Document of The World Bank FOR OFFICIAL USE ONLY Report No. 119846-EG INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED LOAN IN THE AMOUNT OF US$1,150 MILLION TO THE ARAB REPUBLIC OF EGYPT FOR A THIRD FISCAL CONSOLIDATION, SUSTAINABLE ENERGY, AND COMPETITIVENESS PROGRAMMATIC DEVELOPMENT POLICY FINANCING November 7, 2017 Energy and Extractives, Macroeconomics and Fiscal Management, and Trade and Competitiveness Global Practices Middle East and North Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. THE ARAB REPUBLIC OF EGYPT - GOVERNMENT FISCAL YEAR JULY 1 – JUNE 30 CURRENCY EQUIVALENTS (Exchange Rate Effective as of [SECPO Submission Date]) Currency Unit = Egyptian Pound (EGP) US$1 = EGP [TBD] ABBREVIATIONS AND ACRONYMS AfDB African Development Bank GRS Grievance Redress Service ASA Accountability State Authority GST Generalized Sales Tax CBE Central Bank of Egypt HFO Heavy Fuel Oil CCGT Combined Cycle Gas Turbine HIECS Household Income, Expenditure and Consumption Survey CEO Chief Executive Officer IFC International Finance Corporation CPF Country Partnership Framework IMF International Monetary Fund DPF Development Policy Financing LPG Liquefied Petroleum Gas DSA Debt Sustainability Analysis MDB Multilateral Development Bank EA Environmental Assessment MIGA Multilateral Investment Guarantee Agency ECA Egyptian Competition Authority MIIC Ministry of Investment and International Cooperation EEAA Egyptian Environmental Affairs Agency MOF Ministry of Finance EEHC Egyptian Electricity Holding Company MOP Ministry of Petroleum and Mineral Resources EETC Egyptian Electricity Transmission MSMEs Micro, Small, and Medium Enterprises Company EFF Extended Fund Facility MTDS Medium-Term Debt Management Strategy EGAS Egyptian Natural Gas Holding Company MTFF Medium-term Fiscal Framework EgyptERA Egyptian Electric Utility and Consumer NAFA Net Acquisition of Financial Assets Protection Regulatory Agency EIA Environmental Impact Assessment NCW National Council of Women FDI Foreign Direct Investment NDC Nationally Determined Contribution FIT Feed-in Tariff PFM Public Financial Management GAFI General Authority for Investment and PSIA Poverty and Social Impact Analysis Free Zones GDP Gross Domestic Product SMEs Small and Medium Enterprises GHG Greenhouse Gas SOE State-Owned Enterprise GFMIS Government Fiscal Management VAT Value Added Tax Information System GoE Government of Egypt Vice President: Hafez M. H. Ghanem Country Director: Asad Alam Senior Practice Directors: Riccardo Puliti/Carlos Felipe Jaramillo/Anabel Gonzalez Practice Managers Erik Fernstrom/Kevin Carey/Nabila Assaf Task Team Leaders: Ashish Khanna/Ibrahim Chowdhury THE ARAB REPUBLIC OF EGYPT THIRD FISCAL CONSOLIDATION, SUSTAINABLE ENERGY, AND COMPETITIVENESS PROGRAMMATIC DEVELOPMENT POLICY FINANCING TABLE OF CONTENTS SUMMARY OF PROPOSED LOAN AND PROGRAM ..................................................................................... 1 1. INTRODUCTION AND COUNTRY CONTEXT ......................................................................................... 3 2. MACROECONOMIC POLICY FRAMEWORK ......................................................................................... 6 2.1 RECENT ECONOMIC DEVELOPMENTS ................................................................................................ 6 2.2 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ............................................................... 9 2.3 IMF RELATIONS ................................................................................................................................. 12 3. THE GOVERNMENT’S PROGRAM .................................................................................................... 12 4. THE PROPOSED OPERATION ........................................................................................................... 15 4.1 LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION ............................................... 15 4.2 PRIOR ACTIONS, RESULTS, AND ANALYTICAL UNDERPINNINGS ...................................................... 18 4.3 LINK TO CPF, OTHER BANK OPERATIONS, AND THE WORLD BANK GROUP STRATEGY .................. 42 4.4 CONSULTATIONS, COLLABORATION WITH DEVELOPMENT PARTNERS ........................................... 42 5. OTHER DESIGN AND APPRAISAL ISSUES .......................................................................................... 43 5.1 POVERTY AND SOCIAL IMPACT ......................................................................................................... 43 5.2 ENVIRONMENTAL ASPECTS .............................................................................................................. 50 5.3 PFM, DISBURSEMENT, AND AUDITING ASPECTS .............................................................................. 51 5.4 MONITORING, EVALUATION, AND ACCOUNTABILITY ...................................................................... 53 6. SUMMARY OF RISKS AND MITIGATION........................................................................................... 54 ANNEX 1: POLICY AND RESULTS MATRIX ................................................................................................ 57 ANNEX 2: LETTER OF DEVELOPMENT POLICY .......................................................................................... 62 ANNEX 3: FUND RELATIONS ANNEX ...................................................................................................... 70 ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE ......................................................... 72 ANNEX 5: DEBT SUSTAINABILITY ANALYSIS ............................................................................................ 75 The operation was co-led by Ashish Khanna (Program Leader, MNC03) and Ibrahim Chowdhury (Sr. Economist, GMFDR), with Nabila Assaf (Acting Practice Manager, GTCDR) and Tracey Marie Lane (Program Leader, MNC03) leading the work on business competitiveness. The operation was prepared under the guidance of Erik Fernstrom (Practice Manager, GEEDR), Kevin Carey (Practice Manager, GMFDR), and Nabila Assaf (Acting Practice Manager, GTCDR). The team includes Sherif Hamdy (Senior Operations Officer, MNC03), Sara Al-Nashar (Economist, GMFDR), Hoda Youssef (Senior Economist, GMFDR), Rana Nayer Safwat Fayez (Consultant, GGODR), Vivien Foster (Lead Economist, GEEDR), Joern Huenteler (Energy Specialist, GEEDR), Tu Chi Nguyen (Young Professional, GEEDR), Mohab Hallouda (Sr. Energy Specialist, GEEDR), Marwa Khalil (Energy Specialist, GEEDR), Andreja Marusic (Senior Private Sector Specialist, GTCDR), Maha Hussein (Sr. Private Sector Specialist, GTCDR), Mariam Semada (Private Sector Specialist, GTCDR), Marwa Hamdy (Operations Officer, GTCDR), Graciela Miralles Murciego (Senior Economist, GTCDR), Jean Denis Pesme (Practice Manager, GFMDR), Laurent Gonnet (Lead Financial Sector Specialist, GFMDR), Laila Abdelkader (Financial Sector Specialist, GFMDR), Renaud Seligmann (Practice Manager, GGODR), Mohamed Yehia (Sr. Financial Management Specialist, GGODR), Walid Labadi (Country Manager, IFC), Mark Sorial (Investment Officer, CNGS9), Syed Ahmed (Lead Counsel, LEGAM), Nightingale Rukuba-Ngaiza (Senior Counsel, LEGAM), Benu Bidani (Practice Manager, GPVDR), Nistha Sinha (Sr. Economist, GPVDR), Gabriel Lara Ibarra (Economist, GPVDR), Alaa Sarhan (Sr. Environmental Economist, GENDR), Amal Faltas (Sr. Social Development Specialist, GSURR), Gustavo Demarco (Program Leader, MNC03), Nahla Zeitoun (Sr. Social Protection Specialist), Poonam Gupta (Country Program Coordinator, MNCA3), Junxue Xu (Division Manager, WFALN), Georges Tony Abou Rjaily (Finance Analyst, WFALN), Eric Ranjeva (Finance Officer, WFALN), and Neha Dhoundiyal (Financial Management Specialist, GGO24). Iman Sadek (Team Assistant, MNCEG), Heba Abuelleil (Team Assistant, MNCEG), Nermin Nour (Program Assistant, MNCEG), Hanzada Aboudoh (Program Assistant, MNCEG), Georgette Ibrahim (IT Officer, ITSCR) and Mark Njore (Program Assistant, GEEDR) provided outstanding administrative support. The team is grateful for the support and guidance from Asad Alam (Country Director, MNC03) and for the close and productive cooperation with the IMF team. The team is also appreciative of the excellent collaboration with the Government of Egypt throughout various stages of this operation. The team acknowledges the leadership of the inter- ministerial working group set up by the Government of Egypt on Development Policy Financing, led by the Minister of Investment and International Cooperation and including the representatives of the Ministry of Finance, the Ministry of Petroleum and Mineral Resources, the Ministry of Electricity and Renewable Energy, the Ministry of Trade and Industry, and the General Authority for Investment and Free Zones. SUMMARY OF PROPOSED LOAN AND PROGRAM THE ARAB REPUBLIC OF EGYPT THIRD FISCAL CONSOLIDATION, SUSTAINABLE ENERGY AND COMPETITIVENESS PROGRAMMATIC DEVELOPMENT POLICY FINANCING Borrower The Arab Republic of Egypt Implementation Agency Ministry of Investment and International Cooperation IBRD Loan Financing Data Terms: Variable Spread Loan with thirty-five-year maturity and five years grace period Amount: US$1,150 million Third operation of a programmatic series of three Development Policy Financing (DPF) Operation Type operations The proposed operation is built around three pillars, which are also the program development Pillars of the Operation objectives of the programmatic series: (1) advance fiscal consolidation through higher revenue and Program collection, greater moderation of the wage bill growth, and stronger debt management; (2) Development ensure sustainable energy supply through private sector engagement; and (3) enhance the Objectives business environment through investment laws, industrial license requirements as well as enhancing competition. The DPF is anchored in the Government’s medium-term reform program. Pillar 1: Advancing Fiscal Consolidation • Increased non-sovereign corporate income tax and sales/VAT on goods and services as a percentage of GDP from 5.4% in FY2014/15 to about 6.7% in FY2017/18. • Reduction of the ratio of the Central Government’s wage and salary bill to nominal GDP, from 8.2% in FY2014/15 to 7.4% of GDP by FY2017/18. • Completion of at least four audits on sectors and entities affiliated with the Ministry of Finance by FY2017/18. • Publication of an updated Medium-Term Debt Management Strategy by FY2017/18. Pillar 2: Ensuring Sustainable Energy Supply • Reduction of energy subsidies as a percentage of GDP from 6.6% in FY2013/14 to 3.2% in FY2017/18. • Notification and operationalization of supply code and transmission tariff by FY2017/18. • Reduction in difference between peak electricity demand and available peak capacity from deficit of 5,540 MW in FY2014/15 to a surplus of 1,000 MW by FY2017/18. • Public disclosure of tariff methodology for computation of electricity tariffs. • Publication of a separate gas transmission tariff, transmission code, market rules, and Result Indicators approval procedures by FY2018/19. • Launching of a dedicated web portal with all gas sector rules and regulations by FY2018/19. • Financial closure of private sector-owned renewable energy projects from 0 MW (October 2015) to 1,500 MW (end of FY2017/18). • Increase in the number of energy audits performed for large consumer and government buildings from 134 in FY2014/15 to 234 in FY2018/19. Pillar 3: Enhancing the Business Environment • Increase in business entry, as measured by the average number of company registrations at GAFI Investor Service Centers per month, of 65% in FY2017/18 over the baseline of 867 average registrations per month in FY2014/15. • Increase in the number of GAFI Investor Services Centers offering automated and integrated registration services for companies under both the Investment and Companies Laws, from 0 in FY2014/15 to 4 by the end of FY2017/18. • Average number of days to issue an industrial license by notification of no more than 7 days by the end of FY2017/18. • Reduction in the average number of days to comply with all industrial licensing requirements from 634 days in FY2014/15 to 160 days by the end of FY2017/18. 1 • Increase in the number of anti-competitive practices prevented/eliminated from a baseline of 9 (between FY2012/13 and FY2014/15) to a target of 11 decided during the FY16-18 period. Overall Risk Rating High (i) Are there short and long-term climate and disaster risks relevant to the operation (as Climate and Disaster identified as part of the SORT environmental and social risk rating)? Yes ☐ No ☒ Risks If yes, (ii) summarize briefly these risks in the risk section and what resilience measures may help address them? Operation ID P164079 2 PROGRAM DOCUMENT FOR A PROPOSED LOAN TO THE ARAB REPUBLIC OF EGYPT 1. INTRODUCTION AND COUNTRY CONTEXT 1. Egypt has embarked upon a program of major reforms that are needed to address some of the longstanding structural constraints to inclusive growth and macroeconomic stability. The 2011 Arab Spring ushered in a new era of hope for Egyptians that there would be improvements in governance and government services and a more inclusive economic model, since the growth achieved thus far had not resulted in improved living standards for the poor and lower middle class. Unfortunately, the post-2011 developments were characterized by economic challenges, which deterred trade and investment and exacerbated entrenched structural problems such as weak business climate and high energy subsidies resulting in unsustainable fiscal and external balance. Furthermore, the country has been able to weather additional external shocks of terrorism and regional instability and decline in remittances from the Gulf. 2. This operation is the third in the Development Policy Financing (DPF) programmatic series, and part of an international effort to support the economic reform program of the Government of Egypt (GoE) to address the deep-seated issues needed for economic recovery, more inclusive growth, and responsive government services. The programmatic series is built around three pillars. First, it focuses on restoring macroeconomic and fiscal stability to help regain investors’ confidence, free up domestic financing for the private sector and provide the fiscal space needed for targeted social spending. Second, the program supports the Government efforts to create a more dynamic and commercially oriented energy sector to improve service delivery and enable a scale-up in private investment. Third, the program supports the culmination of several policies to improve the business climate, with simpler rules and processes for investments and licenses to promote both domestic and foreign direct investment (FDI) as well as enhancing competition among both public and private sector operators. 3. The Government’s reform efforts are focusing on pressing macroeconomic challenges, where they have already delivered some visible results, and on bolstering social protection measures to protect the poor and vulnerable from the negative effects of the broader macroeconomic reforms. A combination of fiscal measures simultaneously boosted government revenues, through broadening the tax base, and reined in public expenditures, through sustained energy subsidy reform and control of the public-sector wage bill. There has also been more attention to reporting and reviewing of public sector liabilities. The flotation of the Egyptian pound in November 2016 led to a larger than expected depreciation, halving its value against the US dollar, and together with increases in energy prices led to a sharp rise in inflation. In response, the Government has implemented a multi-pronged strategy to protect the poor and middle class through various social protection measures including increases in the almost universal food subsidy allowance, expansions in the cash transfer programs, and the introduction of measures that support the middle class. 4. The Government’s evolving development model increasingly shifts the focus toward the private sector as the engine of growth and job creation. While the macroeconomic climate for business has been improving, many structural barriers remain in Egypt’s traditionally state-led economy characterized by extensive red tape. A concerted effort is now underway to dismantle constraints on private enterprise and boost investment among both foreign and domestic firms, both large and small. Investment climate reforms include enhanced investor protections in the new Investment Law, institutional reforms to improve the quality of investor services, a strengthened competition framework and increased action against anti- competitive behavior. The Government has also prioritized certain sector-specific reforms, particularly in the energy and industrial sectors. Meanwhile, reforms in the financial sector are next on the agenda, with a slew of regulations under review by the Government and in the Parliament, including key legislation on banking and bankruptcy. 3 5. In the industrial sector, the Government has launched a sweeping reform of the archaic industrial licensing regime, which dates back to 1954, introducing risk-based licensing, new controls, and service standards to this historically complex area of business regulation. If successfully implemented, this would represent a major improvement for the majority of industrial firms, based on good international practice. Risk-based approaches are key to better regulation and play a crucial part in all of its core principles: accountability, transparency, proportionality, targeting and consistency. Regulators use risk-based approaches to target their resources at those activities that present higher threats to public goods such as the environment, safety and health while at the same time imposing minimum burdens on businesses that perform low risk activities. Leading regulatory authorities in the US, the UK, Australia, Canada, Ireland, Italy, the Netherlands and Norway, to name a few, have been consistently employing risk-based approaches. While no regulatory measure can altogether eliminate the risk of incidents related to the performance of high risk activities, risk-based approaches help meet public objectives more efficiently, lower compliance burdens for the private sector while safeguarding public goods, make better use of public resources and improve regulatory coherence. 6. The reforms in the energy sector are closely aligned with Egypt’s contribution to the Paris Agreement on climate change. By addressing the security of supply of natural gas and promoting clean energy and energy efficiency, the DPF series is supporting all four priority areas of Egypt’s Nationally Determined Contribution (NDC) to global efforts for mitigating greenhouse gas (GHG) emissions through: (a) more efficient use of energy, especially by end-users; (b) increased use of renewable energy; (c) use of advanced locally appropriate and more efficient conventional energy technologies; and (d) reforming energy subsidies. The renewables sector represents the international benchmark of Maximizing Finance for Development, where support to the regulatory framework for renewable energy resulted in private sector investments of around US$2 billion for over 1,500 MW of mainly solar power under the feed-in tariff (FIT) program. 7. The energy sector provides a tangible example of how investment has already begun to respond to an improved enabling environment. Energy is a major sector of the Egyptian economy accounting for 8.4 percent of the gross domestic product (GDP). Chronic underpricing of energy and neglect of commercial payment obligations created serious gas shortages in 2014, turning Egypt from an exporter to a net importer of the fuel, and leading to rolling blackouts of electricity with resulting social unrest. Since then, arrears to international oil companies have been largely paid; and sustained energy subsidy reforms have led to a cumulative 170-360 percent increase in fuel prices and 190 percent increase in electricity tariffs, making substantial progress towards cost recovery. At the same time, modern legislation has been ratified for both the electricity and gas sectors, strengthening the regulatory framework, and paving the way for competition through third party access to transportation networks and the eventual transition to wholesale energy markets. FDI has recovered in the upstream gas exploration and production sector, most notably with the discovery of the major Zohr gas field which alone will entail investments of US$11-16 billion and, when operational, would largely eliminate the need for imported hydrocarbons (LNG and HFO) for electricity generation and industry use. In the power sector, a major bilateral agreement has brought commercial finance (approximately US$8 billion) for over 14 GW of new power generation based world class, highly efficient combined cycle gas turbine (CCGT) technology. The combination of efficient gas use with a growing share of renewables is putting Egypt’s electricity sector on the path towards a gradually lowering carbon footprint. With resolution of energy supply, the strategic focus of the sector now needs to be on commercialization and financial viability paired with the continued expansion of the renewable energy program through private sector investment. 8. The program contributes to renewing Egypt’s social contract through the promotion of transparency and inclusive growth. Measures to promote accountability and good governance through enhanced transparency have been mainstreamed in all aspects of the reform program, from citizen budgets, 4 to conflict resolution mechanisms for investors, to public hearings for electricity regulation. Inclusion is also a central principle of the program, reflected in the shift of public expenditure from inefficient subsidies toward social spending, as well as the emphasis on job creation through private sector development. For the first time in 2015, the budget on health and education exceeded that of energy subsidies, and the social protection budget increased by 60 percent in FY2016/17 to protect the poor and marginalized from the impact of high inflation and energy price increases. This operation, through its focus on improvement in the business environment, is expected to generate opportunities for small and medium enterprises (SMEs) and potentially improve women entrepreneurship and employment. 9. This approach is consistent with the World Bank Group’s Middle East and North Africa Strategy, which aims to renew the social contract. The new social contract is based on greater citizen trust, more effective protection of the poor and vulnerable, inclusive, transparent, and accountable service delivery, and a stronger private sector that can spur job creation. These objectives are also fully aligned with the World Bank Group’s Country Partnership Framework (CPF) for Egypt, which seeks to achieve the World Bank Group’s twin goals of eradicating extreme poverty and boosting shared prosperity in a sustainable manner. 10. Overall, the programmatic series has already yielded substantial results and is bringing about important structural changes in the economy. Macro-fiscal stabilization has restored confidence in the economy which is the prerequisite to private sector participation. In the energy sector, a sustained commitment to energy subsidy reform has saved public resources in the order of 5 percent of GDP1, allowing an important rebalancing of public expenditure towards social areas. At the same time, the country has acted decisively to turn around a major energy supply deficit into a no shortage capacity with adequate reserve margin in just three years, and has achieved a substantial quantum of private investment in renewable energy generation and gas sectors. In terms of private sector development, a number of major new pieces of legislation are addressing longstanding structural constraints to business, ranging from reforms in industrial licensing and targeting significant streamlining of business processes and reduction of red tape. Private sector investment has been growing by more than 17 percent a year. The DPF program has retained its triggers since 2015 in almost all action areas without amendment of key expected results, signifying the sustained direction of the reform process. Going forward, these structural changes would require sustained political leadership and public engagement for ensuring effective implementation of new legislations, building institutional capacity, and enhancing accountability and governance within government departments. 11. A guarantee to be provided to the IBRD by the United Kingdom is an important component of the third DPF. The IBRD loan amount of US$1,150 million depends on US$150 million in guarantee coverage expected to be provided to the IBRD as part of the overall international support for Egypt. 2 The United Kingdom has committed in principle to execute a guarantee agreement for the benefit of the IBRD, under which they will guarantee pro rata portions of the repayment of the loan by Egypt. The guarantor will make payment to the IBRD if Egypt fails to make a repayment and such failure continues for at least six months. In the event that a guarantor makes a guarantee payment to the IBRD, then the guarantor will have the right to pursue recovery from Egypt bilaterally. The guarantee is expected to be executed and delivered before discussion of the proposed DPF by the IBRD Board of Executive Directors, scheduled on December 5, 2017. 1 Energy subsidies reached 3.9 percent of GDP in FY2016/17 and are on track to be phased out within three years. In the absence of energy subsidy reforms, it is estimated that subsidies would have reached 8.9 percent of GDP by FY2016/17. 2 The World Bank has received a letter from the U.K. Secretary of State to the World Bank President, committing in principle to provide the above-mentioned guarantee, subject to parliamentary approval by the United Kingdom. 5 2. MACROECONOMIC POLICY FRAMEWORK 2.1 RECENT ECONOMIC DEVELOPMENTS 12. The GoE is demonstrating strong commitment to its reform program aimed to restore macroeconomic balances, strengthen fiscal and external sustainability, and revive growth and employment. Economic activity has been gathering strength and efforts at reining in the budget deficit have begun to bear fruit. With the liberalization of the foreign exchange market, foreign currency shortages have disappeared. These reforms have helped stabilize the macro-fiscal environment and strengthen confidence in the economy. Real GDP growth recorded 4.2 percent in FY2016/17 (starting June 1) with growth accelerating to 5 percent in the final quarter (April-June) of FY2016/17, up from 3.4 percent in the first quarter (July-September). The higher growth rate in the fourth quarter was mainly driven by private consumption notwithstanding the sharp increase in inflation, with investments and net exports also contributing positively to growth. The gradual recovery in growth has coincided with a lower unemployment rate, which has declined to an estimated 11.9 percent in FY2016/17 from 12.5 percent the year before (Table 1). 13. The move to a floating exchange rate regime in early November liberalized the foreign exchange market and unified the formal and parallel exchange rates. Following currency liberalization, the Egyptian pound depreciated from the pre-float official exchange rate of EGP 8.8 per US$ to almost EGP 19 per US$ in January 2017, reflecting some overshooting, but it has since stabilized at about EGP 17.7 per US$ notably with the strong foreign investor demand for local debt instruments and by attracting foreign currency that was previously held outside the official banking system. The central bank has not sold foreign exchange in the interbank market except for the US$100 million that was auctioned on the day of the float, and has only been supplying foreign exchange to state-owned enterprises (SOEs) to finance critical imports. 