Democracy Lab

Egypt's Financial High Noon

Cairo needs to tackle its subsidy addiction. And yes, it’s not going to be easy.

With another meeting earlier this week in Cairo, the Egyptian government continues its tortuous negotiations with the IMF about a $4.8 billion loan. The loan discussions have been ongoing for nearly two years, since soon after the fall of President Mubarak in February 2011. During that time, Egypt's foreign currency reserves have declined from roughly $36 billion to only $13 billion today, and the country faces an increasingly severe balance of payments crisis. It is literally running out of hard cash -- a dire problem since it imports much of its food and fuel. Egypt currently has less than 90 days of supply in its strategic wheat stock, an unnervingly small safety net for the world's largest wheat importer.

Despite a growing sense of urgency, the Egyptian government has not been able, or willing, to close a deal with the IMF. In fact, in the most recent round of talks, the government back-pedaled away from the set of economic reforms it put on the table last November, and now proposes more gradual steps to combat its fiscal deficit. Among the major sticking points with the IMF is Egypt's costly and unsustainable regime of subsidies, which currently consumes close to a third of the government's budget.

While it is widely recognized that food and fuel subsidies are expensive and inefficient, Egyptian leaders do not want to touch the political third rail of subsidy reform. Who can blame them? Seared into the memory of just about every Egyptian politician is the winter of 1977, when bread riots nearly toppled the government of Anwar Sadat. At the behest of the IMF, Sadat tried to roll back state subsidies on food staples and cooking fuel. It took the army -- and the re-imposition of the subsidies -- to restore order, but not before scores had died and hundreds of buildings had been sacked.

With an already tenuous situation on the streets of Cairo, Port Said, and other major cities, the Egyptian government is hardly looking to stir up more trouble for itself by rolling back the popular food and fuel subsidies that most Egyptians have taken for granted their whole lives. But Egyptian leaders also realize that without subsidy reform, the country's fiscal situation is untenable. Sooner or later, serious subsidy reform is inevitable. However, the Morsy government, like the military-led government before it, continues to kick the can down the road. Word has it that it's waiting until a new parliament is elected before tackling the subsidy behemoth.

Inconveniently, the date of the parliamentary election keeps getting postponed, and without some large cash infusion -- which doesn't appear forthcoming from either the IMF or Qatar, which has already given billions -- Egypt's coffers will run dry in just a few months.

Egypt is certainly not alone in its addiction to subsidies. Many rich and poor countries are likewise guilty of adopting subsidies that rarely meet their intended purpose but soon become politically entrenched. OECD countries spend more than $250 billion a year subsidizing agriculture, yet most of that goes to big agribusinesses rather than the revered family farmer. The International Energy Agency estimates that global energy subsidies amount to more than $500 billion. As in Egypt, the benefit of most energy subsidies is skewed not to the poor, but to businesses and middle class car owners, encouraging inefficiency and environmental issues. It is no surprise that Saudi Arabia, which spends some $43 billion per year to keep domestic fuel prices low, is the world's largest per capita consumer of oil. The steep rise of domestic consumption in the Kingdom due to subsidies has some analysts predicting that Saudi Arabia could become a net importer of oil by 2030.

In practice, subsidies create more problems than they solve by distorting the market in myriad ways, from encouraging wasteful consumption and corruption to depressing local production. In Egypt, decades of subsidized bread and other foodstuffs have discouraged domestic investment in the agricultural sector, resulting in lower local production. Corruption in the system is also rampant, with a thriving domestic black market and widespread smuggling of subsidized gasoline out of the country for resale at higher prices.

None of this makes eliminating subsidies any easier. But while the path to reform is littered with failed attempts and riots, some governments have succeeded in weaning off subsidies, and there are lessons to be gleaned from their experiences.

First, it is critical to communicate the importance and purpose of reform. Governments must take time to explain to their major stakeholders -- citizens, business groups, labor unions, and others -- the need for the painful adjustments and the benefits that will accrue from the changes. As a way of buttering up public opinion, Ghana preceded its 2005 fuel subsidy reduction by commissioning an independent study that demonstrated how society's richest benefited the most from subsidies. It also emphasized through billboards and radio spots how the poor would be compensated in other ways, such as raising the daily minimum wage and eliminating schools fees. Through these measures, it was able to avoid the large street protests that had undermined earlier reform efforts.

Iran, too, laid the groundwork for its 2010 subsidy reform through an extensive public relations campaign. The government explained its goal was not to eliminate subsidies for the poor, but to move from a grossly inefficient system based on products (cheap energy) to one based on households (through cash transfers). For months prior to the reform, the government printed electricity bills showing the true cost versus the subsidized rates households and businesses were paying as another way to educate the public.

