GOE RAISES FUEL PRICES TO OFFSET SALARY INCREASE

UNCLAS CAIRO 000959

SENSITIVE
SIPDIS

STATE FOR NEA/ELA, NEA/RA, AND EEB/IDF
USAID FOR ANE/MEA MCCLOUD AND RILEY
USTR FOR MOWREY
TREASURY FOR MATHIASON AND CONNELLY
COMMERCE FOR 4520/ITA/ANESA/OBERG

E.O. 12958: N/A
TAGS: ECON EFIN EPET PGOV EG
SUBJECT: GOE RAISES FUEL PRICES TO OFFSET SALARY INCREASE

Ref: Cairo 930

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SUMMARY
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1. (SBU) Parliament passed a series of revenue generating measures
to offset the cost to the budget of the 30% wage increase announced
by President Mubarak on April 30 (reftel). The measures include
fuel and cigarette price increases, higher automobile registration
fees, and imposition of some new taxes. The measures met with
considerable opposition both in parliament - with all independents
and members of the Muslim Brotherhood bloc voting against the
changes and several ruling party members not supporting the measures
- and among the Egyptian public. Many contacts believe the move
essentially cancels the positive effect of the salary increase.
Economic analysts are also concerned that the measures, especially
fuel prices increases, will exacerbate inflation. From a fiscal
viewpoint, the new revenue will help ensure that the deficit does
not worsen, but politically, this step may make it more difficult
for the GOE to make structural changes to the subsidy system. End
summary.

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PARLIAMENT PASSES NEW REVENUE MEASURES
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2. (U) On May 5, Egypt's parliament approved several new revenue
measures to offset the cost of the 30% public sector salary increase
(approximately LE 4.86 billion, or $916 million) announced by
President Mubarak on April 30 (reftel). Mubarak had ordered the
government to ensure that the salary increase was "budget-neutral."
The Ministry of Finance (MOF) had already submitted the FY 2008/09
budget to parliament before Mubarak announced the salary increase,
thus necessitating additional revenue-generating measures to ensure
the projected deficit of 6.9% did not worsen. While the new
measures may prevent the deficit from worsening, they are unlikely
to help the GOE reach its stated goal of reducing the deficit to 4%
by FY 2010/11. Inflation is also likely to increase as the new
measures, especially a decrease in the fuel subsidy, take effect.
Inflation continued to climb in April, reaching 16.4%, up from 14.4%
in March. Analysts expect inflation to reach 20% in May, when the
fuel price increases register on the CPI.

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ANATOMY OF THE NEW MEASURES
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3. (U) The new revenue measures include (NOTE: All revenues
estimates are taken from media reports):

-- An increase in the price of 90, 92 and 95-octane gasoline, diesel
(gas oil),and kerosene by 35%, 32%, 57%, 47%, and 47% respectively.
The new price for a liter of each of these fuels is now LE 1.75
($.33),LE 1.85 ($.34),LE 2.75 ($.51),LE 1.1 ($.20) and LE 1.1
($.20) per liter, respectively. These measures are expected to
reduce the GOE fuel subsidy bill by LE 5.94 billion ($1.11 billion),
bringing to it to an estimated LE 52.06 billion ($9.73 billion) for
FY 2008/09.

-- A 10% increase in sales tax on locally-made cigarettes and 33%
percent on imported cigarettes. This is expected to raise LE 1.3
billion ($243 million) in additional revenues.

-- A 20% tax on interest earned on treasury bills.

-- Private schools and universities will lose their tax exemptions,
raising an estimated LE 100 million ($18.8 million) in May-June

2008.

-- Prices of natural gas used by energy-intensive industries,
including steel, fertilizer and petrochemicals, will increase 58%
from LE .36 ($.06)/cubic meter to LE .57($.10)/cubic meter,
generating an estimated LE 1.6 billion ($299 million) in revenue.

-- Energy-intensive industries operating in industrial free zones
will also be subject to increased registration fees, equivalent to
LE 600 million ($112 million) in revenues.

-- Quarried clay, used in the manufacture of cement, will be subject
to a new LE 35($6.5)/metric ton tax, expected to bring in LE 1
billion ($187 million) in revenue.

-- New annual registration fees for private vehicles. Registration
fees on vehicles are not high in nominal terms, but will increase
significantly on a progressive basis determined by engine size. The
GOE expects this measure to earn about LE 1.1 billion ($205 million)
annually.

