EGYPT'S ECONOMIC CRISIS: POLICY OPTIONS AND IMPLICATIONS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88T00096R000100020003-7
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 18
• Document Creation Date: December 27, 2016
• Document Release Date: March 25, 2011
• Sequence Number: 3
• Publication Date: January 1, 1986
• Content Type: REPORT

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IILIGf,W, Tli~nn4n~o to of
Egypt's Economic Crisis:
Policy Options
and Implications
MASTER FILE COP!'
I inig NOT GtVE OUT
OR MARK O
NESA 86-10002
January 1986
361
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NESA 86-10002
January 1986
Directorate of Confidential
Intelligence
Policy Options
and Implications
Egypt's Economic Crisis:
coordinated with the Directorate of Operations.
This paper was prepared by I Office
of Near Eastern and South Asian Analysis. It was
Comments and queries are welcome and may be
directed to the Chief, Arab-Israeli Division, NESA,
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Egypt's Economic Crisis:
Policy Options
and Implications
Key Judgments Egypt's capacity to meet its external financial obligations is deteriorating.
Information available Its balance-of-payments position will become untenable without a combi-
as of 16 December 1985 nation of major cuts in import growth, debt rescheduling, and significant
was used in this report.
increases in external assistance.
Deep import cuts will throttle economic growth and severely limit econom-
ic opportunities for a rapidly expanding and frustrated population. Resent-
ment within the lower and middle classes over declining living standards
would probably swell the political opposition, including the ranks of Islamic
fundamentalists, and could ultimately destabilize the country.
The Mubarak regime's approach to reform has not produced significant
improvement in Egypt's economic prospects. Cairo's incremental and
excessively cautious approach provides little incentive for consumers,
producers, and investors to shift gears and adopt new modes of behavior
that might result in increased productivity and investment. Even if Cairo
were to moderately accelerate the pace of economic reform, unsustainable
balance-of-payments deficits would still occur.
The present government is unlikely to push for sweeping reform, despite
lipservice to the contrary, because it believes that major restructuring of
the current system of price supports, subsidies, and government controls
would produce political instability. Egypt's leadership probably assumes
that the strong US commitment to supporting a moderate regime in Cairo
will guarantee major increases in financial assistance from the United
States, lowering the pressure on Cairo to undertake politically risky
reforms.
Even if Egypt succeeds in holding import growth to a rate that covers little
more than the normal increase in population, the government will require
annually an additional $1 billion in cash grants by 1987. Multilateral
rescheduling under IMF auspices would mitigate this problem but would
require Egyptian adherence to strict monetary and fiscal guidelines that
would increase the risk of political upheaval. Cairo will probably be forced
into an IMF standby agreement by 1987 at the latest unless the United
States quadruples its balance-of-payments support.
Confidential
NESA 86-10002
January 1986
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Higher levels of US aid would ease Egypt's external payments constraints,
but they would provide few additional political benefits to the United
States. Balance-of-payments support would be largely invisible to the
Egyptian public and would be unlikely to engender greater support for ties
to the United States. Opposition political groups already voice criticism of
Egypt's dependence on the United States. If US assistance continues to
grow while living standards stagnate or decline, the United States will be
singled out with greater frequency as the cause, not the cure, for Egypt's
economic woes.
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Policy Changes to Date
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Egypt's Economic Crisis:
Policy Options
and Implications
During the late 1970s and early 1980s Egypt enjoyed
a period of rapid economic growth and improved
foreign payments balances. These developments were
spurred by large inflows of foreign assistance (espe-
cially from the United States), sharply rising foreign
earnings from oil and worker remittances, and policies
that stimulated the private sector. As a consequence,
the Egyptian Government could provide extensive
and, from a budgetary perspective, costly consumer
subsidies and price controls to shelter low- and
middle-income consumers.
This era of rising prosperity has ended, and Egypt's
policymakers are confronted with daunting problems
and rapidly narrowing policy options. Economic
growth has slowed, and the
already bad foreign payments situation threatens to
reach unmanageable proportions over the next several
years. Efforts by Cairo to address its payments defi-
cits are likely to require painful cuts in consumption.
The government's ability to manage such an adjust-
ment will be tested to its fullest because rapid popula-
tion growth, grossly inadequate housing and services,
and lack of meaningful employment opportunities
already stretch the fabric of the social order.
