This is the first of two parts of Business Today’s exclusive interview with Hazem El-Beblawi. The concluding part of the interview will be featured in March’s issue of bt.

Q: How would you evaluate the current economic crisis?
Beblawi: I can say that the revolution affected the economic situation but we have to be very clear about the difference between the real economy and the financial economy. I don’t think the events have affected very seriously the real economy; it was affected but to a lesser degree than our finances.

By real economy, I mean the resources of the country, the productive capacity, industry, trade and communications, all these things by and large are reasonably resilient. Of course they were affected: we lost a great deal in tourism both in terms of the numbers of tourists we are receiving and in terms of the rates, we lost a good source of exchange revenue.

Also the inflow of foreign investment has been diminished to almost zero and I suspect there were also some kind of outflows which affect the morale of the investors, both foreign and Egyptian. There was some recession as well in the industrial sector due to strikes, but all in all I would say that the slackening of the economic activity was reasonably contained and reasonably acceptable.

However, the financial situation is serious both as reflected in the budget deficit and the balance of payment deficit and depletion of our foreign reserves. We are facing a situation which I call “a cash flow problem”. We are short of liquidity both in local and foreign currency and what’s needed is a quick solution.

Of course the budget deficit has increased because we lost the income of tourism, but there was an increase in expenditure that affected it as well. The government raised salaries and pensions of various social groups right after the revolution in order to respond to the increasing popular demands. The government acknowledged that people should have been compensated and rewarded but this has increased the burden on it.

The end result is a large and increasing budget deficit imposing serious constraints on the economy. In order to finance it locally the government used to go to the private sector, the banks, through issuing treasury bills which has the effect of crowding out the financing through the private sector and increasing the interest rate for the government which will affect the future debt service.

Q: So you are against the treasury bill tool?
Beblawi: I’m neither for nor against. We use whatever is available since we’re very limited in resources, so it’s not a matter of choice. Some would advocate raising taxes, which is an option but the problem is we don’t just need finance, we need it immediately. Even if we resort to raising taxes, the effect will take time,which we don’t have, which makes our margin of maneuverability very limited. Many things can be done but the problem is Egypt is like a person in need of a blood transfusion and needs the help now — it cannot wait.

Q: But what about using taxation for the long term? I know that in your meeting with one of the businessmen associations they took the initiative and suggested raising the tax to 30% from 25% on net profits.
Beblawi: This issue was raised and I welcomed the move. However, they were talking about corporate tax and I think that progressive taxation, in order to attain social justice, has to be applied to the personal income tax.

A corporation making higher profit should not be taxed at a higher rate, because those making lower profits might only have only four to five shareholders while the second might have 5,000 or 20,000 shareholders. Their capital might differ as well. It’s also much easier to evade progressive corporate taxes. Once the company enters the higher tax bracket, it can be broken up into smaller companies.

I think the real domain for progressive taxes is personal income tax. When I was in office, I directed people to study the reintroduction of a progressive income tax. However, a progressive tax has been claimed unconstitutional on the grounds that the same income was being taxed twice; once through a generic tax imposed on profits or labor then the second time through the personal tax.

Progressive taxation is definitely required but it has to be done in a well designed manner and worked out from all aspects. Moreover, the corporate tax should not be imposed with the objective of attaining social justice but rather as an incentive to promote small and medium enterprises giving them preferential treatment.

Q: You favor getting grants and loans from international and regional finance organizations, but the Supreme Council of the Armed Forces (SCAF) did not seem to approve of this. How did you get them to accept?
Beblawi: First of all, what is beneficial in one situation can be harmful in another. Borrowing in the absolute sense is neither good nor bad; it depends on the circumstances, the state of economy and the state of the international environment.

Secondly, when it comes to any economic decision, it’s not the choice between the good and bad, sometimes it is the choice between the bad and the worse. If we are in a bad situation we try to minimize our losses.

We are facing an unusual situation; the economy was moving along smoothly until the disruption occurred. Now it can be rectified either from the local sources or from international sources. I think local sources would be more costly than if we source our funding from international financial institutions. Borrowing from the local market is not free — it prevents the banking sector from financing industry and the private sector.

The question then is not borrowing from inside or outside, it’s either we finance the budget deficit at a cost of denying the private sector financing resources or try to get resources from abroad. The high interest rate is a burden for the future deficit so this won’t only harm the present generation but also the future generation.

Moreover, our problem is not only liquidity and finance it’s in many cases foreign currency. Borrowing from abroad not only helps the budget deficit but also helps our balance of payments.

There are also some basic misunderstandings; [SCAF] accepted borrowing from foreign lenders to finance projects but not borrowing to finance the deficit. But what if we have industries that are not working, simply because they don’t have the cash flow.

Most cases of bankruptcies were due to shortages in cash flow. The companies that went bankrupt did not have problems of poor technology or shrinking market as much as much as they were short on liquidity.

Q: What do you think of the IMF’s lending conditions for lending to Egypt, conditions like reconsidering subsidies for instance?
Beblawi: These are not conditions, people are misled. It’s only fair that [the IMF] ask what we are doing in order to solve our problems in the future when they are going to lend us money.

They want to make sure that we are using this loan to rectify the situation, so they ask about the problems and discuss them. If we suggest measures which they think we’re not capable of implementing, maybe they’re too drastic or too unpopular, they will discuss them with us. We agree on a package of measures that will be respected and they will have to agree that this is reasonable and useful. Of course it depends on our determination, understanding and our capacity to convince.

Furthermore, with or without a loan from the IMF or others, I think subsidies in Egypt have reached unhealthy levels that are detrimental to the economy and have to be resolved. We have to work it out intelligently, create awareness and make sure that the subsidy really reaches those who need the support. We have to work systematically, establish a good database in order to know who really needs the support and make sure they get it.

The first thing I did when I took office was look at the budget; 33% of the budget is dedicated to subsidies. It doesn’t mean we are doing well, we are preventing people from benefiting from 33% of the budget in other places: we are not giving people good education, we are not giving them good health care, we are not providing good infrastructure like roads and electricity. So providing subsidies is not without a cost: they are resources which would otherwise have been allocated to much important things, but I cannot just abolish them with a stroke of my pen. bt