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Cablegate: Egypt's Fy2005/06 Budget: A Makeover

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 CAIRO 004374

SIPDIS

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

SENSITIVE

E.O. 12958: N/A
TAGS: ECON EFIN ETRD EINV EG
SUBJECT: EGYPT'S FY2005/06 BUDGET: A MAKEOVER

-------
Summary
-------

1. (U) On June 7 the People's Assembly passed the budget
for fiscal year (FY) 2005/2006. The new budget was drafted
using the IMF Government Finance Statistics format, which
allows for better use of fiscal tools and better assessment
of the impact of fiscal policies on Egypt's economy. Total
expenditures in FY 05/06 are projected to reach LE 188.7
billion and total revenues LE 130.2 billion, with a budget
deficit of LE 58.5 billion or 9.3% of projected GDP. The
GOE will need LE 56.4 billion, or 9% of GDP, in net
borrowing to finance its deficit. The new budget format
provides greater detail regarding revenues and expenses,
including itemization of direct and indirect subsidies and
expenditures previously categorized simply as "off-budget"
expenses. The new format directly addresses local and
international concerns regarding GOE fiscal transparency and
the need to continue reforms to support economic growth.
End summary

------------------------------
Parliament Approves GOE Budget
------------------------------

2. (U) On June 7 the Egyptian parliament approved the draft
GOE budget for FY 2005/2006 (July 1, 2005 to June 30, 2006),
which was unveiled by the Ministry of Finance (MOF) in late
May. Projected government expenditures in the approved
budget are LE 188.7 billion, up 17.9% from the current FY
2004/2005. Projected revenues are LE 130.2 billion, up 11%
from the current FY. The projected deficit is LE 58.5
billion, or 9.3% of the projected FY 05/06 GDP of LE 629
billion, a slight decrease from the current FY deficit of
10.3% of GDP. Parliament increased by LE 860 million the
funding allocated for education, health and utilities
programs. President Mubarak is expected to sign the budget
before July 1, after which it will be published in the
Official Gazette. MOF also intends to publish the new
budget on its website.

3. (U) In drafting the budget, MOF used, for the first
time, the IMF Government Finance Statistics (GFS) 2001
system, an international standard system that significantly
improves the budget's transparency. Parliament cleared the
way for use of this new system in April 2005, when it
amended the law regulating the GOE budget. The amendment
allows for restructuring of the GOE budget to render it more
consistent with IMF government accounting standards, a long-
time concern of the international financial institutions and
foreign donors, including the USG. MOF intends to reformat
prior year budgets using the new system and post the
revisions on its website. Until this is done, however,
comparison of the FY05/06 budget with the current FY budget
is only possible for a limited number of items.

4. (U) Unlike the previous budget format, the new GFS
system specifies all expense and revenue items for all
government agencies (with the exception of the military).
Details are provided for all transactions affecting
financial and non-financial assets, as well as expenses
previously classified simply as "off-budget" items. Under
the new system, indirect subsidies are also now clearly
identifiable, as details must be provided for all government
agency expenditures. Unlike the previous format, which
broke the overall deficit into three distinct tiers and made
it difficult to assess the GOE's financing needs, the new
system produces an aggregate monetary deficit figure. This
makes it easier to determine net government borrowing,
project future expenses and revenues based on past
performance, and quantify the impact of fiscal policies on
government finances and the national economy.

-------------------------------------------
Egypt's Statement of Government Operations
-------------------------------------------

5. (U) Revenues: Total revenues in FY05/06 are projected
to reach LE 130.2 billion, compared with LE 102.5 billion in
FY04/05, an increase of 27%. Revenues include LE 81.6
billion from taxes, up 21.5% from the actual preliminary
figures for FY04/05. (Note: This is based on the
assumption that macroeconomic reforms will increase the
growth rate to 5%, thereby increasing the tax base and
offsetting the reduction in the marginal tax rate enacted in
a new tax law, which will be reported septel. End note); LE
2.9 billion from foreign and domestic grants; and LE 45.7
billion from other revenues. The breakdown of the
government's tax income includes LE 40.9 billion from
general income tax, LE 25.5 billion from sales tax, LE 8.99
billion from customs and LE 6.3 billion from other tax
sources, all constituting 62.7% of total revenues. Foreign
and domestic grants, in the form of direct transfers to the
budget, remain relatively stable, averaging LE 1.68 billion
in both FY04/05 and FY05/06. Foreign and domestic grants
for investment purposes dropped from LE 3.4 billion in
FY04/5 to LE 2.9 billion in FY05/06. Other revenues include
proceeds from several economic entities, including the
Petroleum Authority, Suez Canal Authority and the Central
Bank of Egypt. The Petroleum Authority is expected to
transfer LE 12.6 billion to the general budget in FY05/06,
compared with LE 6.5 billion in FY 04/05. The increase is
largely due to re-categorizing of energy subsidies in the
new budget format. Energy subsidies were previously
identified as expenses of the Petroleum Authority, thereby
reduced that entity's profits. The subsidies are now
categorized as general GOE subsidies.

