Bread riots or bankruptcy: Egypt faces stark economic choices

It was a perilous time for Egypt. The International Monetary Fund (IMF) was demanding subsidy cuts in exchange for a loan Egypt's leaders desperately wanted. So they complied, cutting subsidies on the bread, cooking fuel, and gasoline average citizens relied on to live.

Within hours, workers were pouring off the docks in the Suez Canal zone and Alexandria and out of the factories in the Nile Delta, and attacking symbols of the government everywhere – furious about the sudden rise in the price of daily staples.

In Cairo's Tahrir Square, angry youth tore up sidewalks to hurl stones at riot police when they ran out of Molotov cocktails; the police responded with tear gas and baton charges. By the time the smoke cleared, at least 80 Egyptians were dead in the worst rioting the country had witnessed in a generation.

The Egyptian government restored the subsidies.

While this probably sounds familiar, it describes the 1977 bread riots that almost brought down the government of Anwar Sadat and left ransacked the home of his young vice president, Hosni Mubarak. This history should be top of mind for the current president, Mohamed Morsi, who is facing decision time on a national financial crisis that dwarfs the one Sadat faced 35 years ago.

President Morsi's government recently announced a rationing plan for subsidized bread that it claims won't affect the poor. But few are convinced that the plan won't either jack up prices or reduce availability of the bread that is now sold at one-quarter to one-fifth of its production cost.

Beyond the bread, more tough choices lie ahead. Morsi's room to maneuver, however, is shrinking. Political turmoil has frozen high-level decisionmaking, even as the Egyptian pound has plummeted and foreign creditors look askance.

While it's been a long-held theory that Islamist movements like Morsi's Muslim Brotherhood can easily come to power in Muslim-majority states, they often lose public support as they fail to manage the economy to their citizens' satisfaction.

"In one way, what's happening might be good, so people can see that they're inept, they're politicians like everyone else, and they get booted out," says Erin A. Snider, a postdoctoral fellow at Princeton University in Middle Eastern political economy. "But it's going to be very ugly in the interim ... and it's going to make them incredibly resistant to admitting defeat."

Past solution, present options

As in the 1977 crisis, Egypt once again faces an IMF demand for subsidy cuts, a working poor whose struggles are mounting and who feel betrayed and oppressed by their political classes, and a loan the government desperately wants but fears could be its undoing.

Then, Egypt muddled through some desperate years for its poor as Sadat (and after him, Mr. Mubarak) pivoted toward the United States and ultimately reaped lavish aid in return.

Late in 1977, Sadat made his historic trip to Israel, and while that cost him Arab financial support, it led to a tight partnership with the US and international lenders like the IMF, which gave the country credit on easy terms, and debt forgiveness when times got tough.

After Egypt supported the US-led coalition to drive Iraqi troops out of Kuwait, Mubarak was rewarded with at least $15 billion in international debt forgiveness.

But Morsi is neither Sadat nor Mubarak, and Egypt is in far more chaos than it was at any other moment in recent decades. The US doesn't see his Muslim Brotherhood as a reliable partner, and members of Congress are likely to keep loans and aid at a trickle. The IMF has balked at coughing up money without concrete, short-term change in how the government spends that money.

The turmoil, infighting, and occasional rioting of the past two years have scared away foreign and local investment, left the pyramids and the grand temples of Luxor bereft of tourists, and seen already-low wages for the poor deteriorate in real terms.

Morsi is on the hook for all of this, with the elected parliament dissolved by court order last year and yet to be replaced. So far, he and his loyalists have seemed far more interested in consolidating power than in addressing the needs of average Egyptians, despite the rising unrest.

Rioting in February in Cairo and Port Said, the key Suez Canal city, has already dwarfed the events of 1977.

"What we've learned since Mubarak is that the new parties, including the Muslim Brotherhood, but not just them, are only interested in pursuing their own interests," says Mustafa Eid, a young Egyptian businessman who cheered Mubarak's fall, participated in street protests demanding democracy in 2011, and stepped back from politics in disillusionment after watching fellow protesters shot and killed by riot police in central Cairo in late 2011.

"The country is filled with petty corruption, with people that need help, and the people in power are just looking after themselves," he says.

The country's coffers are draining fast. The exchange rate was at 5.8 pounds to the dollar at the end of 2010, shortly before the massive street protests began that drove Mubarak from power. Today, it is trading close to 6.8 to the dollar, a 17 percent drop, most of which has come since the start of the year.

Since so many Egyptian consumer goods – like much of the nation's food – are imported, the collapsing pound has driven up local inflation and put a strain on the government, which planned to spend at least $4.5 billion on subsidized fuel in the first three months of 2013.

