Date: Feb 3, 2018 Source: The Daily Star What Tunisia and Sudan can learn from Egypt on subsidy reform Brendan Meighan In the past year, finance ministers and central bank chiefs throughout the Middle East have paid close attention to how the Egyptian economy has responded to a substantial depreciation of the pound, interest rate hikes and a variety of structural reforms the government agreed to ahead of the International Monetary Fund’s $12 billion loan. Egypt’s idiosyncratic economy serves as an example of how procrastination and prevarication in addressing economic policy tensions that have built up over decades can exacerbate short-term crises – but also how to earn popular political trust in a high-inflation environment. At the moment, Tunisia and Sudan have the most to learn from Egypt, where modest efforts at subsidy reform have proven successful. Although each country’s governmental structures and economic philosophies are dramatically different, with Tunisia adopting a more liberal and flexible exchange rate regime and Sudan continuing to rely on a confusing system of continually falling hard pegs, both are in the middle of navigating a rather tumultuous economic and political environment domestically. Egypt had long subsidized both food and various forms of energy, namely electricity and motor vehicle fuels. With a widening fiscal deficit and a chorus of academic, private-sector and multilateral economists having for years sounded the call for subsidy reform, Egypt shocked observers by moving to cut energy subsidies in July 2014. The move allowed the government to spend some of its domestic political capital to ease the burden on the budget, while also signaling to the international community it was serious about economic – and potentially political – reform. While the political reform has largely failed to materialize, economic reforms have moved forward, albeit after several false starts. Arguably more important than the energy subsidy cuts, however, was the decision to leave food subsidies untouched – at least for the time being. Although energy subsidies can benefit the poor through lower costs for mass transit, they disproportionately benefit a country’s wealthiest citizens, who own houses, run air conditioners, and drive their own cars. Meanwhile, distribution of the benefits of food subsidies is more egalitarian. As a result, cuts to food subsidies are more likely to trigger widespread discontent across economic strata. Tunisia, much like Egypt, has a long and complicated history of subsidizing energy and food. And like Egypt, Tunisia’s subsidies had come to account for an increasing share, year after year, of its government expenditure. Subsidies were raised after the 2011 revolution, increasing from 2.5 percent of the GDP to 7 percent by 2013. As with Egypt, Tunisia’s nominal food subsidies have remained largely untouched. Yet unlike Egypt, in the years following the revolution Tunisia’s politicians never felt they had the political capital to make difficult reforms to energy subsidies. Only in July 2017, at the behest of the IMF and with considerable domestic debate, did Tunisia move to make cuts to its generous energy subsidies. Additionally, Tunisia has increased its value-added tax rate, which has raised the prices of food, and introduced mandatory social security contributions, which have reduced take-home pay. Much like Egypt, Tunisia’s appetite for additional cuts is limited. The government made it clear in October 2017 that it would only consider additional cuts to the 2018 budget after carefully reviewing who the real beneficiaries of these programs are. Following recent demonstrations, it also announced it would increase support for the poor, but has yet to provide details on what form this support will take. Sudan is in a substantially more difficult position than Tunisia. With the loss of oil revenues after South Sudan’s secession in 2011, the government had no choice but to implement draconian subsidy cuts. Cuts to fuel subsidies in 2013 and 2016 ignited widespread popular demonstrations, despite government crackdowns. Even after these cuts, the government’s spending on wheat and fuel still amounted to roughly 5.75 percent of GDP through the end of 2017 – and following the government’s exchange rate unification in January 2018, which raised the U.S. dollar exchange rate for wheat imports, the cost of these subsidies has increased. Sudan opted to eliminate wheat subsidies as of Jan. 1. The government argued that the move will benefit the local market by shifting wheat sourcing from overseas suppliers to the local economy – even suggesting that price of bread will remain the same due to increased local competition. The claim is farcical, given that as of 2015 Sudan produced only 30 percent of the wheat it consumes. An abrupt shift from the international markets to the domestic sector would encounter countless stumbling blocks involving production capacity, harvesting, transportation, storage and distribution that would take years to work out. Instead of prices remaining stable, bread prices doubled within the first few days after the subsidy cut took effect. Subsidy cuts ultimately lead to price increases for consumers, regardless of how effective and economically savvy the government’s efforts are. Interest rate increases, such as the kind Egyptians saw after the pound was floated and subsidies were reduced in November 2016, can do little in the short term to tamp down the inflation caused by devaluation, which increases the prices of imported goods. More significantly, inflation is not only an economic problem, but a political one as well. At first glance, there often appears to be little correlation between the inflation rate and its political ramifications. In the wake of recent subsidy cuts and currency depreciation, year-on-year inflation rates in both Egypt and Sudan have reached above 30 percent. However, while Egypt saw limited public demonstrations against the imposed austerity measures and the effects of exchange rate liberalization, due in part to what Human Rights Watch calls a “zero tolerance policy for protests,” Sudan’s 2013 and 2016 subsidy cuts saw widespread public outcry and subsequent government crackdowns, resulting in hundreds of Sudanese citizens killed. In protests against the recent bread price increases, a similar scene has played out, with at least one protester dead. Needless to say, the antagonism between the populace and the ever-oppressive Sudanese government does little to calm the markets. Conversely, Tunisia has managed to keep inflation rates in the single digits since 2011, reaching only 6.4 percent in 2017. Though this is a low rate by regional standards, violent protests ensued, with many commentators blaming the IMF. This discrepancy cannot be explained purely in terms of macroeconomic statistics. For example, Egypt’s and Tunisia’s GDP per capita is roughly equivalent despite their varied histories and economic structures. Significantly, in both Sudan and Tunisia – and in contrast with Egypt – austerity measures and economic reforms have increased the price of bread. Bread prices, either directly or through ingredients such as wheat flour, are sacrosanct and have long been guaranteed by the government. They are far from the only reason that major protests have broken out in both Sudan and Tunisia but not in Egypt, but they are an especially potent cultural symbol of a social compact between the people and the government. In both Egypt and Tunisia, bread was one of the three things protesters demanded in the opening weeks of the Arab Spring protests. Instead, while exchange rate liberalization and fiscal discipline play a crucial role in breaking the recent economic malaise experienced in Egypt, Tunisia and Sudan, their experiences show that price increases, especially for the goods on which consumers rely, are inherently political issues. The causes for the price increases may stem from macroeconomic factors, but a government’s solution requires popular trust in addition to sound economics. With anger at a boiling point, neither Tunisia nor Sudan has the sociopolitical flexibility at the moment to continue headlong with the various reform measures their respective governments agreed to with the IMF. Only Egypt seems to be able to plow ahead. But even Egypt may be forgetting its past, as the Supply and Internal Trade Ministry has announced plans in July 2017 to liberalize the price of bread and provide in-kind cash subsidies instead of subsidizing bread producers and fixing the price per loaf of bread. While it may be an economically rational decision, its political wisdom is questionable. Brendan Meighan is a macroeconomic analyst focusing on the Middle East. Follow him on Twitter @BrendanJMeighan. This commentary first appeared at Sada, an online journal published by the Carnegie Endowment for International Peace (www.carnegieendowment.org/sada).  A version of this article appeared in the print edition of The Daily Star on February 03, 2018, on page 7.