Remittance earnings from 2-3 million Egyptian work-
ers abroad also dipped by an
estimated 28 percent over the previous year. Much of
the drop in remittances, Egypt's single largest source
of foreign exchange, is, we believe, attributable to the
government's poorly conceived attempt to reform the
complex, multitiered exchange rate system. Adopted
in January 1985, the latest reforms attempted to alter
the free market for foreign exchange by severely
restricting transactions in this market and establish-
ing a flexible bank rate of exchange that would be
controlled by the government. Uncertainty about the
new system, amplified by repeated government rein-
terpretations of the rules, caused foreign currency
inflows to drop. Moreover, Cairo's reluctance to allow
significant flexibility in the bank rate permitted the
spread between the government rate and free market
rate to grow and thus provided even less incentive for
foreign currency holders to convert their funds within
the commercial bank system.
In April 1985 the government repealed most of the
new foreign exchange rules, legalizing free market
transactions but maintaining the flexible bank rate.
Recent Developments
During the past year Egypt's economy exhibited few
signs of long-term health. Weak world oil prices,
confusing exchange rate policies, and, despite some
reforms, inappropriate internal pricing contributed to
a marked deterioration in the country's balance of
payments. We estimate that Egypt's foreign payments
swung from a modest $200 million surplus in the
fiscal year ending 30 June 1984 to a projected $1.3
billion deficit during FY 1985.
Egypt earned about $2.2 billion from oil sales in 1985,
down 15 percent from the previous calendar year.
Declining petroleum revenues stemmed largely from
the sluggish world oil market, which depressed prices
and held exports to 250,000 barrels per day (b/d).
Petroleum sales still accounted, however, for about 60
percent of Egypt's commodity exports and 20 percent
the flow of hard currency through
the commercial bank system remained sluggish, caus-
ing arrearages in foreign currency payment obliga-
tions to grow. By September abnormally heavy pur-
chases of dollars by both private- and public-sector
institutions sparked a further dramatic depreciation
of the free market rate and provoked a minor econom-
ic crisis. The free market rate has subsequently
appreciated as a result of market forces, averting at
least temporarily a major financial crisis and postpon-
ing the need for intervention by the government.
Nevertheless, the basic structural weaknesses of the
multitiered exchange rate system remain intact.F_
of its foreign exchange earnings.
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Table 1
Egypt: Estimated Balance of Payments, 1985-90
In line with its foreign exchange reforms, Cairo has
pushed a restrictive import allocation policy that has
also contributed to lower growth rates.
a government-
administered import system based on lists of commod-
ities banned from importation cut deeply during early
1985 into private-sector imports. It did little to stem
the tide of public-sector purchases. General dissatis-
faction with the system's cumbersome procedures and
its negative impact on private-sector growth have led
to its suspension.
a new system based on graduated custom
Policy Changes to Date
Cairo's efforts to address the serious economic distor-
tions caused by the complex system of subsidies and
fixed prices have accelerated within the past year. In
our judgment, these reforms are too piecemeal and
gradual to have had substantial impact on economic
performance. Nevertheless, from the perspective of
Egyptian policymakers, sensitive to the political rami-
fications of increasing consumer prices, reform efforts
are viewed with a considerable sense of accomplish-
ment, according to US Embassy reporting.
Pricing changes to date encompass three broad areas:
food subsidies, energy, and agricultural procurement
prices. Food subsidies, the most politically sensitive
component, have undergone the least change. The
government has doubled the price of flour and intro-
duced a 2-piaster bread loaf to replace the previous
1-piaster loaf. Nevertheless, this bread-priced at
slightly over 1 cent a loaf-is heavily subsidized and,
even for Egyptians, so cheap and abundant that
Western observers have reported its use as fodder for
livestock.
The Mubarak regime's sensitivity regarding food
issues was most recently demonstrated by its stand on
produce pricing. After an abortive attempt to decon-
trol vegetable prices in May 1985, Cairo resorted to a
voluntary system of price restraints to quell growing
consumer dissatisfaction. This failed to produce price
levels acceptable to the general public, and in October
Prime Minister Lotfy announced the resumption of
compulsory pricing. The rapid resort to controlled
prices, in our view, demonstrates the regime's weak
commitment to economic liberalization.
