2025-27. The assistance is planned to be disbursed in three instalments, disbursed evenly throughout the MFA’s duration, provided that the policy measures have been implemented in a timely manner and that other relevant pre-conditions remain fulfilled.
The assistance will be managed by the Commission. Specific provisions on the prevention of fraud and other irregularities, consistent with the Financial Regulation, are applicable.
The Commission and the Egyptian authorities will agree on a Memorandum of Understanding setting out the structural reform measures associated with the proposed MFA operation, including aspects of timing and sequencing. Moreover, as is normally the case with MFA, the disbursements would inter alia be conditional on satisfactory reviews under the IMF programme. The Commission will work closely with the Egyptian authorities to monitor progress on the policy actions and the pre-conditions, as specified above.