In Egypt's case, the government needs to launch a concerted public relations campaign that exposes the wastefulness and corruption in the current subsidy system, and that also explains the potential in reallocating funds to more productive investments and targeted assistance to the poor. Cleaner air and less clogged streets should also have some appeal for urban elites.

Second, governments must present a comprehensive reform program that matches concrete benefits with subsidy reductions. Iran, for example, deposited cash compensation into household bank accounts in the weeks leading up to its subsidy reductions. Although these deposits were frozen until the day of the price increases, people were reassured knowing the money was actually there. According to an IMF assessment of Iran's subsidy reform program, in the first 12 months of the program the government replaced some $50-60 billion in energy subsidies with $30 billion in cash transfers to households and another $15 billion in support to industries to help them make investments in greater energy efficiency.

In contrast, Nigeria hiked fuel prices in January 2012, with only vague promises to channel the savings into future infrastructure spending in return. Given the government's sorry track record in meeting its commitments, the public was duly skeptical. Not surprisingly, widespread strikes and riots occurred, forcing the government to back down.

India, which spends north of $40 billion a year on food and energy subsidies, is heading down the path of transformational reform by replacing its bloated and corrupt subsidy system with direct cash transfers to the poor. Its challenge is one of execution. It first has to ramp up its rural banking network to make cash transfers on such a scale feasible -- a gargantuan task in a country of 1.2 billion people. Regional tests are off to a bumpy start, with beneficiaries complaining that cash transfers have not been delivered as promised.

In undertaking any major subsidy reform, Egypt faces its own credibility gap with citizens. Subsidy reform has been talked about on and off for years, with various plans presented but never implemented. Just in the past two years, several half-hearted initiatives have been put forward only to be ignored. In the face of such uncertainty, hoarding has spread, contributing to fuel shortages across the country. This makes clear and honest communication all the more important.

The way forward for Egypt is not rocket science: An effective subsidy reform program should focus first on the most costly and inefficient fuel subsidies, and then phase in other reductions in a systematic way. It should couple subsidy cuts with targeted cash transfers to poor households and transitional support for energy-intensive industries like glass and cement that will be most affected. Reform certainly won't be easy, but given that it's inevitable, a well-planned process is preferable to the alternative.



Syria Is Already More Violent Than Iraq

And its destruction will define the Middle East for years to come.

The year 2006 was pure horror for Iraq. It was hard to imagine the war going any worse: Sunni groups, spearheaded by al Qaeda's powerful local affiliate, launched a series of bloody suicide bombings against Shiite holy sites and civilian areas. On Feb. 22, 2006, a bomb ripped through the golden dome of the al-Askari mosque, one of the holiest sites in Shiite Islam -- though no one was killed in the attack, more than 1,000 people were killed in just the first day of sectarian bloodletting. Meanwhile, Iran-funded Shiite militias were making a mockery of the Iraqi government's claims of authority, controlling huge swathes of territory and attacking U.S. forces that tried to stop them.

According to the Brooking Institution's Iraq Index, a total of 36,591 Iraqi civilians and security forces died violently that year. Another 3,902 insurgents were killed in the fighting, according to figures released by the international military coalition. That means an average of 3,374 Iraqis were killed each month, or roughly 111 Iraqis died per day.

The destruction wrought by the Syrian conflict has already surpassed that horrible level of violence. The United Nations estimates that 70,000 people have lost their lives in Syria since the beginning of the conflict, and the death toll has only escalated in recent months. According to the pro-opposition Violations Documentation Center, 4,472 Syrians have been killed on average each month since December. That means over this span of time, an average of 149 Syrians have lost their lives daily.

Syria's population is roughly two-thirds that of Iraq -- it is home to roughly 22 million people, while Iraq's population totals around 31 million. Syria's victims, in other words, are coming from a considerably smaller population pool.

Ten years after the U.S. invasion of Iraq, it is hard to escape the war's effects on the Middle East: It shaped rising Sunni-Shiite tensions throughout the Arab world, served as the frontline in the U.S. struggle with Iran, and altered the political landscape in Damascus and Beirut. Now two years since the start of the Syrian uprising, the civil war there appears poised to define the coming decade in the Middle East no less than Iraq defined the previous one.

The Syrian refugee crisis has not yet reached the magnitude of Iraq -- but it is fast approaching it. The refugee wave in Iraq peaked around 2007, when the U.S. "surge" in troops caused more civilians to flee: According to the U.N. refugee agency, there were roughly 2.2 million Iraqi refugees at this point.