3 Capital controls were gradually removed, reflecting improved liquidity in the foreign exchange market. The flexible exchange rate regime is functioning well and the parallel market has practically disappeared. 3 The Central Bank of Egypt (CBE) intends to discontinue this practice in the coming months. 6 Table 1. Key Economic Indicators FY2011 FY2012 FY2013 FY2014 FY2015 FY2016 FY2017 FY2018 FY2019 FY2020 Last updated August 2017 Actual Actual Actual Actual Actual Pre-actual Estimate Forecast Forecast Forecast Real Sector and Prices Real GDP Growth Rate (y/y) 1.8 2.2 2.2 2.9 4.4 4.3 4.2 4.5 5.3 5.8 Population (in millions) 80.4 82.4 84.7 86.7 89.0 91.1 n.a. n.a. n.a. n.a. Unemployment Rate (last Q of FY) 11.8 12.6 13.4 13.3 12.7 12.5 11.9 11.5 10.5 9.5 CPI Annual Inflation Rate, (Period Average) 11.0 8.6 6.9 10.1 10.9 10.2 23.3 22.1 14.0 12.0 Public Finance (in percent of GDP) Total Revenues 19.3 18.1 18.8 21.4 19.0 18.1 18.2 18.8 18.7 18.5 Tax revenues 14.0 12.4 13.5 12.2 12.5 13.0 13.3 13.9 14.6 14.4 Grants 0.2 0.6 0.3 4.5 1.0 0.1 0.0 0.0 0.0 0.0 Other non-tax revenues 5.2 5.1 5.1 4.7 5.5 5.0 4.8 4.9 4.1 4.1 Total Expenditures (excl. NAFA) 29.3 28.1 31.6 32.9 30.0 30.2 28.8 27.6 25.8 23.9 Current expenditures 26.4 26.0 29.5 30.5 27.5 27.6 26.3 24.9 23.1 21.1 Capital expenditures 2.9 2.1 2.1 2.5 2.5 2.6 2.6 2.7 2.7 2.8 NAFA -0.2 0.0 0.1 0.5 0.5 0.5 0.2 0.0 0.0 0.5 Overall Budget Balance Including Grants -9.8 -10.0 -12.9 -12.0 -11.4 -12.5 -10.9 -8.8 -7.1 -5.9 Primary Balance -3.6 -3.7 -5.0 -3.9 -3.5 -3.5 -1.9 0.3 1.8 1.8 Overall Balance Excluding Grants -10.0 -10.6 -13.2 -16.5 -12.5 -12.7 -10.9 -8.8 -7.1 -5.9 Gross Budget Sector Debt (Domestic + External) 82.0 78.1 88.2 89.4 93.1 102.8 108.7 99.9 96.9 91.5 External Sector (in percent of GDP) Trade Balance -11.5 -12.2 -10.7 -11.2 -11.7 -11.5 -15.0 -13.7 -13.1 -13.2 Current Account Balance -2.6 -3.6 -2.2 -0.9 -3.7 -6.0 -6.6 -4.6 -3.9 -3.7 Net FDI Inflows 0.9 1.4 1.3 1.4 1.9 2.1 3.3 3.7 3.7 3.8 Capital and Financial Account Balance (does not include errors & omissions) -1.8 0.4 3.4 1.7 5.4 6.4 12.3 4.5 2.4 4.8 Net International Reserves (end of period, US$ billion) 26.6 15.5 14.9 16.7 20.1 17.5 31.3 33.5 33.5 34.0 in months of merchandise imports 5.9 3.1 3.1 3.3 3.9 3.7 6.6 6.7 6.5 6.3 External Debt 14.8 13.4 15.0 15.1 14.6 16.8 33.5 32.7 32.3 30.7 External Government Debt 11.5 9.2 10.7 9.7 8.0 8.0 15.0 14.9 14.5 14.4 Monetary Sector (annual percent change) Broad Money 10 8.4 18.4 17.0 16.4 18.6 35.2 22.2 20.0 16.5 Credit to the Private Sector 0.8 7.1 9.8 7.4 16.7 12.5 37.8 8.7 15.5 13.0 Credit to the Private Sector (in real terms) -10.2 -1.5 2.9 -2.7 5.8 2.3 14.5 -13.4 1.5 1.0 Source: World Bank and Ministry of Finance. Note: CPI = Consumer Price Index; NAFA = Net Acquisition of Financial Assets. 14. Important fiscal reforms on both the expenditure and revenue side led to a marked improvement in the fiscal accounts despite higher fuel subsidy costs. Before reforms, low tax revenues contributed to a widened fiscal deficit, which reached a record high of 16.5 percent in FY2013/14. Since then, the overall budget deficit steadily narrowed to 10.9 percent of GDP in FY2016/17, due to a larger tax revenue intake (income tax reform and the introduction of the Value-Added Tax [VAT] as well as improved tax collection) and efforts to contain and improve the efficiency of expenditure, notwithstanding higher spending for energy subsidies, partly due to depreciation. The decline in expenditure in FY2016/17 was primarily driven by decreasing wage bill ratio and more efficient social spending and to a lesser extent by lower spending on other current expenditures while maintaining the level of capital expenditure (table 2). 7 Table 2. Key Fiscal Aggregates (Percentage of GDP) FY2011 FY2012 FY2013 FY2014 FY2015 FY2016 FY2017 FY2018 FY2019 FY2020 Pre- Actual Actual Actual Actual Actual actual Estimate Forecast Forecast Forecast Total Revenues 19.3 18.1 18.8 21.4 19.0 18.1 18.2 18.8 18.7 18.5 Tax Revenues 14.0 12.4 13.5 12.2 12.5 13.0 13.3 13.9 14.6 14.4 Grants 0.2 0.6 0.3 4.5 1.0 0.1 0.0 0.0 0.0 0.0 Other Non-Tax Revenues 5.2 5.1 5.1 4.7 5.5 5.0 4.8 4.9 4.1 4.1 Total Expenditures 29.3 28.1 31.6 32.9 30.0 30.2 28.8 27.6 25.8 23.9 Wages and Salaries 7.0 7.3 7.7 8.4 8.1 7.9 6.4 5.6 5.2 4.7 Purchase of Goods and Services 1.9 1.6 1.4 1.3 1.3 1.3 1.1 1.2 1.3 1.3 Interest Payments 6.2 6.2 7.9 8.1 7.9 9.0 8.9 9.1 8.9 7.7 Subsidies, Grants and Social Benefits 9.0 9.0 10.6 10.7 8.1 7.4 8.1 7.6 6.4 6.2 Energy Subsidies 5.0 6.2 6.9 6.5 4.0 3.0 3.9 3.1 1.4 0.8 Other Expenditures 2.3 1.8 1.9 1.9 2.1 2.0 1.7 1.4 1.3 1.2 Investments 2.9 2.1 2.1 2.5 2.5 2.6 2.6 2.7 2.7 2.8 Cash Deficit 10.0 10.0 12.8 11.5 11.0 12.1 10.7 8.8 7.1 5.4 NAFA -0.2 0.0 0.1 0.5 0.5 0.5 0.2 0.0 0.0 0.5 Overall Deficit 9.8 10.0 12.9 12.0 11.4 12.5 10.9 8.8 7.1 5.9 Overall Deficit Excluding Grants 10.0 10.6 13.2 16.5 12.5 12.7 10.9 8.8 7.1 5.9 Primary Balance -3.6 -3.7 -5.0 -3.9 -3.5 -3.5 -1.9 0.3 1.8 1.8 Sources of financing of projected overall budget deficits (percent of GDP) External borrowing 5.7 4.9 2.5 1.0 Domestic sources of financing 5.2 3.9 4.6 4.9 Source: World Bank and Ministry of Finance Note: NAFA = Net Acquisition of Financial Assets. 15. The larger than expected exchange rate depreciation and implementation of subsidy reforms have exerted sharp upward pressure on domestic prices, pushing annual inflation to above 30 percent. Depreciation was larger than expected due to pent-up demand for foreign exchange and the withdrawal of CBE from direct participation in the foreign exchange market. The inflation impact was further compounded by the introduction of the VAT, robust credit growth, and constraints on supply chains. After hitting almost 33 percent in July, annual inflation has started to ease over the past two months, reaching 31.6 percent in September.4 16. The CBE has tightened monetary policy to curb inflationary pressure. An initial hike in policy rates by 300 basis points in November 2016 was followed by two increases of 200 basis points each in May and July 2017, respectively. Following the most recent increase, the discount rate and the main operation rate of the CBE have risen to 19.25 percent, while the overnight deposit and lending rates have climbed to 18.75 percent and 19.75 percent, respectively. In October, the CBE raised the required reserve ratio on local currency deposits to 14 percent from 10 percent. Furthermore, the CBE has started introducing elements of 4 Monthly headline inflation, which averaged at 4 percent in the three months following the exchange rate liberalization, has dropped to 1 percent in September. 8 an inflation targeting framework. Inflation forecasts were introduced to guide expectations and an inflation target has been set at 13 [±3] percent for end-2018. To further enhance transparency and communication the CBE published its first quarterly monetary policy report in March 2017. 17. The sharp depreciation and flow of official finance linked to policy reforms have improved the external financing position. The current account deficit narrowed to US$15.6 billion in FY2016/17 compared to US$19.8 billion the year before. However, there was an increase as percentage of GDP due to the impact of depreciation on the US dollar-denominated GDP. The improvement in the current account was driven by a smaller trade deficit owing to a rise in both oil and non-oil exports and an incipient recovery in tourism and remittances. The exchange rate reform has encouraged more conversion of remittances through official banking channels. 18. The capital and financial account registered a sharp increase in net inflows to US$29 billion in FY2016/17 compared to US$21.2 billion in FY2015/16. This improvement was driven by a large increase in net portfolio investments as the liberalized exchange rate, attractive returns on Egyptian pound- denominated assets, and reduced risk started to draw in foreign capital. Net FDI inflows have also picked up, although from a low base, reaching 3.3 percent of GDP in FY2016/17 compared to 2.1 percent in FY2015/16 In light of these developments, the overall balance of payment position reversed into a net inflow of US$13.7 billion from an outflow of US$2.8 billion a year earlier. The exchange rate adjustment, along with additional multilateral, bilateral, and market funding increased net international reserves sharply to US$36.5 billion at end-September 2017 (above 7 months of import coverage), up from US$19 billion in October 2016. With rebuilt international reserves, the authorities repaid arrears to international oil companies, which were reduced to US$2.3 billion from US$3.5 billion at end-2016. 19. The banking sector has weathered the transition towards a flexible exchange rate regime and remains resilient. On the back of increased foreign exchange liquidity, the sector’s net foreign asset position has moved back into positive territory in May 2017. The depreciation had a moderate impact on asset quality and profitability, and liquidity. As of March 2017, average capital adequacy ratio stood at 14.9 percent, well above the Basel and CBE-mandated floor. The share of nonperforming loans in total loans stood at 5.7 percent, with loan-loss provisioning coverage of 92 percent. The banking system remains liquid as evidenced by an overall loan-to-deposit ratio at about 47 percent. 2.2 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY 20. On the back of recent reform measures, in particular the liberalization of the exchange rate and the fiscal consolidation, Egypt’s macroeconomic imbalances are expected to narrow further. 5 Ongoing business environment reforms will improve the private sector’s supply response to the elimination of foreign exchange shortages and correction of the overvaluation of the exchange rate. Critical pieces of legislation have been passed, including a long-awaited investment law and an industrial licensing law, which aim to strengthen the business climate, attract investments, and foster growth over the medium term. The projected growth path is gradual and assumes real GDP to increase to 4.5 percent in FY2017/18, up from an estimated 4.2 percent in FY2016/17, driven by private consumption supported by a rebound in remittances, a pick-up in private investment and a further recovery in net exports. As economic reforms progress and key sectors continue recover, especially manufacturing, and oil and gas extractives, including from new gas discoveries real GDP growth is projected to rebound to 5.3 percent in FY2018/19, and to increase further to 5.8 percent the year after. 5 The macroeconomic policy framework is broadly consistent with the IMF’s first review under the EFF. 9 21. Inflationary pressures are expected to remain high albeit temporary, driven largely by fuel price and electricity tariff adjustments. Higher prices for hydrocarbon products and electricity and an increase in the VAT rate by 1 percentage point to 14 percent, all of which became effective at the start of FY2017/18, have increased inflationary pressures. However, with the recent monetary tightening, the gradual fading- out of the one-off effects of the reform measures and favorable base effects, headline inflation is expected to decline to 14 percent at the end of FY2017/18. Beyond the current fiscal year, the CBE aims to bring inflation down into single digit territory, which could prove challenging as the interest rate transmission mechanism is impeded by supply-side bottlenecks and low financial inclusion. 22. With continuation of fiscal reforms, including measures supported by this operation, the budget is projected to move toward a sustained primary surplus of nearly 2 percent of GDP by 2019. The overall budget deficit is projected to narrow to 8.8 percent of GDP in FY2017/18 driven by enhanced revenues and continued rationalization of expenditures. Total revenues are projected to increase by 0.6 percentage points to 18.8 percent of GDP in FY2017/18, largely due to the full-year impact of the VAT and the increase in the VAT rate by 1 percentage point to 14 percent effective July 2017. Total expenditure is expected to decrease by 1.2 percentage point to reach 27.6 percent of GDP in FY2017/18, as the cumulative energy price adjustments and wage bill restraint contain recurrent spending. Debt service payments are expected to increase temporarily due to higher interest payments on domestic and foreign currency-denominated debt. Fiscal savings generated through higher energy prices and the containment of the wage bill will improve the expenditure structure by allowing for increased spending on social protection measures and a gradual shift away from current expenditure towards higher capital spending. 23. Egypt’s fiscal financing needs are projected to be met in FY2017/18. The projected fiscal deficit is expected to be fully financed through domestic and external borrowing. The Government is expected to finance the deficit through the issuance of treasury bills and bonds targeted at domestic banks, as well as non-resident investors. Disbursements under the International Monetary Fund (IMF) Extended Fund Facility (EFF), the proposed World Bank DPF 3, and the African Development Bank (AfDB) loan, as well as proceeds from potential Eurobond issuances in this fiscal year will contribute to financing the budget deficit. These financing sources will help phase out the need for the monetary financing of the deficit, strengthening the credibility of the inflation outlook. 24. The deficit in the external current account is expected to narrow going forward. Competitiveness gains from the real depreciation should continue to support export recovery, while the coming on stream of the Zohr gas field will reduce the need for costly gas imports. Meanwhile, the gradual improvement in security conditions should support tourism, which is experiencing a sharp pick-up. As a result, the current account deficit is projected to narrow to 4.6 percent of GDP in FY2017/18 and 3.9 percent the year after. In view of the improved economic outlook FDI inflows are expected to increase gradually. The external financing gap in FY2017/18, estimated at US$1.9 billion, is expected to be met through largely multilateral and some bilateral financing. Multilateral institutions are expected to provide US$1,650 million in financing of which the World Bank will provide US$1,150 including a US$150 million Guarantee from the United Kingdom through this operation and US$500 million from the AfDB. For FY2018/19 the financing gap is slightly smaller at US$1.7 billion, with the gap expected to be covered through rollovers of some maturing liabilities and some new financing (table 3). 10 Table 3. External Financing Requirements and Sources, FY2016/17 – FY 2019/20 Estimate Forecast (in US$ million) FY2016/17 FY2017/18 FY2018/19 FY2019/20 Gross financing requirements 25,100 23,800 17,200 18,000 External Current Account Deficit 15,600 11,800 10,700 10,600 Maturing Short Term Debt 7,000 9,100 4,100 4,300 External Debt Amortization 2,500 2,900 2,400 3,100 Available Financing 25,100 21,850 15,450 18,000 FDI (net of outflows) 7,700 9,400 10,150 11,000 Medium and Long Term Disbursement 6,700 10,200 9,200 5,300 Other Net Capital Flows 12,500 3,450 (3,100) 1,700 Other Sources of Financing (for example, arrears to international oil companies) (1,800) (1,200) (800) – Financing Gap – 1,950 1,750 – Sources of External Financing 1,950 1,750 Multilateral Institutions 1,650 Bilateral 300 Other (including eurobond) 1,750 Source: World Bank Note: Medium and Long-Term Disbursements in FY2016/17 include disbursements under the IMF EFF, the World Bank’s DPF 1 and DPF 2, and the AfDB. Starting FY2017/18, Medium- and Long-Term Disbursement, in addition to public borrowing, also includes the expected annual disbursement of US$4 billion under the IMF EFF. Potential loans from the World Bank, the AfDB and other financing sources are treated as ‘below the line’ items used to close the financing gap. 25. Egypt’s government debt has increased further, but is deemed sustainable over the medium term, although there are significant risks. Owing to the large depreciation and increased external borrowing the foreign-currency denominated debt increased sharply in FY2016/17, albeit from a very low base, and offset the decline in domestic debt. Consequently, the public debt ratio increased to 108.7 percent of GDP at end- FY2016/17 from 102.8 percent the year before. The Debt Sustainability Analysis (DSA) shows that under the baseline scenario, which assumes a gradual pickup in economic growth and a continuation of the fiscal adjustment program, the debt-to-GDP ratio is projected to decline to about 82 percent by end-FY2021/22. Despite the improved debt outlook, the debt ratio will remain high and debt-servicing costs will continue to exert pressures on public spending. The envisaged decline in the debt-to-GDP path over the medium term could be reversed if the projected economic recovery is not sustained and fiscal consolidation efforts lose momentum. These risks are mitigated by a captive domestic investor base, buffers in form of government deposits of around 10 percent of GDP, and a moderate external debt ratio, which is largely long-term and on concessional terms. Additional details about the DSA and stress tests to the baseline scenario are presented in annex 5. 26. Egypt’s macroeconomic policy framework is adequate for this operation, particularly in light of the adopted policy reform measures to float the exchange rate and correct the fiscal imbalances, but downside risks are significant. While recognizing that the Government’s reform program is front loaded, inflation remains high, at least for the time being, and imposes social and economic hardship to the population. Risks to debt sustainability, already significant, could be further amplified by a slowdown or 11 reversal in fiscal reforms and increase financing needs. Any delays in implementing real sector reforms can also undermine expected gains in competitiveness and economic growth trajectory. In addition, tighter global financing conditions and prospects of monetary policy easing in Egypt as inflations recedes could trigger volatility amid a re-pricing of risk and capital flow reversals prompting higher borrowing costs and exchange rate pressure. This in turn could test the CBE’s willingness to resist pressure to manage the currency and lead to a loss of reserves. Sluggish recovery of Egypt’s main trading partners pose additional downside risks to Egypt’s growth outlook. Risks are mitigated by the strength of the policy package, frontloading of fiscal measures, and strong political support for the objectives of the program. 2.3 IMF RELATIONS 27. In July 2017, the IMF Executive Board completed the first review of Egypt’s economic reform program supported by an arrangement under the three-year US$12 billion EFF, which was approved last November. Total disbursements under the EFF amount to about US$4 billion. The authorities’ reform program supported by the EFF will help Egypt restore macroeconomic stability and promote inclusive growth. Policies supported by the IMF program aim to correct external imbalances and restore competitiveness, reduce the budget deficit and place public debt on a declining path, boost growth and create jobs while protecting vulnerable groups. In completing the first review, the Executive Board approved the authorities’ request for waivers of the June performance criteria for the primary fiscal balance and the fuel subsidy bill. These were missed due to higher costs of imported food and fuel products caused by large depreciation of the Egyptian pound. The waiver was approved in view of the important measures taken in June to contain fuel subsidies and the planned stronger fiscal adjustment in the next two years, which will keep the program objectives on track. 3. THE GOVERNMENT’S PROGRAM 28. The DPF is anchored in the Government’s medium-term reform program. The GoE has developed a long-term vision—Egypt’s 2030 Sustainable Development Strategy—and a medium-term reform plan. This medium-term reform plan was developed in consultation with the civil society and the private sector and was endorsed by the Parliament in April 2016. Significant progress has been made on the implementation of the program during the last three years. 29. The reform program sets ambitious targets for sustainable, private-sector-led growth and job creation, to be achieved by FY2018/19. Overall objectives of the economic program include: (a) achieving sustainable and high real GDP growth reaching 5.5–6 percent by FY2018/19, (b) lowering poverty rates from 27.8 percent in 2015 to 24 percent in 2019, (c) increasing the pace of private sector job creation to reduce unemployment to 10–11 percent and in particular to address the high youth unemployment rate, (d) achieving greater efficiency and fairness in government spending while bringing down the fiscal deficit to around 7 percent of GDP, (e) lowering government debt burden within the range of 90–92 percent of GDP, (f) reducing inflation to single digits around 7–8 percent thereafter, and (g) increasing foreign exchange reserves to cover about 5.5 months of imports over the medium term. 30. The initial phase of the reform program focused on achieving macro-fiscal stability, which involved a strong commitment to fiscal consolidation. To improve fiscal balance, the Government implemented a combination of measures to boost revenue while consolidating public expenditures. On the revenue side, the broadening of the tax base helped shore up the budget. On the expenditure side, the Government continued its commitment to gradually phase out energy subsidy and control the public-sector wage bill. The Government is also continuing its efforts to strengthen public financial management (PFM) and fiscal transparency. 12 31. The Government’s ambitious plan to eliminate energy subsidies has yielded significant results amid growing headwinds. Between July 2014 and July 2017, the Government implemented four annual electricity price reforms and three fuel price increases. As a result, energy subsidies fell steeply from 6.5 percent of GDP in FY2013/14 to 3 percent in FY2015/16. Subsidies were set to fall further to 2.5 percent of GDP in FY2016/17 but the substantial depreciation of the Egyptian pound and resulting increases in the cost of energy production meant that subsidies instead rose to 3.9 percent of GDP in FY2016/17. However, the Government remains committed to containing energy subsidy which is also shown in the shift of the Government’s approach to energy price setting. 32. Macro-fiscal stabilization is an essential prerequisite for restoring business confidence. With a renewed focus on enabling private-sector-led growth, the GoE has embarked on a comprehensive reform encompassing the regulatory, institutional, and procedural frameworks to create an enabling environment for investment and business operations. The legislative reform involves passing three key laws (on investment, industrial licensing and the stock exchange) and advancing at least four more (the amended Companies Law, as well as laws on bankruptcy, leasing/factoring and capital markets). In an effort to modernize the institutional framework to attract investment, the Supreme Council for Investment was established and a unit in the Ministry of Investment and International Cooperation (MIIC) was set up to formulate strategies that improve the international ranking of Egypt’s business environment. Mechanisms are being created to streamline procedures and transform the investment landscape, notably, a network of Investor Service Centers will act as one-stop shops empowered to accelerate administrative procedures. They will provide an improved, integrated and automated online registration process based on clear service standards, as well as a conflict resolution and follow up service for investors. This effort would be complemented by forward looking legislations in the renewables and gas sector that enable private investment. 33. Two central reforms for improving Egypt’s business environment are the new Investment Law and the comprehensive modernization of the outdated industrial licensing regime. The first reform of the industrial licensing legislation since 1954 will streamline the industrial licensing process. The licensing regime introduces service time limits as well as grievance procedures. In addition to cutting red tape, the new Investment Law (June 2017) is designed to make Egypt an attractive destination for foreign investors by providing guarantees of fair and equitable treatment, so that they enjoy the same treatment as national investors. The law promotes investment through the provision of incentives that are targeted to priority sectors and lagging regions, publication of an investment map charting business opportunities, and availability of land and infrastructure in different locations. Free zones will be used to promote export industries and capture the benefits of business clustering. 34. Reforms to the financial regime for businesses should help enhance access to finance. Key among these reforms is the new draft bankruptcy law submitted to the Parliament, which includes the introduction of rescue proceedings and the adoption of a less punitive approach for debtors. The legal framework for financial leasing and factoring is also under reform, with a new draft law recently adopted by Cabinet that clarifies the duties and obligations of lessors and lessees. 35. Supportive measures are also being targeted towards the SME sector. Of significance is the Government’s decision to revise the outdated 1981 Companies Law. The revisions under consideration allow one owner to establish a limited liability company (a single-person company). Prior to these revisions, one owner could only register as a sole-proprietor, bearing the risk of personal unlimited liability. This new form affords single members limited liability and other protections. In addition, the new Egypt Ventures Fund aims to provide a wide range of business development services and seed capital to start-up enterprises, with a focus on youth and underprivileged groups. The law on shared transport seeks to provide a regulatory framework and social protection for rapidly expanding jobs through online car transport services. 13 36. Substantial enhancements to the social protection system are helping improve the inclusiveness of Egypt’s social contract. The energy subsidy reform, wage restraint, and the new VAT have freed up space to increase social protection spending in FY2017/18 as an intended measure to offset the social impacts of the currency devaluation and rising energy prices (see box 2 in section 5). An Inter-Ministerial Committee on Social Justice is spearheading efforts to ensure this spending is channeled through more efficient and better targeted social safety nets, instead of generalized subsidies as in the past. These efforts include: (i) overhauling the longstanding food subsidy program with better administrative efficiency and income ceilings to better target the poor; (ii) scaling up the cash transfer (Takaful and Karama program), which benefits the poorest families in Egypt, more than 90 percent of which are female-headed, and supplementing it with a new program, Forsa, dedicated to providing job opportunities to youth; and (iii) protecting the middle class by focusing on skill enhancement, financial inclusion and improved service delivery. 