EGYPT: INFLATION ON THE RISE

UNCLAS CAIRO 006636

SIPDIS

STATE FOR NEA/ELA, NEA/RA, AND EB/IDF
USAID FOR ANE/MEA MCCLOUD
USTR FOR SAUMS
TREASURY FOR NUGENT/HIRSON
COMMERCE FOR 4520/ITA/ANESA/TALAAT

SIPDIS

E.O. 12958: N/A
TAGS: ECON ENRG EG
SUBJECT: EGYPT: INFLATION ON THE RISE

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Summary
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1. (U) Inflation began creeping back into Egypt's economy in late
spring, as food prices rose in response to an outbreak of bird flu.
Prices rose further in late July, when the GOE reduced its massive
energy subsidy. Higher fuel costs affected prices across the board,
leading the GOE to intervene in a variety of ways to keep prices
under control. Despite the intervention, the start of Ramadan
further squeezed consumers, who normally spend lavishly during the
fasting month. The GOE maintains that economic growth and rising
wages are the real driving factors behind inflation. While there is
scant evidence to back up the claim to rising wages, consumer
spending has increased, prompted by greater liquidity and low
interest rates. The tempered reaction of the Egyptian public to
rising prices leads many analysts to speculate that the GOE will
further reduce subsidies in the near future. The challenge will be
targeting the reductions to ensure the poorest sectors of society
are not adversely affected. End summary.

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Inflation Fueled by Bird Flu, Subsidy Reduction
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2. (U) After more than a year of declining prices, inflation began
creeping back into the Egyptian economy in late spring. From a low
of 4.4 percent year-on-year in April, overall inflation has risen
steadily over the last six months to 9.5 percent currently. An
outbreak of bird flu in January, which devastated Egypt's poultry
sector, began pushing up prices of poultry and other meats in April.
The cost of food and non-alcoholic beverages, which has the
heaviest weighting (39 percent) in the Consumer Price Index, rose
5.7 percent in April, and continued to climb through the summer,
peaking at 11.7 percent in August. Communication costs also shot up
in April, as Egypt's telephone monopoly Telecom Egypt raised rates
on fixed lines to compensate for losses from competition by mobile
phone providers. Telephone rates increased 20 percent monthly from
April through June, and 22.7 percent in July.


3. (U) In late July, consumers and industries felt more pain as the
GOE reduced its massive energy subsidy. Prices of natural gas for
industrial use and electricity generation rose by 25 percent,
kerosene 88 percent, fuel oil 67 percent, diesel oil 25 percent and
gasoline (90 octane) 30 percent. The energy subsidy reduction
effected prices across the board, as industries passed on to
consumers the increased cost of manufacturing and transportation.
Housing and utility costs rose 6 percent in August and September, up
from 2.2 percent in July. Cement prices, a key factor in
construction costs, increased 10-25 percent in August, depending on
proximity to cement factories. Overall ex-factory prices rose from
LE 310-315/ton to LE 350/ton, while in some retail markets,
particularly those with no nearby cement factory, prices rose to as
high as LE 390/ton.

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GOE Intervenes to Control Prices...
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4. (U) Ironically, the energy subsidy reduction forced the GOE to
increase other subsidies. Dr. Abdel Sattar Eshrah, Economic Advisor
for the Federation of Egyptian Chambers of Commerce (a joint
governmental and business entity),told econoff that bakers
complained they could not maintain stable bread prices as more
expensive fuel led to higher operating costs. The GOE reduced the
price of a case of government flour from LE 20 to LE 14.5 (and
revamped its inspections of bakers who obtain flour at the new price
to ensure quality). The overall effect on the GOE budget was still
positive however, as food subsidies - representing only 2.1 percent
of GDP - are less expensive than energy subsidies, which represent 8
percent of GDP. The GOE intervened more directly in the cement
sector. Minister of Trade and Industry Rachid met with cement
producers in August to persuade them to observe a price cap of LE
330/ton for retail sales and LE 290/ton ex-factory. Although the
cap was voluntary, Rachid threatened harsh export tariffs for
producers taking advantage of higher prices on foreign markets. He
also promised assistance to companies that lost money by adhering to
the cap. The plan succeeded, and by the end of the month ex-factory
prices fell to as low as LE 300 per ton.

