2007/2008 BUDGET APPROVED

UNCLAS CAIRO 002167

SIPDIS

SIPDIS
STATE FOR NEA/ELA, NEA/RA, EB/IDF
TREASURY FOR IA/MATHIASEN AND HIRSON
COMMERCE FOR 4520/ITA/ANESA/OBERG
E.O. 12958: N/A
TAGS: ECON EFIN EINV EG
SUBJECT: 2007/2008 BUDGET APPROVED

Summary
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1. (U) The Egyptian budget covering fiscal year 2007/2008 (July 1,
2007-June 30, 2008) was recently approved and the preliminary
results from the just-ended fiscal year were released as well.
Revenue collection remained robust (although not as strong as last
year) and growth of expenditures tapered off from last year, so a
deficit reduction is expected. The new budget contains many of the
same characteristics as budgets past, but some wrinkles as well.
Although deficit reduction is a key element of the economic reform
program, the government envisions an increase of expenditures in
2007/2008, so some recent progress on deficit reduction may be lost
next year. End summary.

Reforms reaping some benefits
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2. (U) Recently released budget documents indicate that the Finance
Ministry is already beginning to celebrate additional revenues
created from some of the recently enacted reforms: (i) wider tax
base as a result of lower rates and increased compliance, (ii)
tariff rate reductions leading to higher customs revenues, (iii)
Treasury Single Account reform reportedly generating interest
payment savings, (iv) interest payment savings from the
restructuring of the relationship between the National Investment
Bank and the Social Insurance Funds, (v) the stamp duty, and (vi)
the reduction in energy subsidies.


3. (U) Actual revenue collection for the recently-ended fiscal year
is expected at LE 172.1 billion ($30 billion),a 13.8 percent
increase over last year. Expenses were LE 212.1 billion ($37.3
billion),a 2.1 percent increase over last year. A significant
contributor to those increased revenues is estimated one-time
inflows of LE 28.6 billion ($5 billion) from privatizations. The
bulk of that comes from the third mobile license sale (LE 15 billion
or $2.6 billion) and the Bank of Alexandria sale (LE 9 billion or
$1.6 billion).

Subsidies are a mixed bag
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4. (U) Subsidies have long been an important part of any Egyptian
budget. Roughly 15 percent of the 2005/2006 budget (or six percent
of GDP),for example, was dedicated to energy subsides (excluding
electricity). To put that in perspective, the Egyptian Center for
Economic Studies estimates that energy subsidies are twice the
amount the government spends on defense and three to four times
those spent on health. Until the 2005/2006 budget year, these
subsidies were always implicit (i.e. not referred to in any budget
document),but Parliament and international pressure helped
encourage the government to reflect these figures.


5. (U) The new budget states a very welcome upfront goal of
redistributing subsidies from wealthy to the lower-income classes.
Energy subsidies have quadrupled in the last three years as a result
of steadily rising oil prices, even when taking into consideration a
partial reduction in subsidies last year, and Egypt still has some
of the highest energy subsidies as a percentage of GDP in the world.
The new budget envisions energy subsidies dropping slightly from LE
40 billion to LE 37 billion (from $7 to $6.5 billion),while the
overall subsidy bill will edge upwards from LE 54 billion to LE 58
billion (from $9.5 to $10 billion). Another improvement in this
year's budget is that the electricity subsidies, which had remained
implicit, are exposed as a line item (LE 2 billion or $352 million)
for the first time.

What to do with the windfall?
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6. (U) The Government is committed to reducing the budget deficit by
1 - 1.5 percent each year until reaching a goal of three percent in
2010/2011. Per the GOE figures, that yearly target was achieved in
FY2006/2007, as the estimated overall budget deficit fell from 8.2
percent to 6.7 percent. Faced with the choice of using the
windfalls to further reduce the deficit or to spend the windfalls,
the government envisions more of the latter in 2007/2008, while
stating its intention to still meet the 2011 deficit target. As a
result, the overall deficit is expected to tick slightly upwards to
6.9 percent of GDP next fiscal year. Much of the windfall in
2006/2007 went to retirement of non-performing loans in the public
banks (LE 9.2 billion or $1.6 billion). Other uses last year were
for the railroad refurbishment and expansion of sewage treatment
plants. The government has many social objectives it feels it must
address so the 2007/2008 budget envisions uses for teachers
salaries, housing, training, Upper Egypt, etc.


7. (U) Comment: Using the privatization receipts to clean up the
non-performing loans at the state-owned banks will obviously improve
the banks' bottom lines. However, the GOE still needs improve bank
management and risk management tactics so that the build up of bad
loans does not immediately repeat itself.

Transparency and budget process still needs help
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8. (U) Data accuracy and availability continues to be a problem in
Egypt, although improvements certainly have been made in recent
years, most notably with Egypt qualifying for the IMF's Special Data
Dissemination Standards several years ago. In 2006, the Open Budget
Institute gave Egypt a score of 18 (out of 100) on budget
transparency. The U.S. continues to work with the Ministry of
Finance to improve budget processes and transparency, but more work
remains. The Egyptian budget is not programmatically driven, nor
does it use results-based budgeting approaches. While the
Parliament is increasingly interested in trying to debate the
content of the budget, without aggregations by function, or analysis
of previous years' results or failures, the Parliamentarians' job is
made quite difficult. The Constitutional amendments approved earlier
this year do give the Parliament more potential influence over the
budget process. The amendments: allow Parliament to amend the
Government's budget proposal, allow Parliament to move funds from
one budget chapter to another, and provide Parliament with more time
to evaluate the budget before the fiscal year starts.

Inflation vs. deficit reduction
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9. (U) Despite the improvements in budget transparency, an analysis
of the budget still shows many areas of wasteful and unproductive
spending, and a lack of spending on development of human capital.
Unless wasteful spending is addressed, it may be difficult for the
GOE to make the needed investments in human capital and
simultaneously stay on track to reduce the deficit by 1.5 percent
each year. While the GOE expects several additional new revenue
measures in the coming year (real estate tax and VAT, most notably),
their revenue impact is also expected to be minimal, at least
initially. Government spending is a large contributor to money
growth, and is contributing to higher than anticipated inflation in

2007. It is precisely these fears of increased inflation which
account for GOE hesitation in introducing the VAT and making further
subsidy reductions. While these two steps would have a positive
effect on the deficit, increased inflation exacerbate the already
skeptical attitude of much of the Egyptian population toward the
benefits of the government's economic reforms.