37. Measures to promote transparency and accountability have been mainstreamed across all aspects of the reform program. As part of its fiscal stabilization efforts, the Ministry of Finance has begun the implementation of a fully digitalized Government Fiscal Management Information System (GFMIS) so that all revenues and expenditures in the state budget are centrally processed through a single account at the CBE, thereby enhancing transparency. Following the series of electricity price hikes, the regulator, Egyptian Electric Utility and Consumer Protection Regulatory Agency (EgyptERA), has issued new public hearing regulations to provide a channel for participation and feedback in advance of all major regulatory decisions on tariffs and licenses. As the petroleum sector moves to implement a major market reform for natural gas, parallel efforts are underway to modernize the management and governance of the sector by having focused companies to ensure that roles and responsibilities are more clearly defined. Business environment reforms involve improved transparency in the process of granting industrial licenses, the provision of enhanced protection and guarantees to investors, and the online publication of information on licensing and permit requirements. The new Investment Law includes a transparent procedure for dispute settlement and a time- bound grievance mechanism. Finally, there have been concerted attempts to involve youth in the development dialogue, including conferences led by the President to understand their concerns on education and job opportunities. 38. Egypt declared 2017 the Year of Women in Egypt, signaling a special focus on female inclusion and empowerment. In response, the National Council of Women (NCW) launched a multi-pronged National Strategy for the Empowerment of Egyptian Women with a horizon to 2030, and a comprehensive agenda covering political, economic and social aspects of female empowerment. To raise awareness, the NCW has launched a nationwide media campaign—‘Taa Marbouta – The Secret of Your Strength’—aiming to support female inclusion in all aspects of society, as well as ending violence against women, and highlighting the role of men in supporting women. The NCW is also developing a program to promote women’s financial literacy and financial inclusion. The MIIC is preparing a new operation targeted at female entrepreneurs, with support from the World Bank. 39. Efforts to incentivize households to switch to reliable and more convenient modern energy sources, such as natural gas, can contribute to closing gender gaps in Egypt. In Egypt, the burden of ensuring continuous access to liquefied petroleum gas (LPG) primarily falls on women. This often involves long waiting lines, seeking LPG cylinders from stores, grocers, vendors, house guards and non-governmental organizations, and carrying these heavy cylinders back to the house. Replacing LPG with natural gas can result in time saving and enhance the ability of women to engage in income-generating opportunities.6 6 Clancy, Joy; Matinga, Magi; Oparaocha, Sheila; Winther, Tanja. 2012. “Social Influences on Gender Equity in Access to and Benefits from Energy.” Washington, DC: World Bank. 14 Freeing up time in itself is often not sufficient for economic empowerment of women.7 However, time saving can allow women to engage in more productive activities (particularly at the household), own businesses, and earn income. 40. The reforms targeted at subsidies, efficiency, and governance of the energy sector are essential for fiscal consolidation and to mitigate carbon emissions. The reduction in energy subsidies since 2014 is adding US$14 billion annually to fiscal consolidation and sustainability of social protection budgets. This is being complemented with deep governance reforms in the electricity and petroleum and gas sectors, thereby increasing accountability and transparency in sector operations, and improving operational efficiency and sector financial viability. This is critical in ensuring consumer support for tariff reforms. In addition, over 70 percent of Egypt’s GHG emissions came from the energy sector in 2015. Emissions from the power sector have been growing as oil filled the gap left by shortages of natural gas and subsidized energy prices did little to encourage energy efficiency. The comprehensive energy reform program that is under way encompasses a number of measures that are expected to contribute to reducing the carbon intensity of the energy sector over time at negative net cost. First, sustained energy price reform has led to cumulative price increases of 190 percent for electricity and 220 percent on average for fuels between FY2014/15 and FY2017/18, providing much stronger price signals to consumers. Second, measures to develop 14 GW of new, highly efficient gas-fired power generation capacity, and to expand the supply of domestic and imported natural gas, will allow substitution away from more carbon-intensive fuel oil for power generation and other industrial applications. For example, if the share of natural gas in the fossil fuel mix for power generation is restored to its level in FY2011/12, GHG emissions from the power sector would decline by 13.5 million tCO2, or 14 percent of power sector emissions (assuming an efficiency improvement from the fuel switch of 4 percentage points). Third, Egypt’s renewable energy program has achieved financial closure for 400 MW of new wind and solar power generation, and paved the way for a pipeline of more than 1,500 MW of additional projects, as well as enhancing incentives for decentralized solar generation. Fourth, the new Electricity Law includes regulatory measures to promote energy efficiency among large industrial customers. Fifth, the modernization of the legal, regulatory and institutional framework for both the electricity and gas sectors, and the planned introduction of competitive markets could be expected to increase pressures for greater efficiency along the entire energy supply chain. 4. THE PROPOSED OPERATION 4.1 LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION 41. The design of the DPF program incorporates lessons from DPF 1 and DPF 2 as well as earlier engagements in Egypt. The Independent Evaluation Group’s 2009 Country Assistance Evaluation report titled ‘Egypt: Positive Results from Knowledge Sharing and Modest Lending’ concluded with two recommendations: (a) to continue promoting improvements to systems that improve governance (citizen budgeting, simplification of taxation, and business procedures); and (b) to focus on policy and institutional reforms in energy and business competitiveness. This DPF operation directly supports the government reforms in these areas. The prior actions under the DPF series were based on a homegrown program of the Government, selectively choosing top national policy priorities backed by deep analytical engagement of the World Bank in these prioritized policy areas. The programmatic nature of the DPF has ensured continued focus on sustainable outcomes in the areas of revenue maximization, expenditure control, energy subsidy reform, enhanced competitiveness of the private sector, and structural reforms for governance and efficiency in the operation of the Government and its key departments. 7 Deloitte Consulting. 2014. Women, Energy, and Economic Empowerment: Applying a Gender Lens to Amplify the Impact of Energy Access. 15 42. The proposed DPF supports the Government program, which seeks to mitigate risks for enabling private investments in Egypt through removal of macroeconomic distortions and improvement of the business climate. The program also enhances financial viability of sectors like energy, and supports its sustainability through transfer of savings from energy subsidy reduction to the social protection budget for food subsidies and targeted cash transfers. These are in line with international best practices and lessons from other countries. Initiating private investment in solar through a FIT scheme and moving to an auction- based mechanism in the next phase is also in line with international good practice. 43. The DPF has the following three development objectives, each supported by a corresponding pillar: (1) advance fiscal consolidation through higher revenue collection, greater moderation of the wage bill growth, and stronger debt management; (2) ensure sustainable energy supply through private sector engagement; and (3) enhance the business environment through investment laws, industrial license requirements as well as enhancing competition. 44. The proposed DPF contributes across the four major themes of Egypt’s development strategy: macro-fiscal stabilization, private sector-led growth, social and economic inclusion, and transparency and accountability. The measures supported by the DPF series carry strong government ownership and are clearly nested within Egypt’s own reform program (see Table 4). A range of measures to improve revenue collection and reduce expenditures, in particular by reforming energy subsidies, will support macro-fiscal consolidation. Private sector-led growth will be advanced through a package of reforms designed to cut red tape, reduce barriers to entry, and promote better competition policies, while the liberalization of energy markets will create significant opportunities for private sector engagement. The prior actions of the proposed DPF include features that enhance transparency and accountability, including by strengthening regulatory institutions for energy and business sectors; publishing information on the electricity tariffs, the Government’s budget, and debt framework; and increasing transparency on business regulations and licensing procedures. Several fiscal and business environment measures are specifically targeted at SMEs, thereby favoring broader economic inclusion. Moreover, energy subsidy reforms are intended to redirect part of the fiscal savings toward social spending. 45. The policy matrix supported by the programmatic DPF series is included in Annex 1. It includes the prior actions of all three operations of the series as well as the results indicators. The prior actions of DPF 3 build on previous reforms under the series and are critical for the continued progress toward the results of the reform program supported by the DPF series. 16 Table 4. Contribution of DPF 1-3 Prior Actions to the GoE’s Reform DPF Series Four Themes Pillar 2: Pillar 3: Additional Reforms Being of GoE’s Pillar 1: Ensuring Enhancing the Undertaken Beyond DPF Reform Advancing Fiscal Sustainable Business Pillars Program Consolidation Energy Supply Environment 1. Macro-fiscal • Income tax reform • Reduction in • Enhanced • Real estate tax stabilization • VAT (Initial rate energy investment • Property tax reform 13 percent; increased subsidies climate through • Capital gains tax reform to 14 percent in • FDI in energy a new • Excise and cigarette tax rise FY2017/18) investment law • Upgrading the tax • Delinking variable pay administration function from basic pay • Public expenditure reform • Debt management • Civil Service Law reform • Medium-term fiscal • Cap on number of new framework (MTFF) recruits in the public sector • Establishing Sovereign relative to the number of Guarantees retirees Committee. • Streamlining water subsidies • Tax dispute settlement • Introducing e-filing and e- payment for VAT and corporate income tax. • Establishing a central department for professional taxpayers. • Revising fees for government services 2. Private • Unifying income tax • Private-sector • Amendments to • New Suez Canal sector-led • VAT led renewable the Companies Development Project growth • Tax dispute settlement energy Law, enabling • National Project for Roads development establishment of • Settling investor disputes • Free entry for single-person • Investments in upstream gas private power limited liability contracts and gas companies • Energy security through companies • Improved liquefied natural gas imports competition • Amendments to Financial environment Leasing and Factoring Law • Streamlining • Issuance of presidential industrial decree to amend provisions licensing of Egyptian Stock Exchange • Initial public offerings of public sector companies • Gas Law • Submitting the Bankruptcy Law to Parliament • Financial Leasing and Factoring Law approved by Cabinet • Capital Markets Law submitted to Parliament • Establishment of the SME Authority 17 DPF Series Four Themes Pillar 2: Pillar 3: Additional Reforms Being of GoE’s Pillar 1: Ensuring Enhancing the Undertaken Beyond DPF Reform Advancing Fiscal Sustainable Business Pillars Program Consolidation Energy Supply Environment 3. Social and • Energy • Amendments to • Takaful and Karama transfer economic subsidy the Companies • Unified registry inclusion savings Law, including • Upper Egypt development redirected to enabling • Rural sanitation project social establishment of • Agricultural competitiveness protection single-person • Social housing project • Distributed limited liability • Natural gas connections solar energy companies • Skills and education project for SMEs and • Streamlining • Microfinance Law citizens industrial • Enhancing accessibility to licensing for land and to urban SMEs communities 4. • Midyear review • Strengthening • GAFI published • Civil Service Law reform Transparency statement EgyptERA regulatory • Ports automation and • Managing contingent • New gas requirements • Electronic tax collection accountability liabilities regulator and incentives • Project automation • Public Debt Strategy • Corporate • Reduced • PFM Strategy • Civil servants’ wage governance discretion and • Investor Conflict Resolution automation reforms in increased Unit • PFM Unit SOEs transparency in • Governance Unit established • Internal audit unit • Policy and industrial • Sovereign Guarantees Strategy Unit licensing Committee in the • Strengthened • Publishing the risks to Ministry of competition the implementation of Petroleum authority the national budget and Mineral Resources Note: Measures in grey-filled columns are supported by the World Bank Group under the Egypt DPF series. 4.2 PRIOR ACTIONS, RESULTS, AND ANALYTICAL UNDERPINNINGS Pillar 1: Advancing Fiscal Consolidation 1.1 Enhancing Government Revenues 46. The Ministry of Finance has embarked on an ambitious tax reform agenda with the aim to broaden the tax base, enhance the role that tax policy plays in the economy, and build an effective and fair tax system. The Income Tax Law (prior action for DPF 1) and the introduction of the VAT in September 2016 were important milestones in the tax reform agenda. In March 2017, the Government issued the Executive Regulations of the VAT Law, which further clarified the tax treatment in a number of areas that were unclear under the previous Generalized Sales Tax (GST) legislation and provided guidance on tax filing procedures, the tax refund mechanism, and billing and payment processes.8 The VAT, which exempts basic goods and services to protect the poor, is contributing to the broadening of the tax base as evidenced by the continuous 8 For example, the VAT Law also allows for a more expedited tax refund process, which allows refunds to be processed within 45 days as opposed to three months under the previous GST system. 18 increase in the number of new taxpayers that have registered under the VAT, which reached about 45,000 in August compared to 17,000 in February. 47. The tax dispute legislation (prior action for DPF 2), which was approved by the Parliament in September 2016, is playing an important role in resolving the backlog of dispute cases. The new law is based on pragmatic provisions that have made the dispute resolution process easier, more efficient, and final and are aimed at building trust with the taxpayer. To date, 8,500 cases are being handled under this law, and as of August 2017, 3,000 disputes between the tax authority and taxpayers have successfully been resolved, which led to the settlement and agreement on final taxes at EGP 2.2 billion. 48. The Government remains committed to design a tax framework for micro and small businesses (trigger in DPF 3), but the approach has changed. It is now planned to be introduced as part of an overarching framework for micro, small, and medium enterprises (MSMEs) together with other MSME policy components. For fiscal consolidation, the authorities have focused on difficult big ticket measures that are supported by the IMF program and the World Bank’s programmatic DPF series. The Government’s focus on ensuring the seamless and proper implementation of the VAT and the Tax Dispute Law and other recently introduced taxes has led to some delay in introducing a tax framework for MSMEs, which is primarily aimed at tackling informality. More importantly, the tax aspect embodies only one segment of a larger government initiative to create an enabling framework for MSMEs. To this end, the Government recently established the Agency for Development of Medium, Small and Micro Enterprises, which is tasked to develop policies and strategic plans for the development of MSMEs. This comes as a step prior to the issuance of a new SME law, the draft of which is currently being prepared. Furthermore, SMEs are included as a strategic sector under the Investment Law to benefit from tax incentives of up to 30 percent of investment cost. The aim is to overcome some of the hurdles which stand in the way of the formalization of MSMEs, which are a sizable part of the Egyptian economy. To reap the full benefits of the tax regime, the framework will be complemented by additional measures on, for example, improving access to finance and developing social security, which are envisaged under the broader MSME initiative. 49. Results. Important tax reforms described above and supported under the programmatic DPF series have gradually widened the tax base, created a fairer and more equitable tax system, and mobilized tax revenues. The latter have steadily increased to 13.3 percent of GDP in FY2016/17 from a low of 12.2 percent in FY2013/14 and are projected to reach almost 14 percent this fiscal year. In terms of the results indicator, non-sovereign corporate income tax and sales/VAT on goods and services increased from 5.4 percent of GDP in FY2014/15 to 6.9 percent in FY2016/17, which already exceeds the target of 6.7 percent set for FY2017/18. The ratio is expected to increase further to 8.1 percent in FY2017/18. 1.2 Containing the Wage Bill DPF 3 Prior Action 3.1: The Borrower, through its Ministry of Finance, has issued a wage bill report entitled Note on Key Reforms and Development of Wages dated August 2017 notifying that at least seventy percent (70%) of the wage bill is automated and that an action plan for the completion of the automation process has been developed. 50. The wage bill was on an accelerated path and unsustainable trajectory during FY2010/11 – 2013/14. Increases in the number of permanent employees in the Government, higher bonuses granted to various groups and segments every year, and increases in the minimum wage from EGP700 to EGP1,200 per month led to a rapid rise in the wage bill. In fact, wages and salaries grew faster than any other spending chapter during this four-year period. 51. Starting in FY2014/15, the Government began to introduce measures to control and reduce the wage bill to a sustainable footing. Successive budget laws set instructions that have helped limit the growth 19 of the wage bill, enhance equity and transparency of employees’ wages and remuneration schemes ac ross various budgetary entities, and improve and simplify the wage setting process. A new wage structure has been developed and implemented, which includes the automatic increases in employees’ total wage and salary bill. This is achieved by breaking the link between the basic and variable pay, which used to account for most of the annual growth of the wage bill under the previous system, by turning the variable pay into a permanent lump sum amount. 52. The Ministry of Finance has made substantial progress in the automation of the payroll system (Prior Action 3.1). An early phase of payroll automation took place in FY2009/10, which resulted in only 0.1 percent of the total payroll being automated. However, this ratio increased steadily to 19 percent in FY2013/14 and 26 percent in FY2014/15. The automation of wages and salaries progressed further to 45 percent in FY2015/16, and at the end of FY2016/17 reached 70 percent. With 80 percent of the public-sector payroll automated at end-September 2017, the authorities are well on track to complete full automation of wages and salaries payments for all government employees by the end of this fiscal year. This is part of a larger plan to process all expenditure and revenue in the state budget through an electronic system, which the Ministry of Finance has started to roll out. 53. The Government is taking measures to reform the public sector. A Supreme Committee headed by the Prime Minister was established in April 2017 to develop administrative reforms, notably through restructuring, automation, and training and capacity building programs. Members of the Supreme Committee include the Minister of Planning and Administrative Reforms, Minister of Finance, Minister of Local Development, the Central Agency for Organization and Administration and representatives of the private sector and civil society. To contain the size of the public sector, where one public servant currently represents close to 14 citizens, needs are predominantly being covered through internal placements following the advertisement of vacant positions at the central level. One of the committee’s mandates is to put in place a clear and merit-based hiring process for positions that require undersupplied skills, and, hence, cannot be filled through internal placements. On a case-by-case basis, the recruitment of undersupplied skills can occur, provided the number of new recruits relative to retirees is in the range of 15 percent to 25 percent. The introduction of such a cap is an important milestone compared to the previous system, whereby decisions on the numbers and modalities of new recruits did not follow specific rules and were left to the discretion of each organization, resulting in a bloated public sector. With some 160,000 to 170,000 employees retiring annually the size of the public sector is expected to shrink gradually, which will help to further contain the wage bill. 54. Results. During this DPF series the authorities have demonstrated strong policy commitment to reduce the wage bill ratio. The new wage system, significant progress in the automation of the payroll system, and reforms to contain the size of the public sector have contributed to a marked decline in the wage bill ratio. The Central Government’s wage and salary bill (results indicator) has now fallen for three consecutive years, from 8.2 percent of GDP in FY2014/15 to 6.4 percent in FY2016/17, exceeding the results indicator target by 1 percent of GDP and one year ahead of schedule. The ratio is projected to decrease further to 5.6 percent of GDP this fiscal year. The decline in the wage bill played a pivotal role in improving the expenditure structure, providing space to absorb the impact of depreciation on the budget, and reducing the overall fiscal deficit. 1.3 Strengthening Debt Management and Aspects of Public Financial Management DPF 3 Prior Action 3.2: The Borrower, through its Ministry of Finance, has: (i) issued Ministerial Decree No. 290/2017, which establishes an internal audit dedicated unit with adequate staffing, budget and procedures aligned with international guidance related to independence, audit planning, risk assessment and periodic reporting. 20 (ii) issued Ministerial Decree No. 201/2017, which establishes a Sovereign Guarantees Committee entrusted to develop policies for issuing sovereign guarantees, review the applications for issuing such guarantees, and evaluate periodically the financial stability of the recipients of the guarantees. (iii) begun publishing a section in the FY2017/18 Budget Statement on economic risks to the implementation of the national budget. 55. In addition to establishing a PFM Improvement Unit in 2016 to consolidate the fragmented PFM reforms, the Ministry of Finance has embarked on several activities to operationalize the newly established unit and to enable it to fulfill its mandates. These included the establishment of an internal audit unit, relevant capacity building and training to the internal audit team, identifying the first set of pilot audits to be undertaken and completing a planning exercise for the pilots in preparation for the field audit work expected within this fiscal year. This is in line with the government-wide plan to roll out the internal audit function across ministries. 56. This prior action captures the comprehensive steps taken by the authorities to analyze and manage fiscal risks to help ensure sound public finances. The Ministry of Finance established a Sovereign Guarantees Committee that is headed by the Minister and includes senior Ministry of Finance officials and has the mandate to review the requests for new guarantees, assess the associated risks, and decide on the guarantee request. The authorities further prepared a report on outstanding stock of state guarantees. As part of its efforts to enhance fiscal transparency the published FY2017/18 budget statement included for the first time a section on risks to budget implementation. The risks covered include changes in underlying macroeconomic assumptions, contingent liabilities, including loans and facilities guaranteed by the treasury, international arbitrations, and Public Private Partnership (PPP) projects, as well as risks related to short-term debt. These actions underscore the Government’s continuous effort to strengthen fiscal resilience. 57. Results. The DPF series has focused on strengthening debt management and aspects of PFM. On debt management, the authorities published an MTDS (prior action for DPF 1) in December 2015 with an updated strategy for 2017-2020 expected to be published before the end of 2017. The adoption of the updated MTDS will strengthen efforts to safeguard sound debt management, which is critical to macroeconomic stability, and inform investors and lenders about the Government’s intended policies and plans. By sharing key debt management goals, investors are given higher certainty about market developments, which can reduce risk premiums. The strong linkage between effective debt management and a resilient macroeconomic framework is further reinforced by the recent steps taken by the authorities to strengthen fiscal risk management by establishing a Sovereign Guarantees Committee and enhance fiscal transparency. 58. In addition to strengthening debt management, the policy area was extended to better reflect PFM aspects that this DPF series aims to tackle. By the end of the DPF series, at least four audits on sectors and entities affiliated with the Ministry of Finance would be completed, applying an ex-post risk-based methodology rather than a traditional ex-ante transaction-based compliance control. After the internal audit function becomes fully operational, it is expected to serve as a model for other line ministries. These are important steps toward strengthening publics sector governance, risk management, and internal controls, and will contribute to achieving a more effective resource allocation and improving the quality of public service outcomes. 