Egypt: Budget deficit jumps 76% y/y to EGP 790bn in Jul-Jan

• As percent of full-year GDP, fiscal gap jumps to 5.9% of GDP, or 44% above pro-rated budget target
• Tax revenues rise strong 42% y/y mostly due to higher Income and VAT revenues, however, outlook has deteriorated
• Interest payments surge y/y due to higher interest rates, weaker pound
• Interest payments account for 124% of tax revenues in Jul-Jan and remain major credit weakness
• Spending on subsidies jumps 91% y/y; government retains costly bread subsidy to ease social tension
• IMF revises upwards fiscal deficit target for FY 2023/24 to 10.7% of GDP after additional borrowing, weaker pound

Egypt's overall fiscal deficit widened by sharp 76% y/y to EGP 790bn (USD 25.5bn) in the first seven months of FY 2023/24 (Jul-Jan), as strong y/y increase in interest payments, grain subsidy, and compensation of employees outpaced strong y/y increase in tax revenues, according to the finance ministry's monthly report. The fiscal gap-to-GDP ratio rose to 5.9% from 4.4% a year ago, as strong but slowing nominal GDP growth supports the key metric. The sharp deterioration in fiscal metrics points towards strong pressures in the fiscal account due to high interest payments and the weaker pound, while more indicators point towards slowing domestic demand, which should ultimately drag on tax revenues. The maturity of local currency debt remains low, and the government wants to extend it to ease the burden of expensive domestic debt. The IMF expects the fiscal deficit to widen to sharp 10.7% of GDP in FY 2023/24 on the back of high interest rates, the wage increases and the hike in social programs and subsidies. The actual fiscal deficit during the first seven months of 2023/24 is 64% above the pro-rated target (EGP 481bn), so the IMF's projection for 2023/24 seems more realistic than the government's one.

The government hiked the budget for subsidy and social protection by nearly 50% to EGP 530bn in FY 2023/24 as Egyptians struggle with surging living costs, FX shortages, and slowing economic growth. The government has revealed a new set of social measures aimed at easing the financial pressures on the most vulnerable and public sector employees, which are expected to cost the budget EGP 60bn a year. These measures include raising public sector wages, pensions, and grants. The government has also raised the annual income tax exemption threshold by 25% to EGP 45,000. This was the second time the exemption was raised in 2023 after the government lifted it from EGP 24,000 to EGP 36,000 from the beginning of the fiscal year. The tax cut is expected to cost around EGP 10bn.

The government recorded a primary surplus of EGP 173bn (1.3% of GDP) in Jul-Jan, compared to a primary surplus of 0.3% of GDP a year ago. Egypt had committed to a reform program built around fiscal primary surpluses, but the series of external shocks have become serious impediments to achieving the targets. A renewed and expanded program with the IMF may help Egypt reduce the fiscal deficit and the public debt, but Egypt needs to enhance revenue mobilization to lower its high public debt and large gross financing needs.

Budget implementation during Jul-Jan

Revenue

Fiscal revenue rose by strong 38.6% y/y to EGP 952bn in the period, accounting for 7.1% of full-year GDP. Tax revenues rose robust 42% y/y to EGP 778bn driven by Income (up 47% y/y) and VAT (up 30% y/y) as the government has rolled out programs to support consumption, which has come under pressure in more recent quarters. Egypt has imposed a new tax bracket of 27.5% on individuals, whose annual income exceeds EGP 800,000, although the tax exemption allowance on annual income was raised to EGP 45,000. Tax revenues from Suez Canal doubled y/y to EGP 67bn supported by higher tax rates as well as higher traffic and higher tonnages passing through the canal. Transit fees and transit surcharge fees for crude oil and petroleum product tankers have been raised a few times over the past two years, so the government eyes record large USD 8.7bn revenue in 2023. However, the security challenges in the Red Sea are already dragging on traffic and we estimate Egypt has lost USD 700mn revenue due to the traffic disruptions. Meanwhile, non-tax revenues rose by 25% y/y to EGP 174bn due to higher current revenue from service fees (such as public universities, medical centers, and research institutes).

We remind the government has been working on a medium-term revenue strategy in which it aimed to increase tax revenues by 2.0pps of GDP over the next four years by integrating the informal economy into the formal economy, expanding the tax base, and collecting public treasury dues. Egypt wants to link the tax and customs databases was and to digitize the tax system, and there has been some progress in these reforms. However, the economic challenges are likely dragging on government plans, while the IMF sees revenues-to-GDP staying flat over the medium term.

Expenditure

The total expenditure rose by strong 54.0% y/y to EGP 1,750bn in the period, which accounts for 13.0% of full-year GDP. The increase in spending came on the back of higher interest payments, wages, and subsidies to the state grain buyer. Interest payments rose sharp 100% y/y to EGP 963bn and account for 55% of total spending and 124% of tax revenues in the period. Debt service costs are thus the single largest category in spending and constitute a major credit weakness. The central bank has raised interest rates by cumulative 13pps since March 2022, which has made domestic debt more expensive - the relatively short maturity profile of Egypt's domestic debt makes the public finances vulnerable to interest rate movements. Further, the continuous increase in T-bills returns suggests the local market is now saturated and further purchases of local debt notes would come at higher interest rates. The finance ministry projects that public debt rose to 96% of GDP as of June 2023, up from the initial target of 84.0%, on the back of a weaker FX rate and rising interest rates. The government now expects debt-to-GDP to fall to 91.3% as of end-June 2024, and is aiming to cut the ratio below 80% by 2026/27.

Public investments fell 10% y/y to EGP 114bn as the government wants most of the ministries to freeze non-essential projects and spending that requires USD. The cabinet just announced that public investments will be reduced by 15% during the second half of the year, and focus will be put on infrastructure projects that are near completion. The expenditure on social benefits rose 6% y/y to EGP 113bn, partly because of the increased contributions from the treasury to the pension funds as well as new social programs and expanded coverage of the existing programs. Egypt had said it would support the most vulnerable amidst rising living costs as more and more families struggle with surging consumer inflation. Meanwhile, subsidy payments jumped 91% y/y to EGP 111bn, on the back of increase in subsidy payments to the state-run grain supplier (up 28% on the year). The government had also frozen the scheduled increase in electricity tariffs until Jan 2024. Egypt had already eliminated all fuel subsidies (excluding on butane gas cylinders, and fuel for bakeries and electricity plants), and was planning to reduce the costly bread subsidy before Russia's invasion of Ukraine. The war in Europe had forced the government to postpone its plans as bread prices are a sensitive topic in Egypt, where many families rely on subsidized bread, and pose risks for social tension.