Though spending on wheat subsidies has fallen, that's because the government has been drawing on a strategic wheat reserve to keep the ovens on at government bakeries, which sell flatbread for pennies a loaf. The wheat reserve now holds enough to supply demand for three more months, down from six months in the middle of last year.

The pressure on the pound and total subsidy spending of about $20 billion a year has put the central bank in dire straits. Foreign reserves that stood at $35 billion in January 2011 are now hovering close to $13 billion.

That's why the IMF money, about $4.8 billion in all, is so crucial. While the IMF's cash by itself wouldn't make Egypt's problems go away, it would signal other governments and subsidized lenders to dip into their pockets as well.

If the IMF loan were granted, "that would probably see our debt ratings upgraded; more money would follow it," says Mohamed Osama al-Khely, a banker and an appointed member of Egypt's Shura Council. "But if you increase taxes or cut subsidies, you're going to hit the poor, the streets. To recover, we need a political rest. Not more turmoil."

The traditionally ceremonial and powerless Shura has been legislating in the absence of parliament. It is packed with both appointed and elected members of the Muslim Brotherhood. (Since Egyptians didn't expect parliament would be dissolved, few voted in the Shura elections, which had only 7 percent turnout.)

Mr. Khely isn't from the Brothers and has a jaundiced view of his new colleagues. The people the Brothers put up for the council were at best the B team, he says. "These guys aren't really professionals; they spend most of their time waiting for orders from outside."

Islamic banking focus

What kind of orders have they been receiving? They spent much of the first part of the year trying to hammer out legislation on Islamic financing. This involves borrowing arrangements that dress up payments to creditors not as interest but as equity returns, since usury is forbidden by Islam in the eyes of the Muslim Brotherhood.

Such Islamic financial instruments are popular with devout lenders, but Khely says his colleagues are under the impression that there's a groundswell of religiously motivated capital that's about to head their way thanks to their efforts.

"It's like talking [about] fixing the windshield wipers when the engine of the car is broken," he says. "They're totally consumed with doing something 'Islamic' ... when the crisis is growing."

A few months ago, Samir Radwan sat in his elegant flat in Cairo's Maadi suburb, equal parts rueful about and detached from Egypt's economic predicament.

The longtime economic consultant with a PhD from the University of London had been called in as interim Finance minister by the military-ruled government at the time Mubarak fell. Egypt was at the brink of a deal with the IMF.

Egypt's finances were stronger, optimism was high for a country coming out of decades of a military-backed dictatorship, and he was close to a deal. He'd taken the job, working for Field Marshal Mohamed Tantawi (acting president in all but name) despite family objections. "I had to. Maybe I could help."

By June 2011 Mr. Radwan had worked out a loan with the IMF for more than $3 billion at 1.5 percent interest – a steal – and without any of the IMF's often onerous, and potentially destabilizing, subsidy cuts. Then Egypt's military leaders stepped in.

There were rumblings about Egypt's "dignity" being compromised from the street and in the country's halls of power.

Before the deal could be done, "Tantawi said to me that he didn't want to leave a legacy of debt when he left," Radwan says. So the deal was abandoned.

Egypt's economy, as well as the trust that can be as valuable a commodity as cash, continued to deteriorate. IMF demands started to go up along with Egypt's needs. Radwan says he doesn't envy Egypt's current financial stewards.

"The situation has changed ... in my time I had $35 billion in reserves and a stable currency," he says. The wheels really came off at the end of last year, when Morsi decided to decree to himself legislative powers that allowed him to rush through a new constitution, but which polarized Egyptian politics to such an extent that international lenders like the IMF don't trust he'll be able to make good on any promises he makes.

"The government found themselves caught in a paradox," says Radwan. "They wanted the loans on the one hand, and on the other they wanted to rush through the constitution."

A constitution and a fissure

Morsi got his constitution. But he also got a badly split, furious country. Protests almost every Friday since have racked Cairo and other cities; in mid-March, clashes outside the Muslim Brotherhood's headquarters sent another paroxysm through the body politic.

The situation is burning up the political capital the Brothers had when Morsi was elected president last summer. Never tested by power in their 80-year history, they had projected to Egypt's public a can-do, clean, religious image. Their fall from grace may open the door for more secular-oriented politics, in the view of some analysts.

For now, Egypt is caught between two old imperatives: the need for international aid and the need to look after its poorest citizens. The clock is ticking.

Sadat, with the cold war raging and the option of pivoting toward the West, for which Egypt was handsomely rewarded, staved off subsidy cuts and ended up getting the money his country needed.

Morsi's situation is as dire – if not more so. But finding new friends, or rekindling old friendships, may prove harder for him.