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... but Ramadan Increases Consumer Woes
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5. (U) Despite GOE intervention to moderate prices - including
lifting an imported poultry ban to prepare for high demand during
Ramadan - the start of the fasting month in late September
exacerbated pressure on consumers. Shopkeepers generally exploit
consumer willingness to spend lavishly during Ramadan, and weak
competition and even weaker consumer protection make predatory
pricing easy for suppliers and shop owners. Ramadan coincided this
year with the beginning of the academic term, when household
discretionary spending traditionally inflates to buy new clothes and
school supplies. Press reports lamented the effect of high prices
on the poor, and pointed out that public sector wages, and to a
lesser degree salaries in the private sector, have not kept pace
with rising consumer costs.

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GOE Claims Growth is the Real Cause
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6. (U) GOE officials maintain that the driving force behind
inflation is economic growth, rather than external factors. GOE
figures estimate a growth rate of 6.9 percent for FY 2005/2006, the
highest level in 15 years. Officials also maintain that public
sector wages are keeping pace with inflation. Amina Ghanem, an
Advisor to the Minister of Finance, told econoff that the annual
increase in the public sector wage scale generally offsets higher
living costs. The normal increase is 10 percent annually, only
slightly higher than the current inflation level. The 2005 increase
- a one-time jump of 20 percent - was widely seen as an election
year pitch to the public sector by President Mubarak, who was
running for re-election in Egypt's first ever multi-candidate
presidential election. Given the extremely low base rate of public
wages, however, and years of double digit inflation following the
floating of the Egyptian Pound in January 2003, most analysts
believe the annual increases, even last year's, are not sufficient
to meet basic consumer costs and keep pace with inflation.

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Despite Stagnant Wages, Consumers Still Spending
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7. (U) While there is scant evidence of a rise in real incomes,
consumption spending has risen. Household credit, a prime indicator
of consumption spending, shot up 26 percent in March/April and 28.6
percent in July, compared to only 10.8 percent in October 2005.
Liquidity has risen 12-13 percent y-o-y since January 2006,
stimulated in part by last year's 50 percent tax cut. Low interest
rates on bank deposits, triggered by low Central Bank rates, have
also reduced consumers' incentive to save. The Monetary Policy
Committee (MPC) of the Central Bank has held corridor interest rates
unchanged since April 2006 (an overnight deposit rate of 8 percent
and lending rate of 10 percent),constantly declaring that
inflationary pressures are within moderate limits. In its October
meeting, however, the MPC signaled the possibility of a rate
increase in November.

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Reaction Tempered
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8. (U) Despite grumbling over wages, public reaction to high
inflation has been moderate. Local papers have run stories on the
harsh conditions for the poor this Ramadan, but grumbling has not
turned into protests or violence. The stoic reaction of Egyptian
consumers has led some observers to speculate that the GOE will make
more subsidy reductions soon. Dr. Tamer Abu Bakr, head of the
Petroleum Committee of the Egyptian Businessman's Association and
member of the National Democratic Party Energy Committee, told
econoff that he expects another fuel subsidy reduction in early

2007. The still massive energy subsidy, at least LE 40 billion (USD
7 billion) by most estimates, is responsible for 40 percent of the
GOE's budget deficit, which stands at approximately 10 percent of
GDP.


9. (U) Nevertheless, the GOE will be hard-pressed to further reduce
its fuel subsidy without affecting the poorest segment of the
population. Hany Kadry Dimian, Director of the Macro-Fiscal Unit at
the Ministry of Finance, told econoff that the GOE's aim in subsidy
reform is to target subsidies to the poor. This is the reason that
the GOE left the price of 80 octane gasoline - the lowest-quality
gasoline available - untouched in July. However, according to Abu
Bakr, this had an unintended effect, in that people who previously
used 90 octane gasoline are now using 80 octane, regardless of the
effect on their engines. Future subsidy reductions will somehow
have to deal with 80 octane gasoline, which could prove to be a
sensitive social issue.

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Comment
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10. (U) While economic growth has outpaced even the GOE's
expectations, it has not, unfortunately, translated into job
creation. The GOE is therefore faced with the double challenge of
maintaining growth while mitigating the negative effect of inflation
and subsidy reductions on the poor and unemployed. For the time
being, Egyptians seem prepared to take the government's word that
growth will eventually lead to jobs, but much of the educated middle
class isn't waiting around, and continues to seek opportunities for
work abroad. Indeed, remittances from family members working
overseas are often the only thing keeping Egyptian families afloat
as prices increase, but job opportunities do not. End comment.
RICCIARDONE