59. Climate change co-benefits. Sovereign guarantees have been critical to attract investments in strategic sectors, especially renewable energy. They allow for the 1,500 MW of solar and 250 MW of wind to be contracted recently, which is expected to bring the share of renewables in the power sector installed capacity to 10 percent. Going forward, there will be further need for sovereign guarantees to achieve the GoE’s target of 20 percent of installed capacity coming from renewables by 2022 (an additional 4,000 MW 21 is needed). However, limited fiscal space is putting pressure on the Government to curtail guarantees. Enhanced guarantee and debt management, as supported by this prior action, will ensure that future guarantees are issued more selectively, hence giving space for guarantees of most critical investments, including renewables. By encouraging private investment in renewable energy, this prior action is well aligned with the multilateral development bank (MDB) list of eligible climate mitigation activities under Category 9.1 “…capacity building on sustainable energy”.9 Pillar 2: Ensuring Sustainable Energy Supply 2.1 Reforming Energy Subsidies DPF 3 Prior Action 3.3: The Borrower, through its: (i) Ministry of Electricity and Renewable Energy, has issued Ministerial Decree No. 312/2017 on annual electricity price adjustment; and Prime Minister, has issued Prime Ministerial Decrees No. 1435/2017, 1436/2017 and 1437/2017 for the fuel price adjustment for FY2017/18 consistent with the FY2017/18 Budget Statement. (ii) Cabinet has issued Cabinet Letter 14724-5 dated July 5, 2017 approving the extension to achieve full cost recovery in the power sector by FY2021/22. (iii) Ministry of Finance and the Ministry of Petroleum and Mineral Resources, has approved a joint policy proposal for periodic fuel price indexation, which has been submitted to the Prime Minister for consideration. 60. Resisting pressures to pause price reforms due to challenging economic and social conditions, the Government followed through with its annual energy price adjustment in June 2017, as institutionalized under Prior Action 3.3 (i), hence preserving the path toward cost recovery. The latest adjustment raised diesel and gasoline prices by between 40 percent and 55 percent and electricity tariffs by 40 percent on average.10 LPG prices, which were highly subsidized and spared from price increases in 2014 and 2015, were doubled to improve alignment with costs (even after the latest increase, cost recovery is estimated at 35 percent only). This price adjustment coincided with a period of high inflation exceeding 35 percent, as well as severe social and economic hardship resulting from the sizeable currency depreciation. To mitigate negative social impacts, social protection expenditures are budgeted to increase by 60 percent in FY2017/18, translating into substantial benefit increases across both universal and targeted social programs (see box 1). 61. The achievement of the Government’s medium-term energy subsidy trajectory has been affected by the major devaluation which substantially increased the costs of fuel and electricity production. Even recent substantial energy price adjustments were not enough to reduce energy subsidies to the projected level of 2.5 percent of GDP for FY2016/17, which instead reached 3.9 percent of GDP (of which 2.9 percent of GDP was for fuels and 1 percent of GDP was for electricity). In view of the magnitude of the devaluation, the Government revised its MTFF. The fuel and electricity price adjustments in June 2017 are consistent with this revised MTFF. 62. Prior Action 3.3 (ii) captures the continued government commitment to achieving full cost recovery in the power sector in the medium term, including any adjustments in fuel prices and exchange rates. The original objective of reaching cost recovery by FY2018/19, based on a five-year tariff adjustment schedule announced in FY2013/14, was not achieved due to the devaluation; at the same time retail tariffs for consumers in FY2017/18 are already higher than what had originally been targeted for FY2018/19. The Government’s continuing commitment to cost recovery can be seen in the recent Cabinet approval of a new 9 MDBs, 2016. 2015 Joint Report on Multilateral Development Banks’ Climate Finance. 10 With respect to petroleum prices, this is the second increase in eight months and the third increase since July 2014. The recent increase in electricity tariffs constitutes the fourth consecutive round of upward adjustments since July 2014. 22 subsidy trajectory targeting FY2021/22 as the year by when electricity subsidies would be fully phased out. This approach is consistent with the policy adopted by the Supreme Energy Council in 2016, which shifted the focus to meeting subsidy targets rather than setting price trajectories that are subject to external shocks and may not necessarily meet budgetary constraints. 63. As captured in Prior Action 3.3 (iii), the Ministry of Finance and Ministry of Petroleum and Mineral Resources have submitted to the Prime Minister a joint proposal for periodic fuel price adjustment during the fiscal year to respond to unanticipated changes in fuel cost. Under the policy adopted by the Supreme Energy Council in 2016, a process is already in place whereby fuel prices are revised annually in light of movements in foreign exchange and oil prices to ensure that subsidy targets are met. An inter-ministerial working group, set up between the Ministry of Finance and the Ministry of Petroleum and Mineral Resources, has adopted a proposal for more frequent automatic indexation of fuel prices based on movements in international oil prices and foreign exchange throughout the year. The automatic indexation mechanism, which is being developed with World Bank advice and global benchmarks, is designed to provide clear linkages between the price and cost of different fuels, a transparent formula for calculating regular price adjustments, a protection mechanism for handling large shocks, and an institutional framework assigning clear responsibilities to different stakeholders. This more sophisticated policy would limit the accumulation of unanticipated subsidies on the government budget during the course of the year due to uncontrollable cost fluctuations, while at the same time providing some protection against excessive price fluctuations for consumers. The proposal, already approved by the two Ministers involved, has been submitted to the Prime Minister. 64. Results. Egypt has shown remarkably sustained commitment to the path of energy subsidy reform throughout the DPF series, despite significant macroeconomic shocks along the way. Since the start of the DPF series, there have been two substantial adjustments in fuel prices and three annual increases in electricity prices. The careful handling of these tariff increases, through ensuring better quality of supply, eliminating power shortages, communicating proactively with the public, and implementing parallel social protection measures, helped to secure public acceptance of repeated large tariff adjustments despite a challenging social context. 65. The subsidy bill which was at 6.6 percent in FY2013/14 is now expected to reach 3.2 percent of GDP by FY2017/18, and 1.4 percent of GDP by FY2018/19, continuing a downward trend thereafter. The subsidy target for the DPF of 1.5 percent by FY2017/18 was revised to 3.2 percent to be consistent with the revised MTFF, implying a one-year delay in meeting the target, due to the impact of currency devaluation. The important impact of the DPF prior actions is best appreciated by considering the counterfactual: in the absence of price reforms during 2014-17, it is estimated that Egypt’s energy subsidy bill would have risen to 8.9 percent of GDP by FY2017/18, despite the decline in oil prices. Cost recovery for fuels and electricity has increased by 15 percentage points on average.11 66. Climate change co-benefits. Consistent with the World Bank’s 2016 Climate Change Action Plan, this prior action, which relates to efficiency pricing of fuels and electricity,12 is expected to contribute to the reduction of carbon emissions due to the anticipated demand response resulting from the increase in prices to end consumers. It is considered part of the MDB list of eligible mitigation activities under Category 9.1 “efficient pricing of fuels and electricity (efficient end-user tariff).” 11 Cost recovery is defined here as the electricity sector’s financial cost recovery, including operating expenditures, depreciation, and financing expenditures. 12 To stimulate energy efficiency by large consumers while limiting increases for small consumers, the electricity tariff adjustment incorporated a strong price penalty for households consuming more than 1,000 kWh per month. 23 Box 1. Egypt’s Energy Price Reforms and Fiscal Impact In 2014, the GoE committed to an ambitious plan to Table 5. Energy Price Increases eliminate energy subsidies, which needed a mid- Year-on-year changes Cumulative course correction due to changes in the (percent) changes macroeconomic framework. The goal was to 2014 2015 2016 2017 (percent) progressively drive energy subsidies down to a target of Diesel 64 0 31 55 232 0.5 percent of GDP by FY2018/19, leaving only limited Gasoline 80 78 0 47 55 306 support for LPG and electricity to benefit low-income Gasoline 92 41 0 35 43 170 consumers. Between July 2014 and July 2017, the Government implemented four annual electricity price Gasoline 95 7 0 0 6 14 reforms and three fuel price increases (table 5). As a LPG 0 0 88 100 275 result, energy subsidies fell steeply from 6.6 percent of Natural gas 144 0 45 25 344 GDP in FY2013/14 to 3 percent in FY2015/16. Subsidies (vehicles) were set to fall further to 2.5 percent of GDP in Electricity 31 19 33 40 190 FY2016/17 but the substantial depreciation of the Egyptian pound and resulting increases in the cost of energy production meant that subsidies instead rose toward 3.9 percent of GDP in FY2016/17. Given macroeconomic challenges, the Cabinet has approved the deferral of the cost recovery target for electricity till FY2021/22. Energy subsidies are now projected to decline to 3.2 percent of GDP by FY2017/18 and 1.4 percent by FY2018/19, continuing a downward trend thereafter owing to the planned tariff adjustment. Also, in the absence of any energy price reforms since 2014, it is conservatively estimated that subsidies would have been higher by EGP 256 billion in FY2017/18, raising the energy subsidy bill to 8.9 percent of GDP. Electricity tariffs in FY2017/18 are already higher than had originally been targeted for FY2018/19, as per original plans, demonstrating government commitment to energy subsidy reform. The commitment to containing energy subsidy is also shown in the shift of the Government’s approach to energy price setting. Starting in 2016, instead of announcing a trajectory for electricity prices, the Government commits to a subsidy target in its MTFF agreed with the IMF and adjusts prices annually to meet this target. Going forward, the petroleum sector has committed to apply automatic fuel price indexation to reduce the impact of external factors on the subsidy target. Consistent energy price adjustments have yielded Figure 1: Budgeted Health, Education, Social important savings that helped shift the government Protection, and Energy Subsidy Spending budget toward social sectors. Before reform, energy subsidies exceeded the combined budget for education, health, and infrastructure, and were almost three times the budget for government investment. Price reforms have generated savings that contributed to reducing fiscal deficit while allowing for additional government expenditure on education, health and social protection. Government spending on health and education outstripped spending on energy subsidies for the first time in FY2014/15 (figure 1) and has continued to do so. At the same time, spending on social protection is budgeted to increase by 60 percent in FY2017/18, as an Note: ~World Bank estimate. *Ministry of Finance budget of energy intended measure to mitigate the negative social impact subsidy. Number in parentheses are in US$ billion. of devaluation and energy price increases. 24 2.2 Improving Energy Governance DPF 3 Prior Action 3.4: The Borrower, through: (i) its Prime Minister, has issued Prime Ministerial Decree No. 1959/2017, which establishes the new General Assembly of Egyptian Electricity Transmission Company, in compliance with the Electricity Law and the Executive Regulations of the Electricity Law. (ii) the Egyptian Electric Utility and Consumer Protection Regulatory Agency, has issued regulations on the methodology for public hearings on important regulatory decisions entitled Public Hearing Regulation of the Egyptian Electric Utility and Consumer Protection Regulatory Agency, July 2017. 67. Egypt’s electricity sector is undergoing an important vertical unbundling process that paves the way for greater competition, transparency, efficiency and private sector participation. A critical first step is the separation of the EETC, from its current position as a subsidiary of the Egyptian Electricity Holding Company (EEHC), to become an independent transmission system operator. This will improve the transparency and accountability of the sector, provide nondiscriminatory third-party access to the grid and thereby pave the way for private investment and competition in the market, drawing on increased investor interest in the development of renewables and gas based generation. 68. Prior Action 3.4 (i) indicates that the Cabinet has approved the new General Assembly of the EETC (comprising its shareholders) to oversee its legal, financial, and operational autonomy as per the Electricity Law. Through the official appointment of its new General Assembly, where the EEHC chairman would no longer be the chairman of shareholders of the EETC, the EETC’s main decision-making body will start to operate independently from its parent holding company. Among the first actions of the new General Assembly will be to appoint the EETC’s new Board of Directors and to implement the organizational restructuring in compliance with the Electricity Law. Due diligence currently underway, and supported by World Bank-funded technical assistance activities, will then make it possible to follow through with full separation of staff, assets and financial accounts between the EEHC and EETC. The outcomes of the full financial and operational separation will then be referred to in the amendment of the Articles of Association of the EETC, which is required to establish the EETC’s full legal independence from the EEHC as specified in the Electricity Law. The final step will be to introduce an arm’s length Power Purchase Agreement (PPA) for the EETC–as the single buyer in the new unbundled power system architecture–to purchase electricity generated by the EEHC and independent power producers for onward transportation and sale to distributors. 69. Prior Action 3.4 (ii) represents a move towards greater transparency and citizen engagement in electricity sector regulation. The electricity regulator, EgyptERA, has shown a sustained commitment to citizen engagement and transparency in decision-making. The agency already routinely holds public consultations on a wide range of topics, including energy efficiency obligations and renewable energy policies. Modelled on best practice in other parts of the world, the promulgation of a new regulation on public hearings represents a further step in this direction, by allowing consumers to formally participate in and contribute to some of the agency’s most significant regulatory decisions regarding tariff revisions and the award of new licenses. Given the need for sustained significant annual electricity tariff increases, the introduction of public hearings particularly is an important mechanism for improving the transparency and legitimacy of these planned price hikes. 70. Citizen engagement platforms will be designed in a gender-sensitive way and ensure women’s active participation. Public hearings will use effective channels to reach women and will be conducted at places and times convenient for them. In public hearings, a two-way dialogue will be ensured and measures will be taken to empower women, who are the main energy users at the household level, to raise their key concerns and grievances regarding energy service delivery and their interactions with service providers. 25 Fostering engagement of women in consultative processes can in turn alter restrictive perceptions regarding women’s participation in public life. Women can also play active roles in disseminating messages to their communities and in fostering a relationship of trust between providers and communities, hence increasing the awareness of the wider community about service provider plans and activities. 71. Results. International experience suggests that most developing countries take a decade or more to complete the journey of sector restructuring and improving governance. Egypt has made significant initial strides toward strengthening electricity sector governance, putting in place an improved enabling environment to support future investment in the sector and prevent a recurrence of capacity shortages. The passage of a new Electricity Law No. 87/2015 (DPF 1 Prior Action 1.5), and associated Executive Regulations (DPF 2 Prior Action 2.5), creates a modern regulatory framework for the sector, strengthens the regulatory agency, and charts an eight-year transition process towards a competitive market. The critical first stage of restructuring the EETC to establish an independent transmission system operator is already advanced. Major strides have also been made in improving the regulatory framework, including provisions for tariff regulation, public hearings to inform major regulatory decisions, development of a supply code and transmission tariff structure to support the transition to a competitive market, and a significant strengthening of regulations promoting energy efficiency among large consumers. 72. In parallel, Egypt has successfully completed a major power generation investment program. The starting point was a position of significant power shortages, and associated power cuts and social unrest in the summer of 2014. In the space of three years, the capacity deficit of 5,540 MW in FY2014/15 had been turned around into an adequate reserve margin of 3,500 MW by summer 2017, already exceeding the FY2017/18 target of 1,000 MW surplus. This reserve margin is expected to grow further as an additional plant comes on stream and is expected to reduce the running hours of some of the least effective power plants that are run using heavy fuel oil (HFO). 73. Climate change co-benefits. This prior action, by strengthening the governance of the transmission system operator, would improve the operating efficiency of power system operation in Egypt. Without an independent transmission company, the dispatch function has been under the same entity that generates and purchases electricity. Therefore, there was no guarantee that the dispatch is not affected by conflict of interest. The unbundling of the EETC sets the framework for a transparent, cost-based dispatch model, hence ensuring that the cheapest energy source (more efficient thermal plants and renewables, as the latter are already cheaper in many cases than fossil fuels in Egypt) is dispatched and system losses are kept to a minimum. In parallel, private investors will also gain confidence in a fair dispatch system and be more willing to invest in renewables, accelerating the transition towards renewable energy. Such improvement is well aligned with the MDB list of eligible mitigation activities under Category 3.3 “Improvement in utility scale energy efficiency through efficient energy use, and loss reduction”. Furthermore, by providing third party access to the grid for the private sector, it will also encourage further development of lower carbon power generation projects including renewables and gas (Category 1.3 “Measures to facilitate renewable energy integration” under the MDB list of eligible mitigation activities). 2.3 Accelerating the Low Carbon Energy Transition DPF 3 Prior Action 3.5: The Borrower, through its President, has assented to the Gas Market Activities Regulatory Law No. 196/2017, which opens the downstream gas sector to private investors, introduces third-party access to the network, and establishes the independent gas sector regulator as evidenced in its official Gazette dated August 1, 2017. 74. Although Egypt is endowed with significant renewable energy and natural gas resources, its energy mix has shifted toward more HFO and crude oil due to a deterioration of the investment climate post- 26 2011, which discouraged private investments in renewable energy and curtailed the investments needed to sustain supply of domestic gas to the power sector. As supplies dwindled, Egypt started to experience severe energy shortages that peaked in the summer of 2014 and was marred by public protest. The Government was forced to take emergency action, filling a significant part of the gap, left by the unavailability of natural gas, with costlier and more polluting oil products (mainly HFO). Emissions from the power sector grew by 19.8 percent between FY2011/12 and FY2014/15. Between FY2011/12 and FY2016/17, the share of HFO and other petroleum products in Egypt’s energy mix almost doubled. The fuel switch raised generation cost by an estimated EGP 8 billion and led to additional GHG emissions of 4.9 million tCO2 per year (5.1 percent of power sector emissions). To reduce the cost of power generation and limit GHG emissions, it was imperative for Egypt to reverse its shift in fuel mix by restoring the viability of its domestic gas sector. Gas brings many advantages to the power sector, including a substantially lower carbon footprint than other fossil fuels like coal and HFO, as well as strong complementarity with intermittent renewables due to its real-time flexibility of dispatch.13 Shifting the fuel mix away from oil and toward gas therefore facilitates Egypt’s renewable energy development strategy. Furthermore, to further reduce the environmental impact of its thermal power generation, Egypt is nearing completion of 14 GW of new power plants based on some of the most efficient CCGT technology available in the world. The combination of highly efficient gas-fired power production with a growing share of renewables (going from 11 percent of installed capacity in 2014 to a target of 20 percent by 2022, see Prior Action 3.6 below) is putting Egypt on the path toward a low carbon energy future. 75. Prior Action 3.5 marks an important legal milestone in the modernization of the gas sector. Gas supply in Egypt has historically been subject to monopoly provision by the SOE Egyptian Natural Gas Holding Company (EGAS). The ratification of the new Gas Market Activities Regulatory Law permits the implementation of a substantial reform of the sector. Specifically, it paves the way for a competitive wholesale market for gas, supports entry of private investors, introduces third-party access to the network, and creates a new gas regulator to oversee the market transition while providing adequate consumer protection. In addition, the new law and its regulatory framework would open significant opportunities for regional gas integration by allowing gas from external sources to use Egypt’s gas network for reaching Egyptian consumers and using existing assets in Egypt. An important first step toward operationalizing the new gas regulator established by the law was the appointment of its first Chief Executive Officer (CEO) by the Minister of Petroleum and Mineral Resources in October 2017. Among the CEO’s first responsibilities will be to lead the completion of the executive regulations, which the new law requires to be issued no later than February 2018. The gas regulator will be responsible for development of the gas transmission codes, gas transmission tariff, and entrance of new shippers and licensing of alternative suppliers apart from EGAS and Egyptian General Petroleum Corporation. 76. Results. This prior action is part of a series of measures needed to turnaround the gas supply situation, which is key to offset the use of expensive and carbon-intensive HFO in the power sector and bridge the transition toward more renewables. These include the abovementioned new gas law (prior actions under DPF 1-3), a sustained increase in gas prices for consumers in 2014 and 2016 to make the downstream sector financially sustainable, the paying down of arrears to international oil companies to regain investor confidence, a modernization program for the management and governance of the sector (prior action under DPF 2) and the development of a new contractual framework for upstream investments offering more attractive offtake conditions in gas exploration and production. Through the improved investment climate and governance, FDI in domestic gas production is set to make a substantial 13 A recent study shows that, lacking economically viable storage options, increasing renewables requires installing a large number of fast-ramping natural gas plants, which can complement the intermittent renewable generation (Verdolini, Elena, Francesco Vona, and David Popp. 2016. Bridging the Gap: Do Fast Reacting Fossil Technologies Facilitate Renewable Energy Diffusion, National Bureau of Economic Research Working Paper Series No. 22454). 27 macroeconomic contribution by injecting US$11–16 billion into the Egyptian economy and eventually displacing a significant amount of imported HFO and gas, thus saving foreign exchange. Enhanced transparency in sector regulations is envisaged through a functioning web portal with all regulations and all application formats available online by FY2017/18, as well as publication of a separate gas transmission tariff and transmission code and approval procedures by FY2017/18. These governance reforms in the oil and gas sector are also increasingly seen as a role model to be replicated across other sectors within Egypt. 77. Climate change co-benefits. As illustrated by Egypt’s 2014 power supply crisis, gas shortages oblige the country to substitute more carbon-intensive forms of thermal energy such as HFO and coal as emergency response instead of focusing on development of least cost, low carbon alternatives such as solar and wind power that require flexible transition fuels to balance intermittent supply. A vibrant gas market with a strong enabling environment for investment is therefore critical for Egypt to accelerate its energy transition and move forward on the development of a low carbon energy system. In that sense, reforms to the gas market contribute toward climate mitigation efforts as highlighted in the World Bank’s Climate Change Action Plan. DPF 3 Prior Action 3.6: The Borrower, through: (i) its Cabinet, has issued Cabinet Letters No. 13181-5 dated June 12, 2017, and 13182-5 dated June 13, 2017, which approve the use of competitive auctions to procure the next round of private-sector-owned renewable energy capacity. (ii) the Egyptian Electric Utility and Consumer Protection Regulatory Agency, has issued Circular No. 01/2017 (as amended by Circular No. 04/2017) notifying the public of the revised net metering regulations that allow consumers to sell excess electricity to a third party, or to the distribution company at a price equivalent to the cost of service. 