6. (U) Expenses: Total expenses for FY05/06 are LE 188.7
billion, up 17.9% from LE 160 billion in FY04/05. Expenses
include LE 46.7 billion for compensation of public
employees, a 14% from FY04/05. (Note: In what appears to
be an election year move, the GOE has announced a 30% pay
raise for public employees, substantially exceeding the
normal 10% annual increase. End note.) LE 13.2 billion is
allocated for Use of Goods and Services acquired by the GOE
to provide public goods and services; LE 42.6 billion for
interest payments, up 12.4% from FY04/05; LE 50.6 billion
for subsidies, social benefits and grants; LE 18.2 billion
for other expenses; and LE 17.4 billion for purchase of non-
financial assets, also known as investments, which will
decrease by 14% compared to FY04/05. The decrease in
investment spending is likely due to the GOE's move to rely
more on private sector investment to stimulate the economy.
The subsidies, grants and social benefits item includes, for
the first time, details on direct and indirect subsidies for
food and energy. Direct subsidies totaled LE 15.6 billion
in FY04/05 and will increase to LE 35.4 billion in FY05/06.
Interest payments includes interest on domestic public debt
of LE 38.4 billion; interest of LE 4.02 billion for external
public debt; and LE 0.21 billion for expenses related to
debt servicing.

7. (U) Operating Balance/Deficit: The comparison of
revenues and expenses shows government revenues cover only
69% of operating expenses, or 30% of GDP, while revenues
constitute only 20.7% of GDP. The deficit resulting from
the shortage in revenues totals LE 58.5 billion, or 9.3% of
the projected GDP for FY05/06. In the GFS system, the
deficit is also known as the government's Operating Balance,
which reflects the ongoing stability of the government's
operations.

8. (U) Deficit Financing: The GFS system also requires
calculation of the net acquisition of financial and non-
financial assets (i.e., net borrowing), which is projected
at LE 1.73 billion for FY05/06 budget. This amount is added
to the general deficit, increasing the total to LE 60.3
billion or 9.6% of GDP. Total financing needs for FY05/06
are projected at LE 77.8 billion, mainly coming in the form
of loans from the National Investment Bank (LE 14.3
billion), external loans (LE 0.91 billion), and Treasury
bills and bonds (LE 61.7 billion). The GOE's net borrowing
needs are then calculated by subtracting LE 3 billion in
projected proceeds from privatization of public companies in
FY 05/06 and LE 20.5 billion in public debt payments
throughout the year from total financing needs, yielding a
net borrowing need of LE 57.3 billion, or 9.1% of GDP.

-----------------
Policy Objectives
-----------------

9. (U) During his presentation of the budget to parliament,
Minister of Finance Youssef Bhutros Ghali (YBG) stated that
the FY 05/06 budget was not only more transparent, but also
seriously addressed the economic problems facing Egypt,
including the need to increase efficiency, decentralize
fiscal policy, encourage investments, stabilize prices,
create jobs and improve services while focusing on sectors
with a comparative advantage. With this aim in mind, YBG
said the budget sets out three specific policy objectives:

- Growth and achievement of GOE fiscal targets. The budget
set a target growth rate of 6% for FY05/06, while reducing
inflation to 6-7% by increasing investment and employment.
Social programs remain intact to protect low-income earners
and provide basic services, but spending priorities are
designed to ensure, in the medium term, continued growth,
price stability and rational management of the deficit and
public debt.