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Egyptian Exchange Rates
Egypt has a complicated multiple exchange rate
system. The most important rates include:
? Official exchange rate of LE 0.70 = $1.00. This
rate, last changed in January 1979, is used for
public-sector earnings-such as petroleum exports
and Suez Canal receipts-and for government im-
ports of basic commodities and other approved
transactions. The official rate essentially is an
accounting rate for foreign transactions within the
Egyptian Government.
? Official flexible rate or "bank rate" currently at LE
1.35 = $1.00. This rate, established in January
1985, is designed to enable Egypt's public-sector
banks to be more competitive with the free market
in the purchase of worker remittances and tourist
dollars. Largely replacing the official "incentive
rate," the new rate was billed as a flexible rate and
was to be adjusted weekly to correspond to changes
in the free market rate. In practice, the government
has allowed very little flexibility, and the spread
between this rate and the free market rate remains
too large to attract most remittance earnings.
? Free market rate, currently at LE 1.80 = $1.00.
The free market rate varies daily, and transactions
are made through private traders. Workers abroad
and tourists provide most of the foreign exchange.
This market has increasingly been used by public-
sector firms and banks because of inadequate for-
eign exchange in official channels. During late
summer 1985 large-scale official demand for dol-
lars was at least partly responsible for pushing the
free market rate to a temporary high approaching
LE 2.00 = $1.00.
Price increases in the energy sector have been more
rapid, but the contribution to reform is, in our view,
questionable. The government raised gasoline prices
by over 30 percent during 1985; the cost of regular
gasoline following this price hike (converted at the
free market rate) is still, however, only about 48 cents
per gallon. Electricity prices were also increased last
July between 10.5 and 60 percent. The smallest
increase went to low-use residential customers, the
highest to large commercial users. Despite this jump,
domestic energy prices remain comparatively low, less
than 25 percent of world levels and well below energy
price levels in most non-oil-developing countries.
Procurement prices have also been subjected to con-
siderable revision during the past year. The prices the
government pays to producers of cotton, rice, sugar-
cane, and wheat were increased by 20 to 30 percent
during the fiscal year ending June 1985. Our analysis
of price differentials indicates that procurement prices
for wheat have reached about three-fourths of world
price levels, a price trend that, if continued, could
stimulate greater wheat production in the future.
Nevertheless, most procurement prices, including cot-
ton and rice, remain substantially below international
levels and provide Egyptian farmers with little incen-
tive to expand production.
Economic Prospects, 1986-90
We expect the decline in oil revenues to continue
through the end of the decade. Production, according
to oil company estimates, will increase from a current
level of about 900,000 b/d to over 960,000 b/d by
mid-1986 and to over 1 million b/d by early 1987. It
will probably stabilize at this level for at least the next
two to three years before beginning to decline. Despite
such gains, the combination of a weak world oil
market and rapid growth of domestic consumption
will almost certainly continue to depress earnings.
Domestic oil consumption has been increasing at a
rate of 10 to 13 percent over the past several years,
stimulated by Egypt's artificially low prices for ener-
gy and by government policies that have deliberately
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Egypt's Troubled
Agricultural Sector
A newly straightened and deepened mesqa
(private irrigation ditch) in El Minya
Governorat
Egypt's agricultural production has been distorted by
low government procurement prices, which provide
little incentive for farmers to expand acreage of
controlled crops such as wheat, rice, and cotton.
Instead, many farmers have switched to growing
forage crops, such as corn and clover, which are not
regulated by the government and accordingly provide
higher profit margins. Meanwhile, Egypt's food defi-
cit grows. Egypt imports over half of its food needs at
a cost of more than $2.5 billion annually.
encouraged greater use of electricity. This fast pace of
domestic oil use will be slowed somewhat
by the introduction of planned
energy price increases in 1986, probably in the range
of 20 to 30 percent, and by government plans to use
70 percent more gas by 1990.
Even with these developments, we believe that Egypt
will have difficulty effecting significant reductions in
domestic oil consumption in the near term. The
projected rate of price increases for energy does not
appear sufficient to produce the large shifts in con-
sumption required. Our analysis leads us to believe
Figure 1
Egypt: Oil Consumption and
Export Projections, 1985-90
I I I I I I
0 1985 86 87 88 89 90
Consumption
Export
that, at best, Cairo will slow growth of oil consump-
tion to 8 percent per year in 1986 and 1987 and to 5
percent per year in 1988-90. Even these cuts, assum-
ing they occur, will be insufficient to stem a reduction
in oil available for export. Oil revenues will continue
to decline.