78. Through measures taken under DPF 1 and DPF 2, the Government opened up utility-scale renewable energy to private investors and successfully attracted an estimated US$2.5 billion in FDI. Egypt has excellent conditions for commercially viable wind and solar power. However, before the DPF series, the Government had taken only modest steps to use renewable resources, and all of Egypt’s investments in utility-scale renewable energy had been government-owned. In 2016, the Government adopted a target to double the share of its generation capacity coming from renewable sources to 20 percent by 2022 to reduce reliance on fossil fuels. To achieve the target, and in view of limited public resources and positive experience with private investment in other countries, the Government introduced the new Renewable Energy Law (No. 203/2014; prior action under DPF 1) and its associated regulations, which introduce a guaranteed FIT (power purchasing price) for privately owned utility-scale wind and solar power generation to attract investors and demonstrate feasibility. However, the program, originally intended to be completed by October 2016, did not move as rapidly as expected. The Cabinet then issued a decree in September 2016 to extend the program into a second phase through October 2017 (prior action under DPF 2), addressing the concerns raised by developers as well as lowering the effective tariff level for solar energy to around US$0.07 per kWh (20–50 MW solar plants). The reform was successful and around 36 investors signed PPAs for around 1,600 MW of solar power with the EETC, supported by a group of multilateral finance institutions led by the International Finance Corporation (IFC) and European Bank for Reconstruction and Development (EBRD). 79. The successful crowding in of commercial finance for renewable energy projects in Egypt is recognized as international best practice and an example of ‘Maximizing Finance for Development,’ also referred to as the ‘Hamburg Principles and Ambitions’. It demonstrates how financing, including the World Bank’s support through the DPF series and technical assistance on upstream policy reforms can be used to leverage programmatic private investment paired with debt support from development finance institutions such as IFC and EBRD, and with political risk mitigation to equity investors by the Multilateral Investment Guarantee Agency (MIGA). 28 80. After demonstrating feasibility and attracting investor interest through the FIT program, under DPF 3 the Government is taking measures to move toward competitive auctions. While the Government’s focus in 2015-17 was on the FIT program, the Renewable Energy Law of 2014 also provides a framework for further private investment through competitive bidding mechanisms. With the successful completion of the second phase of the FIT program and accompanying significant investor interest, the Government is now keen to move toward competitive price discovery. The Cabinet has approved the request by the Ministry of Electricity and Renewable Energy to move forward with a competitive auction for the next phase of utility- scale renewables (Prior Action 3.6 (i)). This decision is significant since global experience demonstrates that auctions are the most effective mechanism for minimizing the cost of renewable energy as they provide open and transparent competition. 14 Renewable energy at a lower cost can be more competitive with conventional sources, often eliminating the need for renewable energy subsidies, and promoting a larger scale-up of these technologies. 81. In parallel, the Government is taking measures to promote energy efficiency and small-scale renewable energy (Prior Action 3.6 (ii)). Under DPF 2, the Ministry of Electricity and Renewable Energy established a fully functional energy efficiency unit in 2016 with the mandate of training energy auditors and enhancing energy audits for large consumers. Under DPF 3, the Government is taking additional measures to promote distributed solar and reach its target of 300 MW of installed capacity, by reforming the net- metering scheme to make it more attractive for larger systems (up to 500 kW), allowing them to sell surplus electricity to third parties or the distribution companies providing clear regulatory guidelines for the same. This prior action strengthens the incentive for distributed solar by increasing the revenues and hence the financial viability associated with making such investments. 82. Results. The Government’s reforms under this pillar of the DPF series aim to attract private investment in the energy sector. Success is measured by the megawatts of privately owned wind and solar capacity that have reached financial closure, with a target of 1,500 MW by the end of FY2017/18, compared to a baseline of 0 MW in October 2015. As of August 2017, 400 MW of utility-scale projects reached financial closure (150 MW of solar projects under the first phase of the FIT and 250 MW of wind power under the build, own and operate [BOO] scheme). Around 1,600 MW of solar projects and 250 MW of wind power under the second phase of the FIT are expected to reach financial closure by October 2017. Enabling more than US$2 billion of private investment in renewables through a three-year long collaboration between the World Bank, IFC and MIGA is a case study illustration of enabling private investment principles of the ‘Maximizing Finance for Development’ approach. The prior action on energy efficiency has resulted in trained energy auditors from 45 in 2013 to 137 in 2018, with an additional 100 energy audits being done for large consumers. 83. Climate change co-benefits. Through promoting investments in renewable energy, this prior action is expected to contribute to shifting energy production toward low-carbon technologies and to reduction in GHG emissions. It is considered part of the MDB list of eligible mitigation activities under Category 9.1, “renewable energy policies”. 14 Audinet, P., Z. Dobrotkova, and G. Sargsyan. 2017) What Drives the Price of Photovoltaic Electricity in Developing Countries? Live Wire 2017/72, World Bank, Washington DC. 29 Pillar 3: Enhancing the Business Environment 3.1 Improving the Investment Regime and Its Transparency, Particularly for MSMEs DPF 3 Prior Action 3.7: The Borrower, through its: (i) President, assented to Investment Law No. 72/2017 and, through its Prime Minister, issued Prime Ministerial Decree No. 2310/2017, approving the associated Executive Regulations, which enhance certain protections for investors. (ii) Cabinet, has issued Cabinet Letter No. 13325-3 dated June 14, 2017 approving the amendments to the Companies Law, which provide limited liability protection for single-person companies, and has submitted said amendments to its Parliament. (iii) Ministry of Investment and International Cooperation, has implemented institutional reforms in the Investment Law, including improving services to investors -such as: (a) publication of all licensing and permits procedures and requirements for all activities and sectors, and a complete inventory of available investment incentives and eligibility criteria; and (b) introduction of online automated and integrated registration services, including company incorporation and registration services provided by other agencies, as evidenced by its publication of said measures on the GAFI’s website . 84. The GoE has continued its efforts to improve the investment climate for enhanced private participation in the economy in the past year. It has focused on the introduction of new investment legislation as a guarantee to all investors of fair and predictable treatment and sought to implement institutional reforms to improve investor services. Among other things, the new investment law puts in place the principle of national treatment for foreign investors–guaranteeing equal treatment between foreign and domestic investors, which had not been part of the previous law and its 2015 revisions. The Cabinet has approved amendment to the 1981 Companies Law, which allows for the creation of a new form of company – the single-person company. This would enable one owner to establish a limited liability company (a single- person company). Prior to these revisions, one owner could only register as a sole-proprietor, bearing the risk of personal unlimited liability. This new form affords single members limited liability and other protections. To ensure that the legislative changes translate into improved services to all companies, the MIIC has undertaken several institutional reform measures. 85. Prior Action 3.7 supports a set of legislative and institutional reforms that enhance the investment climate. First, it supports the promulgation of the new Investment Law No. 72 of 2017, and the enactment of its implementing regulations. The law and its implementing regulations enhance certain guarantees and protections to investors over what was provided for in the 2015 law, including granting national treatment to foreign investors, market access without prior screening or approval, and residency rights. Second, this prior action supports the Cabinet’s submission to the Parliament of revisions to the 1981 Companies Law, which, among other things, would allow one owner to establish a limited liability company (a single-person company). Prior to these revisions, one owner could only register as a sole-proprietor, bearing the risk of personal unlimited liability. This new form affords single members limited liability and other protections. This action will contribute to equalizing the treatment of small and large investors under the law, giving small businesses greater security and a better chance to grow. Having a registered company status will afford small businesses—currently either unregistered or registered as sole owners with limited liability protections— better access to finance, markets, and legal protections. Third, this prior action supports the introduction of a new automated workflow system which interfaces the GAFI company incorporation system with the systems of other agencies providing Tax ID, Notary, Commercial Registry, Chambers of Commerce Registration, and Lawyers Syndicate. The system also enables a single payment for all these services. This reduces the number of investor interactions with different agencies. This system is also available as an e- service on the GAFI website. Finally, this prior action supports the publication of licensing and permit 30 requirements for different economic sectors as well as the incentives and eligibility criteria for those incentives on the GAFI website. 86. Results. The DPF series has supported a series of reforms to improve the investment climate. Together the Investment and Companies Laws determine key aspects of the regulatory environment in which businesses operate, large and small alike. The DPF series has enabled the World Bank to support the GoE throughout its iterative process of amending the laws governing protections, guarantees, and incentives for business investment, during which the GoE has been able to make a significant shift on the issue of investor protections and guarantees. 87. While the true results of such reforms can only be gauged in terms of levels of investment over the next years, and further reforms remain necessary, a few indicators are proposed to measure short-term results and the impact of these prior actions: (i) the number of GAFI Investor Services Centers offering automated and integrated registration services for companies under both the Investment and Companies Laws, with a target increased from 0 in FY2014/15 to 4 by the end of FY2017/18. This result has been partially achieved (in Cairo and 10th of Ramadan cities). (ii) Increase in business entry, as measured by the average number of company registrations at GAFI Investor Service Centers per month, of 65 percent in FY2017/18 over the baseline of 867 average registrations per month in FY2014/15. This result has been partially achieved with a consistent increasing trend of business entry since DPF 1. The average in FY2016/17 was 1267 company registrations per month, or 46 percent over the baseline year of FY2014/15, so the target of 65 percent would represent a sustained strong trend. 3.2 Reforming Industrial Licensing 88. The DPF series has supported the ongoing reform of the industrial licensing regime, which has resulted in the promulgation of a new industrial licensing law and executive regulations. This represents significant progress on the transformational reforms that are owned by the government. Substantive steps have also been taken towards implementation of the new regulatory framework, including preparation of secondary legislation, review of technical requirements to perform industrial activities, training, and other actions. The reform is intended to lower compliance burdens for the private sector while safeguarding public goods, making better use of public resources, and improving regulatory coherence. Much has already been achieved. The challenge will be to ensure that implementation is undertaken in a manner that is consistent with the objectives of this reform, and the World Bank is continuing to provide technical assistance to this end. 89. The industrial licensing reform process demonstrates the results that can be achieved through sustained policy dialogue, technical assistance, and support through a DPF series. Industrial licensing had seen little to no reform in over 60 years in Egypt. The original law dated back to 1954 and represented a major constraint on the activities of the industrial sector. The reform process began with the high-level commitment to begin the reform process in DPF1, launched by the Prime Minister’s decree on the principles of the reform and the creation of an industrial licensing reform committee. The intra-governmental consultations and engagement with the private sector that stemmed from this decision enhanced the support for a full-fledged reform of the licensing regime. DPF2 supported the Cabinet approval of the draft industrial licensing law, which has since become effective. 90. Results. While the reform process is iterative and adaptive, each DPF built on the actions and achievements of the previous operation, and the DPF series provided the continuity needed to carry out this difficult reform through. The full implementation of the law is expected to significantly reduce the average time to obtain an industrial license, from an estimated 634 days in FY2014/15 to a target of 160 days by the end of FY2017/18. For the majority of firms that qualify for streamlined licensing by notification, the reform promises to be even more dramatic, with an average time of no more than 7 days to obtain an industrial 31 license; in fact, the law requires the licenses by notification to be issued the same day with inspection taking place within 90 days. 3.3 Strengthening the Competition Framework DPF 3 Prior Action 3.8: The Borrower, through the ECA, in its Board session no. 113 on September 12, 2017, approved the adoption of the following secondary legislation to implement the Competition Law, namely: (a) Regulation Relating to Exemptions, under Articles 6 and 9 of the Competition Law; (b) Leniency Guidelines, under Article 26 of the Competition Law; (c) Guidelines on Fines, Settlements and Damages; and (d) Quick-Guide for Competition Impact Assessment of Laws and Regulations. 91. Prior Action 3.8 furthers the efforts of the GoE to promote competition in key markets of the economy by strengthening the ECA’s ability to detect and prosecute anticompetitive violations of both public and private sector operators through enforcement and promoting competition in key sectors by identifying and removing anticompetitive laws and regulations through advocacy. A stronger position of the ECA, regarding both enforcement and advocacy, will be key to generating a competitive business environment and promoting contestable and open markets in Egypt. In turn, it is critical to create incentives for entrepreneurship and to increase pressures on established private entities to innovate. 92. To this end, the ECA’s board has issued a comprehensive package of interconnected and complementary secondary legislation instruments. The first is the adoption of the policy clarifying the procedure and conditions to receive exemptions from the prohibitions of the competition law. 15 This instrument increases predictability and legal certainty for both private and public operators by allowing firms to assess which conducts might increase consumer welfare or serve public interest and thus should not be considered antitrust violations. At the same time this regulation emphasizes the need to effectively prosecute hard core cartels. As a complement to the latter goal, the ECA also approved the leniency guidelines to develop a full-fledged leniency program.16 A well-functioning leniency program can destabilize and deter cartels by creating a permanent threat that any of its members may come forward to the authority to avoid the fine. To this end, the effectiveness of such program will depend on the effectiveness of the ECA’s fining policy. In this sense, the approval of the guidelines for fines and settlements constitutes a critical tool to incentivize cartel members to apply for leniency to get full exemption from the prospective fine and foster deterrence among potential violators.17 Moreover, the adoption of a methodology to identify and remove barriers to competition in legislation, policies, or decrees18 will not only guide the implementation of the ECA’s advocacy mandate, but will also inform the regulatory activities of Egyptian policy makers, government bodies, sector regulators, and private bodies issuing self-regulations or participating in co-regulation schemes on how to minimize the potential risks from reducing competition in the markets. The methodology is based on the Markets and Competition Policy Assessment Tool developed by the World Bank Group. 93. Results. The implementation of pro-competition reforms to the existing regulatory framework has already contributed to a significant increase in the number of anticompetitive practices prevented or eliminated by the ECA in key markets for private sector development such as electricity, telecommunications and media, insurance, pharmaceuticals and medical supplies, textile manufacturing and fertilizers. With 15 such cases decided between FY2015/16 and FY2017/18, the ECA has already exceeded the DPF target set at 11 cases. These results build on the synergies of the actions undertaken throughout the DPF series to strengthen the private sector competition framework in Egypt. The first operation established the grounds to empower the ECA though a new executive regulation that enhanced its independence and enlarge the 15 Regulation Relating to Exemptions, under Articles 6 and 9 of the Competition Law. 16 Leniency Guidelines, under Article 26 the Competition Law. 17 Guidelines on Fines, Settlements, and Damages. 18 Quick-Guide for Competition Impact Assessment of Laws and Regulations. 32 scope of tools to promote enforcement and advocacy. The second DPF created the conditions for the ECA to tackle cartels, notably through new internal administrative procedures to enhance the effectiveness of its cartel investigations by focusing on gathering physical and digital evidence of the anticompetitive conduct. The third operation consolidates prior efforts with a comprehensive package of secondary legislation aiming at increasing predictability, legal certainty and transparency that not only will contribute to enhance the Egyptian business climate but can also generate important savings for Egyptian consumers, particularly by eliminating cartels in basic food products and commodities that typically result in overcharges of more than 20 percent. 33 Table 6. Status of DPF 3 Triggers and Proposed Changes Trigger for DPF 3 at Board Approval of Changes to Trigger, if any Prior Action for DPF 3 DPF 2 Pillar 1: Advancing Fiscal Consolidation 1.1 Enhancing Government Revenues Trigger 3.1: The Ministry of Finance of the Trigger was dropped to streamline the Policy and Borrower issues a decree that introduces Results Matrix and reflect changes in the Government’s a harmonized and simplified tax regime for reform timeline and significant progress with respect to micro and small businesses based on results. The Government remains committed to the turnover. introduction of a harmonized and simplified tax regime for micro and small businesses. Yet, the vision has changed to introduce it as part of an overarching framework for MSMEs, as opposed to separating the tax treatment from other policy components. The objective is to incentivize firms operating in the informal sector to formalize, and ensure that the new regime accounts for the special characteristics of this segment and that it is designed to maximize effectiveness and minimize implementation risks. As part of this vision, a new agency has been established under the Ministry of Trade and Industry to formulate a strategy, policies and regulations for the development of MSMEs. 1.2 Containing the Wage Bill Trigger 3.2: (i) The Borrower’s Cabinet Trigger was retained and streamlined. To focus the Policy Prior Action 3.1: The Borrower, through its Ministry of approves a medium-term plan/rule that and Results Matrix on institutional and policy actions, Finance, has issued a wage bill report entitled Note on sets a cap on the number of new recruits Trigger 3.2 (i) was not included as a prior action. A cap on Key Reforms and Development of Wages dated August in the public sector relative to the number the number of new recruits in the public sector relative to 2017 notifying that at least seventy percent (70%) of of retirees; (ii) The Ministry of Finance of the number of retirees is in place. This cap has been set by the wage bill is automated and that an action plan for the Borrower issues a wage bill report the Supreme Committee established in April 2017 and the completion of the automation process has been notifying that at least 74 percent of the headed by the Prime Minister, which decides on several developed. wage bill is automated and develops an administrative reforms, including on recruitment action plan for the completion of the modalities for the public sector. Trigger 3.2 (ii) was automation process. retained as Prior Action 3.1. The Ministry of Finance has made substantial progress in the automation of the payroll system, reaching 70 percent at the end of FY2016/17. Having achieved payroll automation of 80 percent at end-September 2017, the authorities remain 34 Trigger for DPF 3 at Board Approval of Changes to Trigger, if any Prior Action for DPF 3 DPF 2 well on track to complete full automation of wages and salaries payments for all government employees by the end of FY2017/18. 1.3 Strengthening Debt Management and Aspects of Public Financial Management Trigger 3.3: The Ministry of Finance: (i) Trigger was retained and strengthened. On (i), the Prior Action 3.2: The Borrower, through its Ministry of establishes the internal audit dedicated Ministry of Finance has started to operationalize the Finance, has: unit with adequate staffing, budget and newly established internal audit unit, including through (i) issued Ministerial Decree No. 290/2017, which procedures aligned with international capacity building for the team, identifying the first set of establishes an internal audit dedicated unit with standards; and (ii) establishes the pilot audits. The trigger was strengthened by adding the adequate staffing, budget and procedures aligned with Economic Authorities and SOEs fiscal risk establishment of a Sovereign Guarantees Committee, international guidance related to independence, audit monitoring dedicated unit with adequate headed by the Minister of Finance, which has a mandate planning, risk assessment and periodic reporting. manuals and standard reports, which to review the requests for new guarantees, assess the (ii) issued Ministerial Decree No. 201/2017, which identifies, monitors, and facilitates the associated risks, and make a recommendation on whether establishes a Sovereign Guarantees Committee management of contingent liabilities and to grant the guarantee (Prior Action 3.2 (ii)). This gives entrusted to develop policies for issuing sovereign sovereign guaranteed liabilities. greater weight for the fiscal risk scanning exercise and guarantees, review the applications for issuing such ensures enforceability of the recommendations. The prior guarantees, and evaluate periodically the financial action was further strengthened with a fiscal transparency stability of the recipients of the guarantees. measure. Prior Action 3.2 (iii) was added to reflect the (iii) begun publishing a section in the FY2017/18 inclusion of a section on ‘Risks to Budget Implementation’ Budget Statement on economic risks to the in the Budget Statement. This section was published for implementation of the national budget. the first time in the current FY2017/18 Budget Statement. Pillar 2: Ensuring Sustainable Energy Supply 2.1 Reforming Energy Subsidies Trigger 3.4: (i) The Borrower’s Cabinet Trigger was retained with revised wording to more Prior Action 3.3: The Borrower, through its: implements the annual energy price accurately reflect reforms. On (i), the wording was revised (i) Ministry of Electricity and Renewable Energy, has adjustment for FY17–18 consistent with (substance unchanged) to reflect the Government’s issued Ministerial Decree No. 312/2017 on annual passing through unanticipated changes in revised MTFF 2016-2019. One of the revisions to the MTFF electricity price adjustment and Prime Minister, has the cost of energy to achieve subsidy is moving the target for full cost recovery of electricity to issued Prime Ministerial Decrees No. 1435/2017, ceilings set in the Medium-Term Fiscal FY2021/22 to account for the impact of devaluation. Prior 1436/2017 and 1437/2017 for the fuel price Framework 2016–2019, pursuant to the Action 3.3 (ii) was added to capture this continued adjustment for FY2017/18 consistent with the Supreme Energy Council Policy Decision of commitment. Trigger 3.4 (ii) was retained as Prior Action FY2017/18 Budget Statement. 2016. 3.3 (iii) with revised wording to clarify the current focus of (ii) Cabinet, has issued Cabinet Letter 14724-5 dated (ii) The Supreme Energy Council adopts a the indexation working group on the petroleum sector. July 5, 2017 approving the extension to achieve full cost policy for automatic periodic indexation of The regulator of electricity has been monitoring the recovery in the power sector by FY2021/22. energy prices. 35 Trigger for DPF 3 at Board Approval of Changes to Trigger, if any Prior Action for DPF 3 DPF 2 impact of exchange rate movements on the cost of (iii) Ministry of Finance and the Ministry of Petroleum electricity and follows a separate track. and Mineral Resources, has approved a joint policy proposal for periodic fuel price indexation, which has been submitted to the Prime Minister for consideration. 2.2 Improving Energy Governance Trigger 3.5: (i) The Ministry of Electricity Trigger was retained. On (i), the wording was slightly Prior Action 3.4: The Borrower, through: and Renewable Energy of the Borrower revised to reflect the Government’s decision that the (i) its Prime Minister, has issued Prime Ministerial reestablishes the Egyptian Electricity amendment of the Article of Association of the EETC, Decree No. 1959/2017, which establishes the new Transmission Company as a functionally which is required to reestablish the EETC as a functionally General Assembly of Egyptian Electricity Transmission independent utility in compliance with the independent utility, must refer to the outcomes of the full Company, in compliance with the Electricity Law and Electricity Law and the above executive financial separation. Therefore, the Cabinet has first the Executive Regulations of the Electricity Law. regulations. approved the new General Assembly that represents (ii) the Egyptian Electric Utility and Consumer (ii) The Egyptian Electric Utility and shareholders as per Egyptian Law, to make the EETC Protection Regulatory Agency, has issued regulations Consumer Protection Regulatory Agency independent from the parent holding company (EEHC) on the methodology for public hearings on important issues regulations on methodology for and enable the company to initiate implementing the regulatory decisions entitled Public Hearing Regulation public hearings and consultations on restructuring as per Electricity Law. The company’s new of the Egyptian Electric Utility and Consumer Protection important regulatory decisions. General Assembly will then oversee the full legal and Regulatory Agency, July 2017. financial separation by the deadline of three years as specified in the law. On (ii), the wording was slightly revised to clarify that the newly approved regulations focus on public hearings. Regulations on public consultations will be issued separately but, since public consultations already take place regularly as witnessed through the FIT program and energy efficiency in large industries, constitute more of a formalization of an existing practice. 