A political ultimatum to respond to dissent
On June 30, the anniversary of President Morsi's election, millions of Egyptians demonstrated against the worsening economic conditions in the country and the growing authoritarianism of Morsi. The protests, organized by the Tamarod (rebellion) movement, have increased pressure on the president and undermined the legitimacy of the Qandil-led government.
The armed forces have issued an ultimatum to the political forces and the Muslim Brotherhood, so that they can find a shared solution to the growing internal dissent, to date higher than that which had caused the fall of Mubarak in 2011.
The position of President Morsi, who claims the legitimacy of his election and rejects the ultimatum, appears to be critical at the moment even in the face of the defection of 5 government ministers. Although Morsi's support has dropped significantly, possible clashes between supporters of the president and anti-government demonstrators cannot be ruled out.
What scenarios?
The scenario with the highest probability of occurrence sees the Armed Forces pressing for an agreement between all political forces, including the Muslim Brotherhood and the identification of provisional authorities with the task of governing the country until the next parliamentary and presidential elections.
The hypothesis of a prolonged political stalemate is strengthened. The opposition, united by the Tamarod campaign and strengthened by the ultimatum of the Amate Forces, will hardly be able to remain united in the event of Morsi's removal from the country's political scenario.
The Armed Forces, which still play a key role at a political and economic level, will strengthen their weightwhile avoiding taking power directly. The ousting of a democratically elected president and the installation of a new military regime, especially after the disputed management of the 2011-12 transition period, remains a less likely scenario to happen.
The heightened instability will affect the timing of internal reforms. The risk increases that the governing authorities will not be able to meet the growing expectations of civil society and that postpone the adoption of necessary measures, such as the removal of subsidies, for fear of political and social resistance. Furthermore, the protests further weaken the ability of the authorities to conclude the agreement with the IMF, also delaying the disbursement of related international aid (a total of USD 14,5 billion).
In case Morsi does not accept the prospect of a withdrawal from the country's political scenario and the Muslim Brotherhood line up together in support of the president, would increase the risk of a polarization of political forces and a escalation of violence in the country.
The first possible effects on the Egyptian economy
The recent protests could further affect tourism and foreign investment, already tested by the political uncertainty and the worsening of the security level recorded in the last 2 years. In the case of the the tourism sector (which contributes overall to 15,1% of the GDP) there have been signs of recovery; however the levels continue to be lower than the pre-crisis levels (number of arrivals in the country: -17,3% in Q1 2013 compared to Q1 2010). Foreign investment inflows were also affected: inward FDI fell to 0,7% of GDP in 2012, down from 7,8% in 2007.
And the markets are watching closely. The perception of risk continues to grow, as evidenced by the increase in the cost of coverage against default of Egyptian sovereign debt (Fig. 1). Activity on the bond markets appears moderate in terms of subscription of government T-bills and T-bonds, a sign of the caution with which investors view events in the country.
Rating under monitoring. In recent months the main agencies of rating worsened their ratings on the country's creditworthiness (S&P's and Moody's: CCC+; Fitch: B); the OECD also downgraded its risk category (cat. 6/7). The worsening of the political-social situation and the difficulties of implementing a medium-long term macroeconomic strategy could lead to new downgrade.
An economy on the verge of collapse. Already seen ?
The political stalemate and the rift between civil society and political institutions make it even more difficult for government bodies to put the Egyptian economy back on a growth path and find a solution to the most pressing critical issues, such as the weak fiscal and debt position, the deterioration of reserves and the shortage of foreign currency.
Reserves continue to be under pressure (equal to USD 16 billion at the end of May and sufficient to cover 3,2 months of imports), despite the huge international support. In the past two months, reserves have reached their highest level since January 2012, thanks to loans from Libya and Qatar (USD 5 billion). However, the erosion of reserves has not guaranteed the stability of the Egyptian pound: since the beginning of 2013, the local currency has depreciated by 13,5% against the euro (Fig. 2).
Strong difficulties remain in meeting the demand for currency, despite the introduction by the Central Bank of a auction system for buying and selling foreign currency and the imposition of exchange controls and import restrictions. Since the introduction of the auctions in December, the ECB sold more than USD 3 billion to local lenders to meet demand for hard currency and regulate the import of priority goods (of which USD 1,165 billion in May alone to pay for imports of goods in preparation for Ramadan). A drop in reserves is expected in July, also linked to the repayment of approximately USD 600 million owed by Egypt to the Paris Club countries.
External debt remains low and estimated at 10% of GDP in 2012 (equivalent to USD 38,4 billion at the end of Q1 2013) and held mainly by bilateral and multilateral institutions. However, the share of short-term external debt increased from 8,4% of total debt in 2000 to around 17% in the last quarter of 2012; fig. 3).
The public deficit continues to rise: the budget deficit reached EGP 204.9 billion (11,8% of GDP) during July/May 2012/13. On the expenditure side, subsidies and the payment of interest on debt weigh above all (respectively 26.1% and 18.1% of total expenditure).
Concerns about domestic debt are growing, equal to 80,5% of GDP in 2012 and largely absorbed by the local banking sector. The government has made increasing use of short-term debt (equal to 35,5% of the public debt) and debt financing costs have increased significantly in recent years (yields above 14%; fig.4).