Remittances from workers abroad, the other major
contributor to Egypt's foreign earnings, are likely to
grow only marginally over the remainder of the
decade. Although documentation is sketchy, the eco-
nomic downturn in the oil economies of the Persian
Gulf-the area employing most of Egypt's overseas
workers-has probably already begun to affect expa-
triate earnings. We believe, however, that alarmist
projections that assume large-scale layoffs of Egyp-
tian workers over the next several years are unrealis-
tic. Much of the Egyptian work force in the Gulf
consists of skilled workers whose ethnic and religious
compatibility and willingness to work at lower wages
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tex-
Our projections in figure 1 are based on the premise
that oil prices will decline only moderately over the
next five years. This assumption could be overturned
by the results of the December 1985 OPEC meeting in
Geneva. If OPEC countries attempt to capture a
larger market share, oil prices may, according to
knowledgeable oil analysis, drop to the $20 per barrel
level. A price decline of this magnitude would have
disastrous implications for Egyptian revenue earnings
and would entail the loss of about $700 million in
hard currency during 1986 alone.
than Western expatriates will probably ensure their
continued employment. Nevertheless, we assume that
some layoffs will occur, especially among less skilled
workers, and that reductions in pay and benefits are
likely for many more.
Egypt's other traditional foreign exchange earners are
unlikely to provide significant growth in foreign earn-
ings. Suez Canal revenues have stabilized at just
under $1 billion during the past few years and show
few signs of expansion during the balance of the
decade. Growth will remain constrained largely by
sluggish economic activity in the Gulf region.
Tourist revenues recently have sunk, according to US
Embassy sources, and prospects over the next several
years do not appear bright. The Egyptian tourist
industry, outside a few luxury hotels in Cairo, is
plagued with inadequate infrastructure and notorious-
ly poor service, characteristics that do not encourage
return visits. According to recent press reports, pub-
licity surrounding terrorist hijackings in the Middle
East also has influenced tourists, particularly US
citizens, to avoid what is seen as an increasingly
dangerous region to visit.
Recent increases in procurement prices for cotton
may stimulate production and exports, but not enough
to make a significant difference in overall foreign
exchange earnings. Export earnings from cotton dur-
ing FY 1985 were about $500 million, or roughly one-
third of total nonoil exports.
tiles will face severe international competition and
protectionist policies abroad. Industrial exports are
widely regarded in financial circles as largely uncom-
petitive and likely to remain so for some time. Egyp-
tian industry is dominated by public-sector enterprises
whose low productivity, orientation to the home mar-
ket, and dependence on government pricing policies
make them poor vehicles for export expansion. F_
Given the bleak prospects for most of Egypt's tradi-
tional foreign currency earners and the unlikely devel-
opment over the next several years of new sources of
revenue, we believe that Egypt's balance-of-payments
position will become untenable without a combination
of major cuts in import growth and significant in-
creases in external assistance. We have assumed for
purposes of analysis that the government will be
willing and able to limit import growth to 5 percent
per year over the balance of the decade. Even with
such moderation, Egypt will experience an unsustain-
able deterioration in its foreign payments position.
Economic growth, including the creation of new jobs
for Egypt's burgeoning population, would be among
the first casualties of import cuts. Although subject to
significant swings, imports have risen over the past
several years at an average annual rate of 10 percent.
If the government implements draconian import re-
strictions, it most likely will, given its inclination to
maintain subsidies and price supports, protect public-
sector imports at the expense of the private sector and
also cut capital spending. Such measures will throttle
growth, which has already slipped,
from an average 8.5 percent between 1975 and
1983 to no more than 5 percent in 1985. With
population growth of 2.7 percent annually and urban
growth of 3.5 percent
the Mubarak regime can ill afford to deal with the
social and political consequences of a stagnant econo-
my.
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Figure 2
Egypt: Economic Indicators
Services and 3
distribution
35.8
1975 82-83 83-84 84-85
through
81-82
Composition of Foreign Earnings Consumer Price Growth
Percent Percent
Remittances
25
Petroleum
exports
24
Policy Options
Cairo will continue to explore various policy options to
help reduce its payments deficits and avoid crippling
import cuts. These alternatives include:
? External financial assistance other thanfrom the
United States. Although Egypt will look first to the
United States, it may also explore the possibility of
other bilateral financing, particularly from the oil-
rich Arab states. Egypt maintains active political
links to most Arab states, but the lack of full
diplomatic relations with most and Egypt's absence
from the Arab League-the forum that approved
many large aid flows in the past-are impediments
Foreign Exchange Reserves
Billion US $
to new official aid flows. We do not regard the
prospects for significant funding from such sources
as a viable alternative-even assuming a major
political reorientation by the Egyptian Govern-
ment.