2.3 Accelerating the Low Carbon Energy Transition Trigger 3.6: (i) The Ministry of Petroleum Trigger was retained and streamlined. To focus the Policy Prior Action 3.5: The Borrower, through its President, and Mineral Resources of the Borrower and Results Matrix on institutional and policy actions as has assented to the Gas Market Activities Regulatory issues the executive regulations opposed to administrative actions, Triggers 3.6 (ii) and (iii) Law No. 196/2017, which opens the downstream gas implementing the new Gas Market were not included as prior actions. Trigger 3.6 (i) was sector to private investors, introduces third-party Activities Regulatory Law pursuant to its retained as Prior Action 3.5 in a slightly revised form to access to the network, and establishes the approval by the parliament. reflect changes in the Government’s timeline. The independent gas sector regulator as evidenced in its President ratified the new gas law in August 2017, which official Gazette dated August 1, 2017. 36 Trigger for DPF 3 at Board Approval of Changes to Trigger, if any Prior Action for DPF 3 DPF 2 (ii) The Ministry of Petroleum and Mineral specifies a deadline for the executive regulations of 6 Resources of the Borrower establishes a months after ratification, pushing their approval into new independent gas sector regulator 2018. The executive regulations remain part of the pursuant to the new Gas Market Activities Government’s program and are reflected in the results Regulatory Law. indicator (achievement of the results indicator-approval of (iii) The Ministry of Petroleum and Mineral separate gas transmission tariff and transmission code- Resources of the Borrower nominates the depends on the issuance of the executive regulations). independent transmission system operator in compliance with the requirements set by the gas sector regulator. Trigger 3.7: The Ministry of Electricity and Trigger was retained and strengthened. Prior Actions 3.6 Prior Action 3.6: The Borrower, through: Renewable Energy of the Borrower (i) and (ii) specify the new policy measures taken by the (i) its Cabinet, has issued Cabinet Letters No. 13181-5 announces new policy measures for Government to promote private investment in renewable dated June 12, 2017, and 13182-5 dated June 13, 2017, promoting private investments in clean energy. The trigger was strengthened by elevating the which approve the use of competitive auctions to energy. approval of auctions for renewables capacity from the procure the next round of private-sector-owned Ministry to the Cabinet. This is in line with international renewable energy capacity. best practice of enabling private investment through FIT (ii) the Egyptian Electric Utility and Consumer scheme (implementation of the ‘Maximizing Finance for Protection Regulatory Agency, has issued Circular No. Development’ approach) with a more efficient price 01/2017 (as amended by Circular No. 04/2017) discovery process through auctions while deepening notifying the public of the revised net metering private sector involvement. In addition, the policy also regulations that allow consumers to sell excess provides regulatory clarity on the job intensive business of electricity to a third party, or to the distribution decentralized solar applications. company at a price equivalent to the cost of service. Pillar 3: Enhancing the Business Environment Objective 3.1: Improving the Investment Regime and Its Transparency, Particularly for MSMEs Trigger 3.8: (i) Executive regulations of the Trigger was retained and strengthened. The trigger has Prior Action 3.7: The Borrower, through its: Single-Person Company Law issued. been amended to include the new Investment Law which (i) President, assented to Investment Law No. 72/2017 (ii) The General Authority for Investment strengthens guarantees to investors, including the and, through its Prime Minister, issued Prime and Free Zones of the Borrower registers introduction of the national treatment principle for Ministerial Decree 2310/2017, approving the single-person companies. foreign investors and foreign currency transferability, associated Executive Regulations, which enhance (iii) The General Authority for Investment which were not previously guaranteed. In addition, rather certain protections for investors. and Free Zones of the Borrower publishes than introduce a stand-alone Single-Person Company Law, (ii) Cabinet, has issued Cabinet Letter No. 13325-3 all licensing and permits procedures and the Government has proceeded with1`` a broader reform dated June 14, 2017 approving the amendments to the requirements for all activities and sectors. f the Companies Law, to include introduction of the single- Companies Law, which provide limited liability 37 Trigger for DPF 3 at Board Approval of Changes to Trigger, if any Prior Action for DPF 3 DPF 2 (iv) The General Authority for Investment person company as a new form of company under the law. protection for single-person companies, and has and Free Zones of the Borrower publishes As a result, trigger 3.8 (i) has been replaced with Cabinet submitted said amendments to its Parliament. a complete inventory of available approval of the revised Companies Law, and submission to (iii) Ministry of Investment and International investment incentives and eligibility the Parliament. Cooperation, has implemented institutional reforms in criteria. The institutional reforms in triggers 3.8 (iii) and (iv) have the Investment Law, including improving services to been retained, but strengthened to include the investors such as: (a) publication of all licensing and institutional reforms introduced through an automated permits procedures and requirements for all activities system for registration services at GAFI Investor Services and sectors, and a complete inventory of available Centers, which includes online access for registration. The investment incentives and eligibility criteria; and (b) registration process is automated and includes company introduction of online automated and integrated incorporation with additional registration services registration services, including company incorporation provided by other agencies, including Tax ID, Notary, and registration services provided by other agencies, as Commercial Registry, Chambers of Commerce evidenced by its publication of said measures on the Registration, Lawyers Syndicate, and a single payment for GAFI’s website. all these services into a single workflow. Previously, these services were co-located at GAFI, but not automated, not provided online, and had separate payment systems. Objective 3.2 Reforming Industrial Licensing Trigger 3.9: (i) Issuance of the executive Trigger was dropped to streamline the policy and results regulations of the Law on Streamlining the matrix and reflect changes in Government’s reform Procedures of Granting Licenses for timeline and significant progress with respect to results. Industrial Establishments, including The Government has enacted a new industrial licensing regulations for implementation of law and its executive regulations (part (i) of the trigger) simplified licensing by notification for low- and made significant progress in implementation which is risk industrial activities. still ongoing, so part (ii) of the trigger has yet to be (ii) The Licensing Prerequisites Committee, achieved. Technical assistance will continue to be provided for under the Law on provided on reform implementation. Streamlining the Procedures of Granting Licenses for Industrial Establishments, makes available online all requirements related to establishment, operation, and termination of industrial activities. Objective 3.3 Strengthening the Competition Framework Trigger 3.10: The ECA adopts secondary Trigger was retained and strengthened. Trigger has been Prior Action 3.8: The Borrower, through the ECA, in its legislation to further strengthen anti- retained and strengthened to include the additional Board session no. 113 on September 12, 2017, 38 Trigger for DPF 3 at Board Approval of Changes to Trigger, if any Prior Action for DPF 3 DPF 2 cartel enforcement policy by (i) clarifying adoption of a methodology for reviewing legislation, approved the adoption of the following secondary the procedures and conditions to receive policies and decrees for barriers to competition to be used legislation to implement the Competition Law, namely, exemptions from the prohibitions of the by the ECA and other Borrower agencies to improve the (a) Regulation Relating to Exemptions, under Articles 6 competition law; (ii) developing a full- quality of legislation on competition issues. and 9 of the Competition Law; (b) Leniency Guidelines, fledged leniency program; and (iii) under Article 26 of the Competition Law; (c) Guidelines adopting guidelines for antitrust fines on Fines, Settlements and Damages; and (d) Quick- and settlements. Guide for Competition Impact Assessment of Laws and Regulations. Table 7. DPF 3 Prior Actions and analytical underpinnings Prior Actions Analytical Underpinnings Pillar 1: Advancing Fiscal Consolidation Prior Action 3.1 : The Borrower, through its Ministry of Finance, has issued a Promoting Poverty Reduction and Shared Prosperity, A Systematic Country wage bill report entitled Note on Key Reforms and Development of Wages Diagnostic, World Bank, 2015. dated August 2017 notifying that at least seventy percent (70%) of the wage Evaluation Government Employment and Compensation, IMF, 2010. bill is automated and that an action plan for the completion of the Government of Egypt. Strat-EGY. Egypt’s Five-Year Macroeconomic automation process has been developed. Framework and Strategy FY14/15 –FY18/19. Prior Action 3.2: The Borrower, through its Ministry of Finance, has: IMF and World Bank. Revised Guidelines for Public Debt Management. April (i) issued Ministerial Decree No. 290/2017, which establishes an internal 2014. audit dedicated unit with adequate staffing, budget and procedures aligned MTDS (completed in cooperation with World Bank Treasury Department). with international guidance related to independence, audit planning, risk Analyzing and Managing Fiscal Risks, IMF, 2016. assessment and periodic reporting. Fiscal Risks: Sources, Disclosure, and Management, IMF, 2008. (ii) issued Ministerial Decree No. 201/2017, which establishes a Sovereign Promoting Poverty Reduction and Shared Prosperity, A Systematic Country Guarantees Committee entrusted to develop policies for issuing sovereign Diagnostic, World Bank, 2015. guarantees, review the applications for issuing such guarantees, and evaluate Alba, Pedro, Sherine Al-Shawarby, and Farrukh Iqbal. 2000. “Fiscal and periodically the financial stability of the recipients of the guarantees. Public Debt Sustainability in Egypt.” Working Paper Series 38, World Bank, (iii) begun publishing a section in the FY2017/18 Budget Statement on Washington DC. economic risks to the implementation of the national budget. Pillar 2: Ensuring Sustainable Energy Supply Prior Action 3.3: The Borrower, through its: Arab Countries in Transition: Economic Outlook and Key Challenges, IMF, (i) Ministry of Electricity and Renewable Energy, has issued Ministerial Decree 2015. No. 312/2017 on annual electricity price adjustment; and Prime Minister, has Arab Republic of Egypt 2014 Article IV Consultation —Staff Report, IMF, issued Prime Ministerial Decrees No. 1435/2017, 1436/2017 and 1437/2017 2015. for the fuel price adjustment for FY2017/18 consistent with the FY2017/18 Egypt Energy Subsidies: Just-In-Time Advisory Services to the Ministry of 39 Prior Actions Analytical Underpinnings Budget Statement. Petroleum and Mineral Resources, World Bank, 2015. (ii) Cabinet, has issued Cabinet Letter 14724-5 dated July 5, 2017 approving MENA Economic Monitor —Corrosive Subsidies, World Bank, 2014. the extension to achieve full cost recovery in the power sector by FY2021/22. Subsidy Reform in the Middle East and North Africa —Recent Progress and (iii) Ministry of Finance and the Ministry of Petroleum and Mineral Resources, Challenges Ahead, IMF, 2014. has approved a joint policy proposal for periodic fuel price indexation, which Vagliasindi, Maria. Implementing Energy Subsidy Reforms: An Overview of has been submitted to the Prime Minister for consideration. Key Issues, World Bank, 2012. Reforming Energy Subsidies in Egypt, AfDB, 2012. Energy Pricing Strategy, Energy Sector Management and Assistance Program (ESMAP), World Bank, 2009 (Kantor Management Consultants, EQI) Egypt - Toward a More Effective Social Policy - Subsidies and Social Safety Net, World Bank, 2005. 33550-EG. The Impact of Phasing out Subsidies of Petroleum Energy Products in Egypt, Alternatives for Reform, Egyptian Center for Economic Studies (ECES), 2010. Prior Action 3.4: The Borrower, through: Transparency and Social Accountability in the Egyptian Power Sector, World (i) its Prime Minister, has issued Prime Ministerial Decree No. 1959/2017, Bank, 2015. which establishes the new General Assembly of Egyptian Electricity Assessment of Private Sector Participation in the Power Sector of Egypt, Transmission Company, in compliance with the Electricity Law and the World Bank, 2014. Executive Regulations of the Electricity Law. Five-Year Medium-Term Action Plan (White Book) for the Integrated (ii) the Egyptian Electric Utility and Consumer Protection Regulatory Agency, Sustainable Energy Strategy to 2035, European Union, 2015. has issued regulations on the methodology for public hearings on important Technical Assistance for Institutional Capacity Building of Egyptian Electric regulatory decisions entitled Public Hearing Regulation of the Egyptian Utility and Consumer Protection Regulatory Authority—Phase 1 Market Electric Utility and Consumer Protection Regulatory Agency, July 2017 . Design, European Union, 2012 Tapping a Hidden Resource: Energy Efficiency in the Middle East and North Africa, World Bank, 2009. Prior Action 3.5: The Borrower, through its President, has assented to the Egypt Energy Strategy to 2030, Nexant, 2009. Gas Market Activities Regulatory Law No. 196/2017, which opens the Egypt’s Gas Supply Deficit, Wood McKenzie, 2014. downstream gas sector to private investors, introduces third-party access to EU Gas Study, Mercados, Adetef, 2014. the network, and legally establishes the independent gas sector regulator as Five-Year Medium-Term Action Plan (White Book) for the Integrated evidenced in its official Gazette dated August 1, 2017. Sustainable Energy Strategy to 2035, European Union, 2015. Egypt: The Economic Cost of Natural Gas, PB/ECA, 2007. Prior Action 3.6 : The Borrower, through: Policy Research Working paper on Scaling up Distributed Solar in Egypt (i) its Cabinet, has issued Cabinet Letters No. 13181-5 dated June 12, 2017, Assessment of Private Sector Participation in the Power Sector of Egypt, and 13182-5 dated June 13, 2017, which approve the use of competitive World Bank, 2014. auctions to procure the next round of private-sector-owned renewable Five-Year Medium-Term Action Plan (White Book) for the Integrated energy capacity. Sustainable Energy Strategy to 2035, European Union, 2015. (ii) the Egyptian Electric Utility and Consumer Protection Regulatory Agency, has issued Circular No. 01/2017 (as amended by Circular No. 04/2017) notifying the public of the revised net metering regulations that allow 40 Prior Actions Analytical Underpinnings consumers to sell excess electricity to a third party, or to the distribution company at a price equivalent to the cost of service. Pillar 3: Enhancing the Business Environment Prior Action 3.7: The Borrower, through its: Promoting Poverty Reduction and Shared Prosperity, A Systematic Country (i) President, assented to Investment Law No. 72/2017 and, through its Prime Diagnostic, World Bank, 2015. Minister, has issued Prime Ministerial Decree 2310/2017, approving the More Jobs, Better Jobs: A Priority for Egypt. World Bank Group, 2014. associated Executive Regulations, which enhance certain protections for A Sustainable Competitiveness Strategy for Egypt, Egyptian National investors. Competitiveness Council, 2012. (ii) Cabinet, has issued Cabinet Letter No. 13325-3 dated June 14, 2017 General Authority for Investment (GAFI) Quarterly Reports (2013 –2014). approving the amendments to the Companies Law, which provide limited Doing Business in Egypt, World Bank, various years. liability protection for single-person companies, and submitted said Ongoing Technical Assistance on Investment Policy. amendments to its Parliament. Egypt Investment Climate Assessment reports and survey results (including (iii) Ministry of Investment and International Cooperation, has implemented 2017 survey). institutional reforms in the Investment Law, including improving services to investors such as: (a) publication of all licensing and permits procedures and requirements for all activities and sectors and a complete inventory of available investment incentives and eligibility criteria; and (b) introduction of online automated and integrated registration services, including company incorporation and registration services provided by other agencies, as evidenced by its publication of said measures on the GAFI’s website. Prior Action 3.8: The Borrower, through the ECA, in its Board session no. 113 From Privilege to Competition: Unlocking Private-Led Growth in the Middle on September 12, 2017, approved the adoption of the following secondary East and North Africa, World Bank 2009. legislation to implement the Competition Law, namely, (a) Regulation Jobs or Privileges: Unleashing the Employment Potential of the Middle East Relating to Exemptions, under Articles 6 and 9 of the Competition Law; (b) and North Africa. World Bank Group 2014. Leniency Guidelines, under Article 26 of the Competition Law; (c) Guidelines Ongoing Technical Assistance on Competition. on Fines, Settlements and Damages; and (d) Quick-Guide for Competition Impact Assessment of Laws and Regulations. 41 4.3 LINK TO CPF, OTHER BANK OPERATIONS, AND THE WORLD BANK GROUP STRATEGY 94. This programmatic DPF series remains fully aligned with the three policy priorities highlighted in Egypt’s Systematic Country Diagnostic: macroeconomic stabilization, continued energy subsidy reform, and improvement in governance focusing on improving the business environment. The policy and institutional reforms supported by the proposed DPF operation will directly contribute to addressing these urgent challenges in a coherent and sustainable manner, yielding multiple dividends. Progress in these areas will also support the Government’s ability to deliver, which is essential to maintain and sustain the reform momentum. 95. The World Bank Group’s support under the CPF remains focused on the twin goals of eliminating extreme poverty and boosting shared prosperity in a sustainable manner and is organized under three interdependent focus areas: (a) improving governance, (b) private sector job creation, and (c) social inclusion. The reforms supported by this operation will help achieve some of the key goals identified in the CPF. These include supporting macroeconomic stability; improving the transparency and efficiency of public administration through strengthening citizens’ ability to hold the state accountable through access to information; improving the business climate for private investors, ensuring Egypt’s energy securi ty and diversification; and supporting financial sustainability of the energy sector. By targeting the social and economic inclusion agenda, social safety nets, basic services, social housing, financial inclusion, and agriculture, the investment projects under the Egypt CPF 2015–2019 are complementing the proposed DPF’s focus on macro-fiscal consolidation and private sector-led growth. 96. The proposed third DPF contributes to the implementation of the World Bank Group’s MENA regional strategy. The proposed DPF supports the ‘renewal of the social contract’ pillar of the MENA regional strategy, by pursuing private-sector-led growth, implementing business policies that broaden economic opportunity, and improving citizen engagement through improved transparency and accountability. 97. The operation is aligned with the World Bank’s new MENA Climate Change Action Plan and forms part of a broader World Bank engagement in Egypt to promote sustainable energy supply. The reform program supported by DPF 3 is an integral part of Egypt’s intended climate mitigation contributions under the United Nations Framework Convention on Climate Change (details in section 5.2). The MENA Climate Change Action Plan commits to support critical policy reforms to “remove distortive prices and regulations, open up fiscal space, and catalyze private investments.” The World Bank engagement through the DPF is complemented by several World Bank Group lending and technical assistance interventions supporting the climate change agenda, including the Wind Power Development Project which supports transmission investments to connect wind plants to the grid (IBRD); technical assistance and policy advisory to Egypt’s renewable energy program (IFC, IBRD); advisory to energy-intensive industry on energy efficiency (IFC); technical assistance to support energy subsidy reforms (IBRD); and investments in natural gas-fired power plants and natural gas household connections (IBRD). 4.4 CONSULTATIONS, COLLABORATION WITH DEVELOPMENT PARTNERS 98. The third DPF of the series is jointly prepared with the AfDB and coordinated jointly across the inter-ministerial working group that was set up by the Government for the DPF-supported program. The proposed DPF involved close cooperation and collaboration across management, task team leaders, and team members of the World Bank and the AfDB. The United Kingdom is expected to support the proposed US$1,150 million IBRD loan by providing a guarantee to the IBRD in the amount of US$150 million. The private sector perspective was incorporated based on discussions of the program with IFC country management. The MIIC organized a consultation meeting with all development partners in Egypt on September 24, to share the economic reform program of the Government supported by the proposed DPF. 42 A meeting with civil society representatives to discuss the DPF-supported program took place on October 8, 2017. 99. Consultation has taken place through the Government’s own engagement with the Egyptian population around its reform program. The Egypt 2030 Sustainable Development Strategy was developed through a detailed consultation process with civil society, the private sector, Egyptian youth, and international development partners. Each aspect of the strategy was discussed by the respective ministries and coordinated by the Ministry of Planning through a process lasting months. The new medium-term economic program backed by a medium-term fiscal management program has been extensively discussed with the Parliament during the approval process, while being presented to international investors as well. DPF prior actions such as EgyptERA’s new regulations on public hearings for important regulations promote transparency and citizen engagement. Important legal reforms under the DPF have been discussed extensively with both industry associations and groups of industries that are likely to be affected. For instance, the Electricity Law was discussed by EgyptERA with multiple stakeholders, including civil society institutions, think tanks, and industry groups and was disseminated through websites and newspapers inviting comments and discussions. The gas sector law was discussed with a wide group of stakeholders, including donors and key industry groups, in discussions chaired by the Ministry of Petroleum and Mineral Resources. Detailed deliberation with multiple stakeholders were also undertaken during the preparation of the Investment Law and Industrial Licensing Law. 5. OTHER DESIGN AND APPRAISAL ISSUES 5.1 POVERTY AND SOCIAL IMPACT 100. The reform program supported by the three-year DPF programmatic series is expected to have positive effects on the economy and social welfare in the long term, but will likely have some negative effects in the short term, which require mitigation. The price adjustments are necessary to reduce harmful subsidies, which encourage wasteful consumption, impose pressure on the government budget and the environment, and distort the economy toward energy-intensive sectors. Subsidies also tend to be regressive, benefiting the rich more than the poor. Price increases are expected to reduce households’ purchasing power, but they yield important savings that can be redirected toward mitigation measures that are better targeted to low-income households and activities that enhance inclusive growth. Tariff adjustments also help enhance the financial viability of the providers, allowing them to invest in measures to improve security and reliability of supply. In the long term, the economy-wide effects of the reforms are expected to contribute to the increase, inclusiveness and sustainability of growth. These positive long-term effects are expected to outweigh the losses in the short run, which is the focus of the analysis below. 101. The Poverty and Social Impact Analysis (PSIA) focuses on identifying potential negative short-term impacts of the program’s prior actions on households and discusses mitigation measures. Prior Action 3.3 (i) is the focus of the PSIA: the annual adjustment of energy prices in line with the goal to reduce energy subsidies. It is important to analyze the short-term distributional impacts of this prior action because they affect poor and vulnerable households directly through their energy use and indirectly via their consumption of other products. The remaining prior actions were also reviewed for their potential impact on poor households via price or employment effects (see summary in Annex 4). Prior Action 3.7 is expected to increase the number of registered firms and protect the financial liability of single-person companies. While beneficial for private sector productivity overall, these measures can only have limited impact on the bottom 40 percent given that majority of the self-employed and single-person employers in this group are informal.19 Prior Action 3.8 is expected to prevent anti-competitive practices. The 15 decisions by the ECA against 19 Based on 2015 HIECS survey. 43 anticompetitive practices since June 2015, especially the breaking of cartels in pharmaceuticals and poultry, may remove overcharges from anticompetitive behavior. Food products and nonalcoholic beverages are by far the most important category of consumption for the poorest households and therefore can be particularly welfare enhancing for the poor in these goods markets. 