- Assessment of the macroeconomic impact of fiscal policies.
The new budget format allows the GOE to better identify
revenue and expense items that directly affect economic
activity and production of goods and services. Calculation
of the net balance of financial and non-financial assets
also allows for assessment of the effect of public spending
on the deficit and ultimately the GOE's need for deficit
financing from the banking sector, CBE or other sources.

- Modernization of fiscal policy tools. Restructuring of
the GOE budget complements the recent customs and tax
reforms, which were designed to improve domestic and
external competitiveness.

--------
Comment:
--------

10. (SBU) In line with the GOE's recent agreement to
publish IMF Article IV, the new budget brings the GOE one
step closer to meeting international standards for fiscal
transparency. Local analysts are generally positive about
the new budget and the fact that the GFS format allows the
GOE, and outside observers, to actually assess the outcome
of the GOE's fiscal policies. This will certainly
facilitate the ongoing World Bank public expenditure review
by helping to identify areas in which further reform is
needed. Indeed, the budget appears designed to consolidate
the reforms already made under the Nazif administration and
set the stage for continued reform, particularly in the area
of subsidies. One local private sector economist noted that
by clearly identifying subsidies, the GOE will be better
able to make the case to the Egyptian public that spending
on subsidies is excessive and in need of reform.

11. (SBU) Despite the increase in transparency, however,
the new budget has its limitations. Specifically, it does
not disclose military spending, which accounts for a large
percentage of annual expenses. In not disclosing the
details of military spending, another set of subsidies,
namely those to military personnel and their families, is
not specified. Given the perhaps overly optimistic
projection of revenues for FY 05/06, reform of large
expenditures, such as subsidies, is badly needed to control
an already large deficit. Such reforms, however, will
likely have to wait until after this year's elections. End
comment.

---------------------------------------
Draft Budget As Presented to Parliament
---------------------------------------

12. (U)

(LE Billion) Projected
Budget Budget % Change

Fiscal Years 2004/2005 2005/2006
--------------------------------------------- ------------

Expenses, 160.00 188.67 17.92
Including:
Wages and Compensation 41.00 46.70 11.80
Use of Goods and Services 9.94 13.24 33.20
Interest 38.43 42.61 10.88
Subsidies, Social Benefits
And Grants 29.32 50.55 72.41
Other Expenses 21.05 18.19 (13.40)
Purchase of Non-Financial
Assets 20.26 17.40 (14.15)


Revenues, 102.46 130.15 27.03
Including:
Taxes 71.21 81.61 14.60
Grants 2.90 2.86 (1.38)
Other Revenues 28.35 45.68 61.13

Deficit (Operating Balance) 57.54 58.52

GDP 558.00 629.00
Deficit/GDP (%) 10.3 9.3


Net Borrowing:
Net Acquisition of Assets 1.73

Total Deficit 60.25
Payment of Debt Installments 20.55
-----
80.80
Privatization Proceeds 3.00

Financing Required 77.80
Covered by*:
Loans from National Investment Bank 14.33
External Debts to Finance Investments 0.91
Borrowing using T- Bills and Bonds 61.71
* Available information did not indicate how the
additional LE 850 million will be financed.

New Financing Needs 77.80
Payment of Debt Installments 20.55

Net Borrowing 57.25
Net Borrowing/GDP(%) 9.11


------------------------------
Administrative Classifications
------------------------------

13. (U)

FY04/05 Projected FY05/06

Activities Admin. Municipal Services Total*

Public
Services 55.75 54.09 7.97 0.63 62.69
(LE Billion)

Defense
And Nat'l
Security 14.11 15.63 -- 0.007 15.64

Public Order
And Public
Security
Affairs 7.52 7.90 -- 0.41 8.31

Economic
Affairs 10.91 3.86 1.99 3.43 9.29

Environment
Protection 0.71 0.70 -- 0.26 0.96

Housing,
Utilities/
Communities 3.76 0.90 0.25 2.39 3.55

Health
Affairs 7.64 3.56 3.04 1.61 8.21

Youth, Culture
And Religious
Affairs 5.45 4.95 0.45 0.92 6.32

Education 22.69 4.01 14.46 6.22 24.69

Social
Protection 31.56 47.60 0.52 0.06 48.18

Total 160.10 143.19 28.68 15.95 188.67
* Available information did not indicate how the
additional LE 850 million will be financed.
GRAY

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