' Since the peace treaty with Israel, Cairo's official financial
relationships with other Arab states have been limited primarily to
the sale of military supplies to Iraq
Funds obtained from such
transactions, which appear, according to US Embassy sources, to be
declining in volume, are retained by the Egyptian military for its
own use and do not go into the government's foreign exchange
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The Gulf Arab states are in the midst of their own
financial crisis because of falling oil revenues and
would not be inclined, we believe, to provide the
additional aid Egypt will require. Moreover, de-
emphasis of the Camp David accords would jeopar-
dize current US assistance levels of about $2.3 billion
annually and leave Cairo no better, and possibly
worse off, than before. Finally, financial assistance
from Libya or the Soviet Union would probably
require an even more fundamental political reorienta-
tion by the Egyptian Government and would not, in
our judgment, provide anywhere near the level of
funding Egypt would lose by abandoning its relation-
ship with the United States.
? Debt Rescheduling. On the basis of US Embassy
reporting we estimate Egypt's exter-
nal debt at $31 billion. Annual servicing obligations
on this indebtedness have reached $3.6 billion-
nearly one-third of current account receipts. Hence,
rescheduling, involving deferral of all or part of
these payments, represents an attractive alternative
for the Egyptian Government
The most likely candidates for debt deferral from the
Egyptian perspective are military debts, particularly
US and French loans, which together total almost $7
billion. The French Government, according to the US
Embassy, has already granted a grace period of up to
two years on repayment of at least a portion of the $3
billion owed it. Cairo will undoubtedly press for
similar, or better, rescheduling terms from the United
States on FMS debt obligations. Mubarak probably
views FMS rescheduling as a highly promising debt
relief alternative, given his perception that the United
States attaches high importance to the US-Egyptian
security relationship.
Rescheduling of public-sector nonmilitary debt is a
far more complex problem and may involve political
costs that the Egyptian Government is unwilling to
bear. Current civilian debts,
include over $16 billion in long- and medium-
term obligations and short-term liabilities of over $7
billion. A large debt burden, declining earnings poten-
tial, and lengthening delays in repayment have effec-
tively excluded Cairo from negotiating further
medium-to-long-term commercial loans.]
Table 2
Egypt: Estimated Foreign Debt,
December 1985
Of which:
US FMS debt
Total
The Mubarak government's only viable option with
regard to civilian debt relief appears to be multilateral
rescheduling of long- and medium-term liabilities
under IMF auspices. An IMF standby agreement
would entail considerable cost. In exchange for lines
of credit and extended repayment terms on bank-
syndicated and bilateral loans, Egypt would have to
adhere to strict financial and monetary guidelines,
including much more rigorous subsidy reforms and
more rapid movement toward a unified exchange rate.
Such adjustments, however, would almost certainly
force substantial increases in consumer prices and
probably provoke political unrest.
The Mubarak government is highly sensitive to the
appearance of foreign control over the country's eco-
nomic policies and to the political fallout that could
result from acceptance of an IMF-supported reform
package. Egypt's leaders continually remind US offi-
cials that they have not forgotten the IMF-induced
austerity program in 1977, which they blame for
having caused widespread riots. Furthermore, we
believe the government fears that an embittered and
disillusioned population will vent its opposition to
economic austerity by turning to radical Islamic
fundamentalism.
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Nevertheless, in the absence of large increases in US
aid, Cairo probably cannot delay much beyond 1987
the introduction of an IMF standby agreement. A
Fund program, while onerous and politically danger-
ous, would provide the government with some means
of deflecting criticism from itself. It and an accompa-
nying rescheduling agreement would also provide
immediate economic relief. Moreover, given recent
experiences in IMF standby agreements, the positive
benefit of rescheduling would remain intact even if
Egypt, at a later date, fell out of compliance with the
IMF program.