102. The PSIA uses for the first time the Household Income Expenditure and Consumption Survey (HIECS) 2015 conducted by the National Statistics Office in Egypt. The data contains information about the consumption across households, including expenditures on electricity and fuel items. The estimates follow a commonly used methodology for estimating short-term welfare impacts of price increases associated with rollback of energy subsidies.20 The consumption data of HIECS 2015 are used to update the estimates of the welfare effects of DPF 1 and DPF 2 and estimate the welfare losses associated with DPF 3. Using the HIECS 2015 consumption distribution as baseline, the DPF 1 welfare effects relate to the increase in electricity tariffs implemented in FY2015/16. Next, DPF 2 estimates use as benchmark an adjusted consumption distribution that takes into account the growth experienced by the economy in FY2015/16 as well as the inflationary effects of the devaluation of March 2016. DPF 2 effects thus focus on the welfare effects coming from changes in electricity tariffs, the first adjustment of fuel prices, and the introduction of the VAT system. Finally, the benchmark to analyze DPF 3 is obtained from a consumption distribution that accounts for the growth in FY2016/17, as well as the inflationary pressure of the flotation in November 2016. DPF 3 estimates show the effects of the price increases in electricity and fuel items.21 The average price increases used in the analyses for each DPF round are shown in Table 8. Discussion of the mitigation measures will focus on those expected to be implemented in FY2017/18 as earlier efforts have already been discussed in previous PSIAs. Table 8. Average price changes supported by DPF prior actions (Percentage) July 2015 June/November 2016 June/July 2017 Diesel 0 31 55 Gasoline 80 0 47 55 Gasoline 92 0 35 43 Gasoline 95 0 0 6 LPG 0 88 100 Natural gas (vehicles) 0 45 25 Electricity 11 33 40 Source: World Bank staff calculations. 103. Under DPF 1, the electricity price increase that became effective in FY2015/16 led to an estimated 0.27 percent loss in Egyptian households’ welfare. These effects (Table 9) are calculated from the electricity tariff changes that became effective in July 2015 (that is, an average increase of 11 percent), which, for social reasons, was implemented in such a way as to freeze tariffs (in nominal terms) for residential consumers using less than 200 kWh per month while applying higher percentage adjustments to larger consumers than what was originally planned. Protecting low-income households through lifeline blocks had little effect as the vast majority of households in the bottom 40 percent consumed more than 200kWh per month. The relatively small effect is largely driven by the very low share of expenditure devoted to electricity among Egyptian households (2 percent on average). 20 Previous PSIAs were conducted based on household survey data from 2012/13. The updated data provides qualitatively similar results for DPF 1 and DPF 2 albeit some differences in magnitude as households have adjusted their energy expenditure upward. 21 All estimates do not include behavioral effects and should be interpreted as upper bounds of the potential effects of reforms. While no price elasticities of consumption for the current Egyptian context are readily available, results using elasticities from the literature will be briefly discussed as a sensitivity analysis. 44 Table 9. Estimates of welfare losses from DPF 1 supported actions as share of households’ expenditure (Percentage) DIRECT Impact INDIRECT Impact TOTAL Impact Quintile 1 -0.19 -0.05 -0.24 Quintile 2 -0.21 -0.05 -0.26 Quintile 3 -0.22 -0.05 -0.27 Quintile 4 -0.23 -0.05 -0.28 Quintile 5 -0.24 -0.05 -0.29 Average -0.22 -0.05 -0.27 Source: World Bank staff simulations using HIECS 2015. Note: Results can be interpreted as upper bounds because the price elasticity of consumption is assumed to be zero. 104. DPF 2 includes further changes to the electricity tariffs and price increases to some fuel items. These changes, coupled with other reforms to the tax system, led to a welfare loss among households of about 4 percent. In July 2016, electricity tariffs were raised for all consumption blocks by an average of 33 percent. Furthermore, a new tariff category was created for the high consumers. Households that consumed more than 1000 kWh would now pay a flat rate of EGP 0.95 for every kWh consumed. Several fuel items also experienced important price changes including natural gas used for vehicles and residential purposes, 22 gasoline, LPG, kerosene and diesel. The VAT replaced the GST in early FY2016/17. The PSIA focused on the features of the VAT that are most relevant–higher tax rate and large list of exemptions. The new VAT has one standard rate of 13 percent for all goods and services (up from 10 percent under the GST).23 With the goal to protect the less well off, the VAT exempts some 57 basic goods and services (baby milk and food, bread, tea, coffee, dairy, education, health, electricity), many of which were not exempt under the GST. The VAT is therefore expected to have very little impact on food consumption, which accounts for 47 percent of total spending by quintile 1 (poorest 20 percent) and 31 percent of total spending by quintile 5 (richest). The FY2016/17 fuel price increase led to a welfare loss of around 1 percent whereas electricity tariff increases are estimated to have decreased household welfare by 0.77 percent. The effects, however, seem to be higher among poorer households, with the bottom quintile experiencing a loss of 1.4 percent (0.92 percent) due to fuel (electricity) price increases. The direct effects of the VAT introduction are estimated to represent a loss of around 0.66 percent (Table 10). Indirect effects of fuel and electricity price changes were of similar magnitude as direct effects.24 22 A new classification was also put in place changing the price brackets that define the per m3 cost. 23 As businesses pass on the higher tax rate to consumers, households will experience an increase in prices. 24 The indirect effects are based on the 2010/11 input-output matrix. 45 Table 10. Estimates of welfare losses from DPF 2 supported actions as share of households’ expenditure (Percentage) DIRECT Impact INDIRECT TOTAL FUEL Electricity VAT Total Impact Impact Quintile 1 -1.39 -0.92 -0.65 -2.97 -1.74 -4.71 Quintile 2 -1.17 -0.88 -0.66 -2.71 -1.75 -4.46 Quintile 3 -0.89 -0.70 -0.65 -2.24 -1.75 -3.99 Quintile 4 -0.84 -0.69 -0.65 -2.18 -1.77 -3.95 Quintile 5 -0.81 -0.67 -0.69 -2.17 -1.64 -3.82 Average -1.02 -0.77 -0.66 -2.45 -1.73 -4.19 Source: World Bank staff simulations using HIECS 2015. Note: Results can be interpreted as upper bounds because the price elasticity of consumption is assumed to be zero. Applying a price elasticity of electricity (gasoline) consumption equal to -0.33 (-0.21) would lead to an average total direct effect of -1.92 percent, with the bottom quintile experiencing a loss of -2.43 percent. 105. The electricity and fuel price adjustments under DPF 3 resulted in an estimated welfare loss of 5.6 percent on average, with the largest welfare losses experienced by poorer households due to the increase in the price of LPG. In the case of electricity, households’ losses amount to about 0.8 percent on average, with the poorest households experiencing a loss of just over 1 percent. The fuel price hikes (natural gas, gasoline, LPG and kerosene) have stronger effects (2.1 percent on average) with households in the bottom quintile experiencing losses of about 3.5 percent.25 Indirect impacts are estimated to be an average loss of 2.7 percent, thus leading to a total welfare loss of around 5.6 percent. The poorest households’ loss is estimated to be 7.3 percent. Households in the richest quintile incurred a welfare loss estimate of just 4.4 percent (Table 11). Table 11. Estimates of welfare losses from DPF 3 supported actions as share of households’ expenditure (Percentage) DIRECT Impact INDIRECT TOTAL Fuel Electricity Total Impact Impact Quintile 1 -3.5 -1.05 -4.6 -2.7 -7.3 Quintile 2 -2.9 -1.04 -3.9 -2.8 -6.7 Quintile 3 -1.5 -0.59 -2.1 -2.8 -4.9 Quintile 4 -1.4 -0.60 -2.0 -2.8 -4.8 Quintile 5 -1.2 -0.61 -1.8 -2.6 -4.4 Average -2.1 -0.78 -2.9 -2.7 -5.6 Source: World Bank staff simulations using HIECS 2015. Note: Results can be interpreted as upper bounds because the price elasticity of consumption is assumed to be zero. Applying a price elasticity of electricity (gasoline) consumption equal to -0.33 (-0.21) would lead to an average total direct effect of -2.1 percent, with the bottom quintile experiencing a loss of -3.8 percent. 106. Impacts vary somewhat across social groups based on location and gender, with households in regions with higher poverty rates experiencing larger welfare losses. Households in the rural areas of Upper Egypt – the region with highest poverty rates – experienced the highest welfare loss as a share of household spending (3.87 percent) (Table 12). These large effects reflect the households’ consumption patterns: 25 Consumption of other fuels such as diesel cannot be directly observed in the HIECS 2015 data. 46 households in Upper Egypt devoted over a third of their fuel expenditures to LPG, the item experiencing the largest price increase. By comparison, households in the Metropolitan area devoted 0.53 percent of their expenditures to LPG (15 percent of their fuel expenditures). Upper Urban households also experienced high welfare losses, while households in the Metropolitan region experienced the lowest losses. Female-headed and male-headed households experienced somewhat similar losses (2.85 percent and 2.90 percent, respectively). Table 12. Estimates of welfare losses from DPF 3 supported actions as share of households’ expenditure by location and gender (Percentage) Fuel Electricity Total Direct Location Metropolitan -1.42 -0.62 -2.04 Lower Urban -1.41 -0.74 -2.14 Lower Rural -2.15 -0.75 -2.90 Upper Urban -2.16 -0.86 -3.01 Upper Rural -2.95 -0.92 -3.87 Gender Male headed -2.13 -0.77 -2.90 Female headed -2.04 -0.81 -2.85 Source: World Bank staff simulations using HIECS 2015. Note: Results can be interpreted as upper bounds because the price elasticity of consumption is assumed to be zero. 107. In absolute terms, the cumulative welfare losses of the DPF series are around EGP 1,000 per capita, and are progressive. The estimation of the welfare losses across the DPF series requires the calculation of the present value (value in 2017 prices) of the losses in each fiscal year. The average per capita loss among households in the bottom quintile is estimated to be EGP 485, whereas those in the second quintile are estimated to experience a loss of EGP 640 per capita. Households in the top quintile appear to be affected the most (Table 13). 108. The loss in purchasing power coming from the recent inflation may put additional pressure on households and should be a call for continuous efforts for better targeting and protection of the poor and vulnerable. Inflation averaged 10.2 percent in FY2015/16 and 23.3 percent in FY2016/17, and is projected to average 22.1 percent in FY2017/18, thereby reducing household purchasing power. From a simple extrapolation using simulated distribution, quintile 1 (quintile 2) households would lose about EGP 1860 (EGP 2600) per capita in purchasing power in this period. The inclusiveness of growth is therefore key in shaping the evolution of welfare in the country. The economic reforms are expected to allow stronger sustainable growth in the long term. In the short term, however, strong emphasis should be placed on the targeting power of social assistance to cushion the adverse effects of inflation. 109. The expansion of social protection holds great promise to act as a conduit to mitigate the negative effects of reforms in the medium and long term. In July 2017, the Government announced a series of measures to protect the most vulnerable population from the price increases (see box 2). Some of these measures extend the safety net initiated by the Government in previous years. The consecutive increases in the food card program allowances in 2016 and 2017 (going from EGP 15 per person per month, to EGP 18, to EGP 21 and finally to EGP 50) yielded a cumulative additional benefit of EGP 223 per capita for households in the bottom quintile and EGP 251 per capita for the second quintile. These direct compensations would benefit around 95 percent of the bottom two quintiles who are covered by the program, and are roughly equal to the losses that they incur due to the price increases according to Prior Action 3.3 (i) and about 45 47 percent of their estimated losses from the DPF series (Table 13). In addition, the increases in the allowances of Takaful and Karama are likely to have fully compensated the negative effects of the DPF series among the poorest households. The program is well targeted and covers roughly one third of the population below the national poverty line. Indeed, the program’s beneficiaries are concentrated in governorates that show the highest poverty rates: Assyout (14 percent of all beneficiaries), Souhag (16 percent), and Menia (13 percent). Moreover, in each of these governorates about three quarters of the population belong to the bottom 40 percent. Households from the bottom (second) quintile that are Takaful beneficiaries would be compensated on average by EGP 590 (EGP 618). Taking these indicators together, and considering an estimated average (per capita) transfer of Takaful is EGP 371, 26 beneficiaries of this program are expected to be fully compensated. Table 13. Estimates of effects of DPF actions and expected mitigation effects from food subsidy A. Estimated impacts on households’ welfare FY18 (2017 EGP) Welfare loss per capita Estimated increased per capita Estimated effects from loss from DPF 3 prior actions transfer from food smartcard in of purchasing power due to FY18 expected inflation in FY18 Quintile 1 -228 202 -689 Quintile 2 -292 230 -964 Quintile 3 -459 254 -2075 Quintile 4 -577 286 -2657 Quintile 5 -1037 358 -5164 B. Estimated cumulative impacts on households’ welfare FY16-FY18 (2017 EGP) Welfare loss per capita Estimated increased per capita Estimated effects from loss from DPF series transfer from food smartcard of purchasing power due to inflation in FY16-FY18 Quintile 1 -485 223 -1860 Quintile 2 -640 251 -2600 Quintile 3 -924 278 -4382 Quintile 4 -1169 311 -5609 Quintile 5 -2182 388 -10912 Note: All numbers are in per capita terms. Effects show the present value of DPF series estimated changes. Results can be interpreted as upper bounds because the price elasticity of consumption is assumed to be zero. 110. Looking forward, the Government’s effort to increase household connection to natural gas has the potential to temper the negative impact of LPG price increases, especially among the poor. The bottom 40 percent are more dependent on LPG, spending 1.4 percent of their budget compared with 0.5 percent among the top quintile, making them more vulnerable to LPG price increases. The current expansion aims to reach 1.3 million new connections of natural gas connections by 2019, and at this scale the unit cost of natural gas would be lower than LPG, making it a more attractive alternative as the prices of LPG, currently grossly underpriced, increase to reach cost recovery. 26 The average transfer was obtained by identifying potential beneficiaries of the Takaful program through a simple simulation of the PMT score and eligibility criteria of the program using household survey data from 2015. 48 Box 2. Social Protection as Mitigation Measures for Macro-Fiscal Reforms In response to the inflationary pressure caused by devaluation and increases in energy prices, the Government has implemented a multi-pronged strategy to protect the poor and middle class through social protection measures. Overall, the strategy includes three specific features: first, the social protection budget has been increased by around EGP 85 billion in FY2017/18. Second, the social protection strategy is moving from universal subsidies, which benefit the rich more than the poor, towards targeted mechanisms where the food subsidies are expected to transition to enhanced targeting mechanisms to bottom quintiles with unconditional usage of cash transfers. Finally, in addition to cash transfers, social protection has been broadened to include middle class through programs on skill enhancement, employability among youth and ensure better service delivery. Specifically, the increase in the almost universal food subsidy allowance yields benefit to the whole population and fully compensates the losses incurred by the bottom 40 percent due to the energy price increases in FY2017/18. The longstanding food subsidy program was overhauled: improving administrative efficiency, introducing income ceilings, and raising benefits. Food subsidy allocation per person increased from EGP 21 per month to EGP 50 per month in FY2017/18 (capped at four persons per household, with any additional person receiving only half of the subsidy). Simultaneously, the targeting efficiency is improved with about 10 million (or 13 percent of the total) being removed from beneficiary list. Given the broad coverage of the program (benefiting 89 percent of Egyptian families and 95 percent of the bottom 40 percent), the increase in benefit is expected to compensate almost the full losses incurred by households in the bottom 40 percent due to the energy price increases in 2017, and up to half of the losses incurred by households in the third and fourth quintiles. The expansion of the cash transfer program, which covers one third of the poor, adds further mitigation benefit. The conditional cash transfer program, Takaful and Karama (Dignity and Solidarity in Arabic) was launched in 2015 and strictly targets households below the national poverty line using a proxy means test mechanism. 27 Takaful is conditional upon school attendance and utilization of maternal and child health care services to promote accumulation of human capital among children. Karama provides monthly income to poor elderly people (age over 65) and people with severe disabilities who are unable to work. Starting from 160,000 households in the poorest governorates, the Takaful and Karama program has largely expanded reaching over 1.7 million households by mid- 2017 and potentially 2 million households by mid-2018. The program also is also developing a Unified National Registry to identify the poorest, expected to be complete by mid-2018, which yields an important collateral benefit for other social programs. In addition, the benefit per beneficiary household has been expanded by EGP 100. This increase would translate into an average annual transfer of EGP 371 per capita for beneficiaries of Takaful (Takaful provides EGP 325 every quarter to families with EGP 100 increments for each of up to three children in the household), yielding sufficient benefit to cover the losses caused by all the energy price increases between 2015 and 2017 for the beneficiaries of the program, all of whom live below the national poverty line. In addition to mitigation, social protection also expands measures that aim to lift people out of poverty and support the middle class. A new program, Forsa (Opportunity in Arabic), was started in 2017 to complement the Takaful and Karama program and connect youth in beneficiary households with the opportunity to work so that the families can escape poverty. To increase job creation, the Government, with the support of the World Bank, is putting in new investments for the Labor-Intensive Works Program focusing on poorer regions, such as Upper Egypt. Programs that benefit the middle class, especially those that are prone to fall into poverty, were expanded. Social Insurance Pensions, which covers almost 10 million people, half of whom live below the national poverty line, have been increased by 15 percent. The income tax threshold for low income taxpayers has been increased. Furthermore, civil servants have been provided an exceptional 7-10 percent increase to partly mitigate the erosion of real incomes from the high inflation. The general budget savings also allowed for smaller expansion of subsidies to social services, such as school meal programs, health insurance for vulnerable populations, and training for skill enhancement. 27 Beneficiaries need to satisfy certain criteria (women with small children, with children attending school, elderly or disabled). In addition, the programs apply a proxy means test-type questionnaire for all applicants to evaluate their level of need and identify the poorest. 49 5.2 ENVIRONMENTAL ASPECTS 111. A World Bank team assessed whether any specific policies in Egypt supported by the proposed DPF 3 are likely to cause significant effects on the country’s environment and natural resources. Based on such an assessment, a conclusion was reached that the policies supported by the proposed DPF are not likely to lead to any negative impacts on Egypt’s environment or its natural resource base. In fact, it is believed that the implementation of some policies as per the proposed DPF may lead to positive impacts on the quality of the environment mainly due to the reduction in air pollution. 112. A major milestone in the field of environmental protection in Egypt has been the issuance of Law No. 4 of 1994, amended by Law No. 9 of 2009, which is the main legislation regulating environmental protection in Egypt, and addressing the institutional arrangements and mandates for environmental management and protection in the country. In addition, the law addresses the rules and principles governing, among others, several issues, such as land pollution control, materials and toxic waste, air pollution control, water pollution control, and penalties, and the associated enforcement-related provisions. An Environmental Assessment (EA) for projects is also included in Law No. 4 of 1994 and its amendment. That is, Law No. 4 of 1994 stipulates that any projects or activities that are likely to cause negative impacts on the environment would require, for licensing, to undergo the Environmental Impact Assessment (EIA) process. In 2005, the Egyptian Environmental Affairs Agency (EEAA) issued guidelines for preparing EIAs, which have been modified in 2009. Both the Ministry of State for Environmental Affairs (MSEA) and its executive agency, the EEAA, are the environmental regulators in Egypt. 113. An assessment by the World Bank in 2005 found the EIA system in Egypt to be generally comparable with the World Bank Group’s Environmental Assessment Policy (OP/BP 4.01). However, a few gaps existed essentially pertaining to the preparation and follow-up of the Environmental and Social Management Plans (ESMPs), consultations, disclosure, and dissemination of the EA reports. A more recent assessment of the EIA process in Egypt by the World Bank Group28 revealed that many of the identified gaps have been filled. Significant progress has been made in strengthening the institutional framework as well as in enhancing both monitoring and enforcement functions. In addition, the EEAA has been strengthening the EIA information dissemination, which was carried out through the design of an EIA database. The requirements for consultation and dissemination of EIA reports have been officially added to the EIA requirements in the new guidelines issued by the EEAA in 2010. With respect to the industrial licensing reform supported in the DPF series, guidelines are now being revised by EEAA and IDA which would result in better targeting. A protocol will be agreed between EEAA and IDA and will include the clearing process, the technical requirements for each industrial sector, the accreditation of private inspection offices, and the coordination in environmental inspection. This protocol is expected to be issued by the end of 2017. 114. In 2013, the EEAA has also carried out an institutional reorganization and restructuring as means of enhancing the EIA process further. As an outcome, two additional central departments were established: (a) the Central Department for Environmental Inspection and Environmental Compliance, consisting of a General Directorate for Compliance and a General Directorate for Inspection; and (b) the Central Department for the Protection and Improvement of Industry, Environment, and Energy. Both departments are fully functional. Subsequently, the Environment Management Sector at the EEAA has established a Directorate for the Technical Office consisting of one Coordinator. Its main function is to follow up on the EIA mitigating measures during the construction phase of projects with the support of other technical departments at the EEAA. However, the mitigating measures during the operational phase of projects are to 28 Arab Republic of Egypt: Safeguards Diagnostic Review (SDR) for Piloting the Use of Egyptian Systems to Address Environmental Issues in the Proposed GEF-Financed Egypt Sustainable Persistent Organic Pollutants Management Project. The World Bank Group, 2014. 50 be carried out by the Central Department for Environmental Inspection and Environmental Compliance with the support from Regional Branch Offices and Environmental Management Units in Governorates. Further, on inspection of industrial establishments, the IDA and the private accredited offices will provide additional capacity that will be coordinated with EEAA according to the coordination protocol indicated above. 115. Overall, the proposed DPF operation is expected to lead to positive impacts on Egypt’s environment and natural resource base. This is clearly mirrored by the policy interventions under Pillar 2 that are geared towards ensuring the sustainability of Egypt’s energy supply. In fact, one of the proposed policy interventions entails a planned increase in electricity tariffs which will lead to a reduction in electricity demand and consumption. This will in turn result in positive environmental impacts through the reduction in emissions of air pollutants and lower GHG emissions. This will be reinforced by an improved enabling environment for investments in renewable energies. Within this context, the proposed policy interventions will lead to the accrual of environmental benefits emanating from the reduction in emissions of air pollutants and the associated decrease in health risks and the decrease in GHG emissions, supporting Egypt’s commitment to carry out climate actions as outlined in its NDC document. 116. The prior actions under Pillar 3 are expected to contribute to investment growth. These would include the institutional reforms needed for the implementation of the Investment Law No. 72 of 2017, the issuance of the Executive Regulations of the new Investment Law, revision of the Companies’ Law and the reform of the industrial licensing procedures. The anticipated growth in investments entails environmental risks and subsequently, potential environmental impacts. However, the environmental regulatory framework now and the current institutional capacity in Egypt are deemed to be adequate in ensuring that the necessary environmental management and mitigation measures are well in place. That is, in accordance with Law No. 4 of 1994 (amended by Law No. 9 of 2009), all new projects and industrial facilities and the like need to carry out an environmental due diligence or an EIA. In this regard, the World Bank Group, in collaboration with several development partners including the European Investment Bank, the French Development Agency and Japan International Cooperation Agency, has been working since the 1990s, in partnership with the GoE, to support industrial enterprises in complying with the national environmental standards. In general, it is believed that the environmental regulatory framework and institutional capacity in Egypt are sufficient to ensure that the necessary mitigation measures are in place to avoid, reduce and/or mitigate any negative environmental impacts arising from an overall increase in industrial production either through the establishment of new industrial projects and facilities or through the expansion in the capacity of the existing ones. 5.3 PFM, DISBURSEMENT, AND AUDITING ASPECTS 117. Egypt’s PFM reforms have made progress on various fronts. A PFM Improvement Unit was created in June 2016, which reports to the Vice Minister of Finance for Fiscal Policies and Institutional Reform. The fiscal risk management was further reinforced in July 2017 with the establishment of a ‘Sovereign Guarantees Committee’ and an internal audit unit has been established, which identified the first set of pilot audits to be undertaken within FY2017/18. 