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UPSET REACTION
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4. (SBU) Debate was heated in parliament before the measures passed
by 297 votes. The National Democratic Party (NDP) MPs largely (but
not unanimously) supported the changes and all opposition
parliamentarians (including the 87-member bloc of Muslim Brotherhood
(MB) MPs) voted against them. The opposition accused the government
of conspiring to undermine the impact of the wage increase. One
opposition MP told emboff that the regime proved through this move
that it enjoys "a great deal of stupidity and foolishness." The
government argued on the parliamentary floor and in coordinated
appearances by senior ruling party officials and ministers on
evening TV talk shows, that the changes were necessary to prevent
the wage increase from exacerbating inflation. The MB posted a
statement on its website opposing the fuel price increases, and
called on the government instead to "restore the country's stolen
wealth from business tycoons and punish the corrupt." The MB
roundly blames the government for the current economic difficulties
faced by the poor and middle class and predicted that higher fuel
prices will further deteriorate most Egyptians' standard of living.



5. (SBU) We polled several Egyptian contacts on their reaction to
the price increases. Some said that the government should have
raised passage fees on the Suez Canal or the price of controversial
natural gas exports to Israel instead of burdening the
already-suffering Egyptian population. Other contacts argued that
the president and his government have made those who refused to take
part in the recent May 4 general strike "feel like real fools,"
adding that "the government would have sufficient funds for
everything if it simply cut ministers' expenses and the Ministry of
Interior's legions of Central Security Forces, which beat Egyptian
demonstrators." Many sought comfort in saying that "the president
cannot live much longer and this could be the beginning of a big
wake-up in Egypt." Others derided the government and NDP policies,
saying that "they will ultimately bring the president down."
Separately, gas station workers, who do not receive salaries and
rely on tips instead, said they will be hard-hit by the increase in
fuel prices because customers will stop tipping.


6. (U) Despite these comments, the immediate impact of the price
hikes has been minimal, with no major demonstrations or violence.
However, press reports claim that fistfights, like those seen in
bread lines recently, have been breaking out around Cairo during
rush hour as minibus drivers dispute prices with passengers.
Cairo's privately-run minibuses, which service low-income earners,
have increased their prices as of May 7 by as much as 50%. For
intercity travel, for example, the price of a ticket to go from
Shobra (in Cairo) to the delta city of Mehalla has gone from LE 7
($1.32) to LE 8 ($1.50). Within Cairo, the price has gone from 30
($.05) to 50 piasters ($.10). For already squeezed lower-income
Egyptians, such price increases are difficult to bear. There are
unconfirmed reports that in the wake of the price increases,
thousands of plain-clothes policemen were deployed throughout Cairo
"just in case."

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COMMENT
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7. (SBU) Analysts had been concerned that the 30% salary increase,
coupled with additional spending on subsidies, would set the GOE's
deficit reduction goal back by several years. From a purely fiscal
standpoint, the government's new measures help address these
concerns. The larger-than-expected increase in salaries may have
caught the MOF somewhat off guard, as the new revenue-raising
measures are a mixed bag of ideas MOF had on hold pending the need
to generate additional revenue and hastily conceived ideas that are
not yet fully developed. The energy increases, for example, are the
third in a series since 2004 and are part of a longer-term subsidy
reduction plan previously articulated by the government.
Elimination of the exemption for energy-intensive industries
operating in the free zone, however, lacks some clarity. Tax exempt
status is an important part of being a "free zone," so it remains to
be seen how the move will impact business.


8. (SBU) Some measures may have unintended positive effects. The
tax free status of t-bill earnings has until now been a major factor
in the reluctance of Egyptian banks to identify new customers and
expand their lending. The measure could act as an incentive to
encourage banks to more aggressively seek profits through lending
and through expanding their loan portfolios, providing more credit
to the economy. Banks have had the luxury of not pursuing new
customers, given the favorable rates on t-bills, combined with their
tax free status. As the measure will not apply to bonds, and the
government is trying to expand the bond market, the measure could
also spur development of longer term debt instruments, which the
Egyptian economy needs.


9. (SBU) From a political standpoint, the skeptical Egyptian public
views the 30% salary raise, closely followed by the gas and
cigarette price increases, as President Mubarak "giving with one
hand, and taking away with the other." The price increases feed
into already simmering public resentment about inflation in general.
In the current economic environment, we do not believe the
government will undertake major structural reform of the subsidy
program, though it will continue to chip away at the fuel subsidy.
Even with the current price increase for gas, however, Egypt still
has some of the most regressive energy pricing in the world.
Equally unlikely is the prospect that the government will tackle the
other major fiscal drain, the bloated civil service.
SCOBEY