? Accelerated Reform. From an economic perspective,
a substantial self-initiated acceleration of economic
reform is the most effective option available to
Egypt. It is also about as palatable as an IMF
standby agreement, from Cairo's political viewpoint.
Current plans envision a five-to-seven-year period
for the elimination of most subsidies, a pace that
will yield few dividends in the near term. To
Egyptian policymakers, however, a speedup in re-
form over the next one to two years entails too many
political risks with no tangible economic benefits.
Public statements by Egyptian leaders suggest that
accelerated price increases, reform of the bloated
bureaucracy, divestment of inefficient public-sector
industries, and exchange rate unification are recog-
nized as inherently important goals. These officials
also believe, according to private conversations with
US officials, that such adjustments would initially
entail large and politically unacceptable jumps in
living costs and displacement of workers before
there is any visible improvement in the economy.
We believe that the Mubarak government lacks confi-
dence in its ability to survive during such a period of
economic adjustment. US Embassy analysis supports
our belief that the mass of Egypt's low- and middle-
income urban population already see their economic
status eroding and would regard a rapid reduction in
subsidies as intolerable. Moreover, a strong consensus
within Egyptian society holds the government respon-
sible for providing affordable goods and services to the
public. These attitudes act as powerful constraints to
any accelerated reform effort.
The greatest drawback to the Egyptian Government's
piecemeal approach to reform is, economically speak-
ing, its very gradualism. By delaying needed price
adjustments or by stretching them out into increments
acceptable to the general public, a sense of urgency is
lost and much of the shock value of reform is
dissipated. Cairo's excessively cautious approach to
reform provides little incentive for consumers, produc-
ers, and investors to shift gears and adopt new modes
of behavior that might result in increased productivity
and investment. Instead, it is business as usual for
most Egyptians, despite the burden of price hikes.
Finally, by not providing incentives (for example,
higher wages, increased access to consumer goods)
and by attempting to slip price increases through in a
furtive manner, the regime confirms in the minds of
most Egyptians that reform can only be injurious to
their long-term economic well-being.
Implications for the United States, 1986-90
Cairo will almost certainly expand its efforts to obtain
greater balance-of-payments support from the United
States. The dim prospects of aid from other sources
and the unattractiveness of an IMF standby agree-
ment or greatly accelerated, self-initiated economic
reform leave no other feasible alternative, from the
Mubarak government's perspective. Egyptian officials
are likely to argue that, despite tensions flowing from
the Achille Lauro affair, their country remains the
United States' most supportive friend in the Middle
East and an indispensable partner in the search for
regional peace.
FMS relief.
We believe that Egypt will push hard for FMS debt
rescheduling. The $3.7 billion in military debt obliga-
tions owed to the United States will require annual
payments of about $550 million over the next several
years. The Egyptians are $470 million in arrears on
these payments and are constantly pushing up against
the one-year arrearage limit that could trigger a
Brooke amendment cutoff in all US assistance. Cairo
has requested debt relief in past meetings with US
officials and will almost certainly press harder for
forgiveness, or substantial rescheduling, during the
next year. Egypt's special military relationship with
the United States and shared concerns over the role of
the Soviets, Libyans, and Iranians in the Middle East
will undoubtedly be cited by Cairo as justification for
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Why Inflation Is So Low
in Egypt
Normally, countries with large balance-of-payments
and budget deficits would face inflation rates in the
50- to 200 percent annual range. The low inflation
rate in Egypt, officially 20 percent in 1984, results
from the fact that a large share of consumption,
probably 50 to 70 percent, is subsidized in one form
or another. Further, the prices of most goods mea-
sured in the consumer price index are controlled by
the government. A better picture of the underlying
rate of inflation may be obtained by looking at
subindexes for categories of goods and services that
are more exposed to market influences. For example,
the subindex for services increased by 34 percent in
1984.
While domestic inflation is held to a minimum by
subsidies and controlled prices, international infla-
tion is deflected by the exchange rate system. These
policies combine to lay the costs of inflation on the
government and not directly on the people.
The Mubarak government also will strongly argue for
conversion of more Economic Support Funding (ESF)
into cash transfers, as well as an increase in total
ESF, which currently is $815 million annually. Dur-
ing the current US fiscal year about $300 million of
ESF has been allocated by the United States for
balance-of-payments support; the remainder is dis-
tributed as project assistance through USAID. Cairo
will probably attempt to persuade US officials to
convert more project assistance into grants, citing as
justification the cash grant status of all ESF under
US assistance to Israel. The Egyptians have long
maintained that the United States promised aid parity
with Israel. Egyptian officials may also cite growing
political and social tensions caused by the large US
presence in Egypt and argue the desirability of lower-
ing the US profile by channeling more project assis-
tance directly into Egyptian hands.