On March 6, the number of Syrians who had applied for refugee status with the United Nations hit one million -- the one millionth refugee was a 19-year old mother of two named Bushra, who fled from the city of Homs to Lebanon. And as the violence increases, the refugee numbers are mounting quickly: Since March 6, another 165,000 Syrians have fled their country. The head of the U.N. refugee agency said on March 10 that the number of Syrian refugees could double or triple by the end of 2013 if the conflict is not resolved.

The number of internally displaced people in Iraq during the war and Syria today is already similar. According to the United Nations, 2.4 million Iraqis had been displaced from their homes by the violence in 2007, and relocated elsewhere in Iraq. Meanwhile, U.N. statistics estimate that 2.5 million Syrians are currently internally displaced -- a testament to the fact that violence has spread to almost all cities and areas of the country.

While the challenge of providing for Iraqi refugees was daunting, the Syrian case is, if anything, more so. Syrians are scattered between a number of neighboring countries -- Lebanon, Turkey, Iraq, and Jordan -- and the United Nations estimates that it only has 30 percent of the necessary funds to provide for refugees for the first half of 2013. The plight of Syrians displaced within their country is even worse: The vast majority of aid money does not reach rebel-held areas, held up by red tape at the U.N. relief agencies in charge of aid distribution.

In terms of economic damage, there is no comparing the Syrian and Iraqi conflicts. The Iraqi economy -- boosted by an immense American investment, the lifting of Saddam-era sanctions, and the world's second-largest oil reserves -- emerged from the war battered but not broken. Iraq's GDP contracted by a dramatic 41 percent in 2003, as business came to a standstill with the beginning of the war -- but rebounded by 46 percent in 2004. Since then, the Iraqi economy has expanded an average of 4.5 percent per year. Iraq still faces serious economic problems -- notably, an excessive reliance on energy revenues -- but its troubles are dwarfed by the economic devastation in Syria.

A report prepared by the Syrian Center for Policy Research (SCPR), an NGO focused on economic issues that collaborated with U.N. officials and the Syrian Central Bureau of Statistics, estimated that almost half of Syria's wealth -- 45 percent of GDP, to be exact -- has been destroyed over the past two years. A report by the Institute for International Finance, a global association of financial associations, also found that the Syrian pound had lost 72 percent of its value since the beginning of the uprising, and projected that the country's economy will shrink by another 15 percent in 2013.

Unemployment in Syria, meanwhile, jumped to 35 percent since the beginning of the crisis -- a spike that will affect the livelihoods of over 6 million Syrians. Basic resources are also in short supply: Syria's electricity production has been cut in half due to fuel shortages, Damascus suffers frequent blackouts, and rebel-held areas receive only a few hours of power a day. Bread has also been scarce, with prices in Aleppo shooting up from 21 cents for a bag of eight loaves to nearly $3 in December.

Unlike Iraq, Syria also doesn't have the energy revenues to recover quickly from this war. According to BP's Statistical Review of World Energy, it sits on a meager 0.2 percent of the world's proven oil reserves -- by comparison, Iraq is home to 8.4 percent of the world's known reserves. Syria is also rapidly depleting its energy supplies: Oil production peaked in 1996, and has been declining ever since.

There are many views of how to respond to the Syrian crisis, but there should be little doubt that whatever the world does, Syria will shape the Middle East for years to come. Just like Iraq, the war has opened sectarian wounds throughout the region: In Lebanon, the Shiite militant party Hezbollah has joined the war on the side of Assad, while Sunni groups have crossed the border to assist the rebels -- and both expect the war's outcome to determine the balance of power in Beirut. In Iraq, the government of Prime Minister Nuri al-Maliki, a Shiite, has allowed Iranian planes bearing weapons for Assad to routinely fly across Iraqi airspace -- Iraqi Sunni militants, meanwhile, have provided assistance to the Syrian revolt and even killed 48 Syrian soldiers on Iraqi soil in early March.

Syria's disintegration will do more than exacerbate the Sunni-Shiite rivalry. In the north, the Kurdish community looks poised to carve out a de facto autonomous area, from which it could struggle for power with Arab anti-Assad rebels or even launch attacks into Turkey. In the south, the rebels' four-day kidnapping of 21 U.N. peacekeepers has raised the possibility that the lightly armed U.N. force that has helped keep on the peace on the Golan Heights for four decades could withdraw -- a move that could open the doors to Israeli intervention. And of course, radical Islamist groups such as the al Qaeda-linked Jabhat al-Nusra, which have already gained control of large swathes of territory and heavy weaponry, could maintain these safe havens in the chaos of Assad's fall. That would likely bring the war on terror to Damascus's doorstep.

As Gen. David Petraeus said one decade ago as U.S. forces plunged across the desert toward Baghdad: Tell me how this ends.