In addition to regular ESF, Egypt is receiving from
the United States $500 million in supplemental grant
assistance-all of which will be disbursed during the
current Egyptian fiscal year. Our analysis of Egypt's
1985/86 budget suggests that Cairo has already
incorporated this amount into the capital transfer and
investment portions of its budget, leading us to believe
that the Egyptians assume this supposedly one-time
funding, or the equivalent in new ESF, will be made
available to them on an annual basis after 1986.F-
Given current financial trends, Egypt could require,
in the absence of an IMF standby program and a
rescheduling agreement, an additional $1 billion in
balance-of-payments support by 1987. This would
necessitate a roughly fourfold hike in US aid desig-
nated solely for payments support and, in the absence
of any general aid increases, would require converting
most current US assistance, military and civilian, into
cash grants. An IMF-supported standby program for
Egypt undoubtedly would ameliorate to some extent
the need for greater direct financing but would proba-
bly entail additional costs for the United States in the
form of supporting the IMF program and deferring
loan obligations.
We believe that the Mubarak government will not
accept an IMF adjustment program, at least not on
the IMF's usually strict terms, until it is convinced
that the United States will not provide the large
increases in assistance that would be required to meet
external payments. Depending upon the US response,
we see two possible scenarios evolving over the next
one to two years:
Scenario A-The United States limits additional
financial support. Under this scenario, Egypt would
probably be forced to accept an IMF program. Cairo
may view US unwillingness to extend additional
support as a repudiation of the special relationship it
believes it has established with Washington. Accord-
ingly, US-Egyptian political and strategic relations
would suffer. We do not believe, however, that Cairo
would renounce its adherence to the Camp David
accords unless it was convinced that other donors
would replace the United States, a prospect we regard
as unlikely.
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An IMF-supervised adjustment program and the
specter of foreigners dictating Egyptian economic
policies would give opposition groups a potent issue
against President Mubarak. The accelerated level of
economic reforms, including subsidy reductions and
price increases, would fuel additional discontent with-
in Egypt's lower and middle classes and possibly lead
to an explosive political situation. The government
might be able to deflect some criticism from itself and
assign blame to the IMF and the United States. It
would require, however, a rare combination of politi-
cal resolve, skillfully crafted economic policies, and
deft public relations handling for the Mubarak regime
to survive unscathed.
Less likely, Cairo could decide to act unilaterally like
Peru and consign only a fixed amount of its foreign
exchange earnings-for example, 10 percent-to re-
payment of foreign debt. Unilateral rescheduling
would provide the Egyptian Government with a more
politically palatable alternative to an IMF program
and would also give the government the flexibility to
fashion its own adjustment program-providing it had
the will to do so. A cutoff of short-term lines of credit,
however, would make trade financing extremely diffi-
cult for Egypt, given its low foreign exchange hold-
ings. Most bilateral creditors, including the United
States, would react with displeasure to unilateral
rescheduling but would probably refrain, for political
reasons, from an aid cutoff. The short-term benefits of
going it alone would be quickly dissipated if the
regime did not quickly accelerate the rate of economic
reform.
Scenario B-The United States provides significant
new levels of financial support. Higher levels of US
aid would probably delay Egyptian acceptance of an
IMF-supported adjustment program. It also would,
judging from Cairo's policy initiatives over the past
several years, lead to only modest acceleration in the
government's gradualist approach to economic re-
form. The fundamental structural weaknesses of the
Egyptian economy would remain, to be addressed at a
later date when corrective measures may entail even
harsher adjustments.
Greatly expanded aid levels would do little more than
preserve the political status quo. Additional balance-
of-payments support would appear largely invisible to
the Egyptian public and would not promote greater
support for ties to the United States. Moreover,
opposition political groups already criticize Egypt's
dependence on US aid. In the event that Egyptian
living standards continued to stagnate or decline, the
United States would probably be singled out more
frequently as the cause for Egypt's economic woes.
Cairo might then find itself under greater pressure to
be less cooperative in its dealings with the United
States, despite larger US aid commitments.
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