118. The Constitution provides the legal basis for the budget, for appropriating and spending public funds, and for preparing and approving the final accounts of the state budget. A range of laws deals with specific aspects of financial management. In addition, there are specific laws for entities such as economic authorities and special funds. 119. The state budget covers the activities of the central government, governorates, and public service authorities. The budget is made publicly available annually on the Ministry of Finance website. However, a large number of special accounts and funds, while nominally in-budget, function under separate provisions 51 with limited transparency. Their aggregate balance has been decreased in recent years. A pre-budget statement has been prepared since 2012 to include the general framework for fiscal policy, budget aggregates, and the related priorities. The interface between the Ministry of Finance and the Ministry of Planning, Monitoring, and Administrative Reform in the planning and management of capital investment could be improved. The introduction of program budgeting for nine sectors pursues sound objectives, but its full implementation will take some time. The rollout process will also need recalibration and attention to capacity development. 120. The Cabinet has approved an amendment of the Public Procurement Law to align it with international practice. While the legal framework is subject to improvement, important challenges remain in the consistency of application of the current legislation. The Government has launched a government procurement portal (http://etenders.gov.eg) for mandatory publication of bidding opportunities, documents, bid evaluations, and results that is meant to be rolled out to all government entities. This tool will increase transparency and efficiency, yet enhancing the coverage and system functionalities, such as ‘e- contract management’, could bring about significant additional benefits. 121. The ex-ante control system is implemented by the Ministry of Finance’s financial controllers and includes transaction-based compliance controls. This covers payments, recording of transactions, and production of accounts at a unit level. However, there are variations in performance, timeliness, and deficient controls on budget commitments. The extent of control procedures is perceived to be cumbersome. The integration of the control function in the GFMIS across the expenditure cycle is not fully developed. There is no function in the line ministries that carries out independent internal audit. The financial inspection directorate carries out ex-post reviews of compliance by Accounting Units, but no risk- based approach is used for formulating the annual work program. The Ministry of Finance issued a financial control manual in 2014 to help standardize controls and make their application more predictable. It has also launched the development of a risk-based ex post internal audit function through the PFM Improvement Unit as indicated earlier. 122. The GFMIS has been rolled out partially. It is used to record budget allocations and modifications and to execute the budget through general ledger transactions. However, the full budget execution process chain remains largely manual, with only a subset of accounting units utilizing the ‘procure -to-pay’ functionalities. The Ministry of Finance has announced its plan to automate all remaining accounting units by March 2018. 123. The Ministry of Finance exercises monitoring of cash transactions and balances of the accounting units included in the state budget and maintained in the CBE. The introduction of the treasury single account law, the closing of many special accounts and funds in commercial banks, and the ongoing implementation of centralized e-payments have strengthened cash management. The Ministry of Finance announced stopping the use of paper checks by November 2017 and moving completely to e-payments for staff salaries as well as payments to suppliers and contractors. 124. As the Supreme Audit Institution in the country, the Accountability State Authority (ASA) has a comprehensive scope of coverage and is known to issue its audit report on the government annual accounts on a timely basis. The 2014 Constitution introduced elements to strengthen the ASA’s independence and transparency. The Head of the ASA was dismissed before the end of his term. This affected the perceived independence of the institution, even though it was done in accordance with the provisions of Law No. 89 of 2015 that regulates the dismissal of heads of independent bodies and regulatory authorities. According to the constitution provisions, the annual reports of the regulatory and oversight bodies (including the ASA) shall be submitted to the Parliament, President of the country, and the Prime 52 Minister. The reports shall also be made publicly available. However, the provision for publication of audit reports has not yet been made effective and these reports remain undisclosed. 125. The 2017 IMF Safeguards Assessment of the CBE has not yet been made available to the World Bank for review. The CBE started publishing its audited financial statements in 2012. The financial statements as of June 30, 2017, were audited jointly by the ASA and a local audit firm, which issued an audit report with unmodified (clean) opinion on September 26, 2017. The report referred to the auditors’ consideration of internal controls related to the preparation and fair presentation of the financial statements. World Bank disbursements for several investment loans are channeled in a satisfactory manner through designated accounts maintained in the CBE. Based on the review of the CBE’s audited financial statements and the experience with bank accounts held in the CBE for World Bank-financed projects, no weaknesses in the controls over banking arrangements were identified. 126. Disbursement procedures for single-tranche DPFs will apply to this operation. Once the loan becomes effective, the World Bank will disburse the loan proceeds into a deposit account in U.S. dollars (foreign currency deposit account) that forms part of the country’s official foreign exchange reserves held by the CBE. An amount equivalent to the loan proceeds will be immediately credited in local currency to an account of the Ministry of Finance’s treasury single account, thus becoming available to finance state budget expenditures. The Loan Agreement will indicate the Borrower’s agreement not to use the loan proceeds to finance excluded expenditures (negative list). The Government will confirm the loan deposit and credit through written confirmation within 30 days of disbursement. The Bank reserves the right to request an independent audit of the foreign currency deposit account. 5.4 MONITORING, EVALUATION, AND ACCOUNTABILITY 127. The MIIC continues to be the main coordinating agency for monitoring and evaluation among the five other participating ministries. The prior actions detailed in this operation are the prime responsibility of six agencies: MIIC, Ministry of Finance, Ministry of Electricity and Renewable Energy, Ministry of Petroleum and Mineral Resources, Ministry of Trade and Industry, and the General Authority for Investment and Free Zones. The inter-ministerial working group created for the DPF will remain functional during the course of the programmatic DPF framework where the MIIC will be the coordinator with other ministries on monitoring of the results indicators, which are based on routinely published sector indicators. 128. The program outcomes will be monitored through the measurement of the progress toward the achievement of results indicators included in the policy and results matrix (Annex 1). This measurement seeks to assess progress toward the implementation of the policy and institutional measures supported by the proposed DPF series. The MIIC has the responsibility of presenting the information related to the reform implementation and progress made toward results on time and in a format satisfactory to the World Bank. 129. Grievance redress. Communities and individuals who believe they are adversely affected by specific country policies supported as prior actions or tranche release conditions under a Bank supported DPF may submit complaints to the responsible country authorities, appropriate local/national grievance redress mechanisms, or to the Bank’s Grievance Redress Service (GRS). Complaints to the GRS are promptly reviewed. Affected communities and individuals may submit their complaint to the Bank’s independent Inspection Panel, which determines whether harm occurred or could occur because of Bank noncompliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the Bank's attention and the Bank management has been given an opportunity to respond. Information on how to submit complaints to the Bank’s corporate GRS is available at http://www.worldbank.org/GRS. Information on how to submit complaints to the Bank’s Inspection Panel is available at www.inspectionpanel.org. 53 6. SUMMARY OF RISKS AND MITIGATION 130. The overall risk rating of this operation is high. The major risks to the operation’s ability to achieve its development objective include: (a) institutional and implementation capacity, (b) macroeconomic challenges associated with high inflation and the large public debt ratio, (c) challenging social conditions, (d) governance challenges, and (e) the potential spillover effects of regional and geopolitical challenges. These risks, if materialized, could singularly or jointly affect the Government’s ability to implement the reforms or make the outcome of the development agenda less successful. 131. The political and governance risks are rated high, given the underlining limited institutional capacity, the adverse impact of the economic reforms on the middle class, and the relatively slower governance reforms which are yet to have a tangible impact. While economic and social reforms are progressing, advancing the governance agenda is critical. While reforms to enhance transparency and improve services are underway, particularly in government-to-business relationships, additional efforts are required to cement a stronger government-to-citizen relationship, and to build government capacity in this regard. Notable improvement was achieved with regards to fiscal transparency. Governance reforms have largely focused on initiatives to enhance state efficiency in certain areas such as business registration and automation of investor services. Progress is needed on legislations on ‘Right to Information’ and ‘Whistle Blower Protection’, regulations of the ‘Conflict of Interest’ law, and measures to ensure inclusive development and that citizens’ voice is heard with regards to policy decisions and their implication. At a sector level, improvements in corporate governance practices are being institutionalized in electricity and petroleum SOEs with the World Bank’s technical assistance support. A major modernization program to enhance accountability, transparency, and governance of the petroleum sector enterprises has been launched with support from the World Bank under the UK SPEIG Trust Fund. In a context of high inflation and scarcity of jobs, empowering civil society and supporting its role as an important partner in the fight against corruption and for greater social inclusiveness is key to face the economic hardship and achieve development goals. 132. Without improvements on the governance front, there is a risk to sustaining the economic reforms. The cycle of reforms may not be sustained without an inclusive economic model, accompanied by a responsive public sector and representative institutions. To improve economic governance, a clear strategy and consistent message to the private sector on the role of the state in social and economic development would be helpful to clarify various state bodies’ institutional roles as commercial operators, service providers and market enablers or regulators and avoiding conflicts of interest among them. Efforts have already been undertaken to strengthen citizen engagement and feedback, and provide for grievance redress mechanisms– such as the investor conflict resolution unit— to reduce risks from the broader governance environment. Strengthening the internal audit systems and promoting fiscal transparency through the program as well as World Bank support through other lending operations also provide important mitigating measures. 133. Macroeconomic risks remain high. While important economic reforms that took place over the past 12 months have helped restore confidence and to improve macroeconomic stability, Egypt continues to face large near-term challenges. Elevated inflation and high unemployment, in particular among the youth, impose economic and social hardship on the population (particularly, on low-income groups) and can affect the reforms momentum. To mitigate the effect of inflation on vulnerable groups, the Government is using part of the freed-up resources to strengthen the social protection system. Additionally, debt dynamics are particularly sensitive to the implementation of growth-enhancing reforms and the fiscal consolidation strategy which assumes considerable wage restraint and subsidy reductions over the projection horizon. These risks are mitigated by the strong commitment of the GoE to the reform agenda and the continuation of the IMF program, which together with real sector reforms to support the private sector development is expected to further strengthen the macroeconomic framework. 54 134. The sector strategies risk is high, while the technical design of the program and stakeholder risk is substantial. Implementation of several sector reforms supported under the DPF has gained substantial momentum, including the Electricity Law, the Gas Law and the Investment Law, with a wide range of stakeholders coalescing around the reforms’ objectives and being invested in their success. While the long- term and structural nature of the reforms means that the related risks remain high, the cumulative reform progress reduces the risks related to the sector strategies compared to the previous two operations in the series. Because of the extensive communication campaigns, the public is taking note of the modernization programs in the energy sector and the authorities’ efforts to create models of governance and efficiency with SOEs that could be replicated across other sectors. To support these reforms, an extensive technical assistance program is under-way and is proposed to be expanded with the United Kingdom’s multi-year programmatic technical assistance support on improving policy, capacity building and implementation support to programs. This will assist the Government in implementing reforms and monitoring progress, and strengthen sectoral institutional and regulatory capacity. 135. The institutional capacity for implementation and sustainability risk is high. The reform program is progressing well on the legislative side, with many important laws adopted to foster private sector contribution to growth and job creation. Enacting good laws is an important and necessary first step, but consistent implementation is required for this to translate into effective change. Incomplete implementation due to capacity constraints could undermine the impact of this operation. To ensure an efficient implementation of the legislation, there is an urgent need for enhancing the institutional capacity and addressing operational constraints. This requires putting in place adequate resources and time frame, and implementation can be further enhanced through wider consultations and staff and citizen engagement to provide feedback on implementation bottlenecks and inform decisions. Given that this is the last operation of the programmatic series, the DPF prior actions are supporting institutionalization of key legislation, including their executive regulations in key economic areas like electricity, renewables, natural gas, VAT, and the Investment Law. Several sectors have witnessed deep complementary institutional reforms including sector restructuring and governance reforms in energy, formation of a Fiscal Risk Committee in the Ministry of Finance, and setting up an investors grievance center and online registration of companies and registration process. The implementation of these deep legislative and institutional changes would ensure sustainability of reforms after the DPF series, providing benefits to all Egyptians. 136. Fiduciary risk and environmental risk are rated substantial given the issues noted above, while social risk is high. Fiduciary risks with funds flow arrangement of the loan are perceived as low. There is substantial fiduciary risk because several results indicators are fiscal expenditure and revenue targets, and the Bank’s assessment identified deficient controls on budget commitments, the incomplete integration of control function in the GFMIS, and the lack of a fully developed independent internal audit function. The fiduciary risks associated with are mitigated by the Government’s renewed emphasis on PFM reform and the recent gains in fiscal transparency, which are areas of support of this DPF operation. The latest citizen budget issuance of FY2016/17 was disseminated in September 2016 and the pre-budget statement for FY2017/18 were disseminated in March 2017. In line with the CPF, the World Bank will continue the policy dialogue and provision of technical assistance to support implementation of PFM reforms. Environmental risks may emerge from the implementation of the new investment procedures; however, this risk would be minimized by adequate implementation of the coordination protocol between EEAA and IDA. The social protection mechanisms to cover the marginalized and poor groups of the population have advanced through better targeting and efficient programs, such as the expansion of the cash transfer programs and the overhaul of the food subsidy system. However, the policies and institutions for expanding the reach of social protection need to match with the pace of reforms envisaged in the DPF-supported program, especially on energy subsidies, fiscal revenue expansion, and wage control. The social protection strategy is aimed to protect the very poor and marginal section leaving the middle class to bear the short-term costs of inflation. To mitigate these income losses for middle class, enhanced focus on skill and job creation is being initiated 55 by the Government to provide hope for opportunities going forward. In addition, to mitigate these risks, the Government proposes a comprehensive communication strategy on its reform program and intends to institutionalize a grievance redress mechanism and a citizen outreach program to build greater acceptability of reforms within society. The World Bank has already enhanced its portfolio to Upper Egypt, which has the highest concentration of the poor through programs on targeted cash transfers, local area development, natural gas connections, public works, and technical assistance to support the unified registry. 137. The risk of not engaging outweighs the program risks. Egypt has taken bold steps in its reforms program to restore confidence and macroeconomic stability. Further efforts are still needed to build on these important achievements to unleash the potential of the country and to foster a sustainable private-sector- led growth that is focused on job creation. With Egypt’s large demographics and important economic and political weight in the region, the World Bank Group has a unique opportunity to support the country as an element of stability in a turmoiled region, by encouraging the continuation of reforms and facilitating the implementation of the program. Table 14. Summary Risk Ratings Risk Rating (H, S, M, or L) 1. Political and governance H 2. Macroeconomic H 3. Sector strategies and policies H 4. Technical design of project or program S 5. Institutional capacity for implementation and sustainability H 6. Fiduciary S 7. Environment and social H 8. Stakeholders S Overall H Note: H = High; S = Substantial; M = Moderate; L = Low. 56 ANNEX 1: POLICY AND RESULTS MATRIX Prior Actions and Triggers Results Prior Actions under DPF 1 Prior Actions for DPF 2 Prior Actions for DPF 3 Pillar 1: Advancing Fiscal Consolidation 1.1 Enhancing Government Revenues Prior Action 1.1: The decree promulgating Prior Action 2.1: The Borrower enacted Law Increased non-sovereign Law No. 96 of 2015 has been issued which No. 79 of 2016 Finalization of Taxation corporate income tax and amends the Income Tax Law by unifying Disputes and published said law in its Official sales/VAT on goods and the top income tax rate for all economic Gazette. services as a percentage of GDP actors operating in the Borrower’s from 5.4% in FY2014/15 to territory. The amendments unify the top about 6.7% in FY2017/18. income tax rate at twenty-two and one half percent (22.5%) for all economic actors operating in the Borrower’s territory, including those operating in special economic zones formerly subject to a lower rate of ten percent (10%). 1.2 Containing the Wage Bill Prior Action 1.2: The decree promulgating Prior Action 2.2: (i) The Borrower enacted Law Prior Action 3.1: The Borrower, through its Reduction of the ratio of the Law No. 32 of 2015, endorsing the national No. 8 of 2016 Assessing the Public Budget of Ministry of Finance, has issued a wage bill report Central Government’s wage budget for FY16, has been issued which the State, endorsing the national budget for entitled Note on Key Reforms and Development and salary bill to nominal GDP, includes administrative instructions to all FY17, which contains administrative of Wages dated August 2017 notifying that at from 8.2% in FY2014/15 to government budgetary entities to contain instructions to all government budgetary least seventy percent (70%) of the wage bill is 7.4% of GDP by FY2017/18. the wage bill. The administrative entities to contain the wage bill, including automated and that an action plan for the instructions are to (i) cap bonuses and provision for delinking bonuses and rewards completion of the automation process has been rewards of their respective employees in of their respective employees’ salaries from developed. the basic salary component and published FY16 at the level of FY15; and (ii) delink the variable portion of government employees’ said law in its Official Gazette. salaries from the basic salary component. (ii) The Ministry of Finance of the Borrower issued a wage bill report entitled Government Wages, Key Reforms dated November 2016 notifying that at least forty-five percent (45%) of the wage bill is automated. 1.3 Strengthening Debt Management and Aspects of Public Financial Management Prior Action 1.3: The Ministerial Decree No. Prior Action 2.3: The Ministry of Finance of the Prior Action 3.2: The Borrower, through its Completion of at least four 515 of 2015 has been issued which Borrower issued Decree No. 247/2016 to Ministry of Finance, has: audits on sectors and entities mandates the publication of the Medium- establish and operationalize a Public Finance (i) issued Ministerial Decree No. 290/2017, which affiliated with the Ministry of Term Debt Management Strategy. Management Improvement Unit with the establishes an internal audit dedicated unit with Finance by FY2017/18. following mandates: (a) setting-up an internal adequate staffing, budget and procedures audit function; (b) monitoring fiscal risks of aligned with international guidance related to Publication of an updated Economic Authorities and SOEs, including independence, audit planning, risk assessment Medium-Term Debt and periodic reporting. Management Strategy by 57 Prior Actions and Triggers Results Prior Actions under DPF 1 Prior Actions for DPF 2 Prior Actions for DPF 3 their contingent liabilities; and (c) enhancing (ii) issued Ministerial Decree No. 201/2017, which FY2017/18. government accounting and financial control. establishes a Sovereign Guarantees Committee entrusted to develop policies for issuing sovereign guarantees, review the applications for issuing such guarantees, and evaluate periodically the financial stability of the recipients of the guarantees. (iii) begun publishing a section in the FY2017/18 Budget Statement on economic risks to the implementation of the national budget. Pillar 2: Ensuring Sustainable Energy Supply 2.1 Reforming Energy Subsidies Prior Action 1.4: The Prime Ministerial Prior Action 2.4: (i) The Ministry of Electricity Prior Action 3.3: The Borrower, through its: Reduction of energy subsidies Decree No. 2259 of 2015 has been issued and Renewable Energy of the Borrower has (i) Ministry of Electricity and Renewable Energy, as a percentage of GDP from for implementing the second annual issued Decree No. 436 of 2016 implementing has issued Ministerial Decree No. 312/2017 on 6.6% in FY2013/14 to 3.2% in electricity tariff adjustment as part of a a third annual electricity tariff adjustment annual electricity price adjustment; and Prime FY2017/18. five-year tariff reform plan outlined in the that goes beyond the former five-year tariff Minister, has issued Prime Ministerial Decrees Prime Ministerial Decree No. 1257 of 2014 adjustment plan adopted in the Prime No. 1435/2017, 1436/2017 and 1437/2017 for to reform the gas and electricity subsidy. Minister’s Decree No. 1257/2014, as the fuel price adjustment for FY2017/18 recommended by the Borrower ’s Egyptian consistent with the FY2017/18 Budget Electric Utility and Consumer Protection Statement. Regulatory Agency. (ii) Cabinet, has issued Cabinet Letter 14724-5 (ii) The Supreme Energy Council of the dated July 5, 2017 approving the extension to Borrower adopted a policy for financing achieve full cost recovery in the power sector by variations in actual energy costs compared to FY2021/22. the budget estimates in the Borrower’s (iii) Ministry of Finance and the Ministry of Medium Term Fiscal Framework (2016-19). Petroleum and Mineral Resources, has approved a joint policy proposal for periodic fuel price indexation, which has been submitted to the Prime Minister for consideration. 2.2 Improving Energy Governance Prior Action 1.5: The decree promulgating Prior Action 2.5: The Ministry of Electricity Prior Action 3.4: The Borrower, through: Notification and Law No. 87 of 2015 has been issued and Renewable Energy of the Borrower issued (i) its Prime Minister, has issued Prime Ministerial operationalization of supply mandating the promotion of competition Decree No. 230/2016 notifying the Executive Decree No. 1959/2017, which establishes the code and transmission tariff by in the electricity sector and the separation Regulations of Electricity Law of the Borrower new General Assembly of Egyptian Electricity FY2017/18. of the Egyptian Electricity Transmission that, inter alia, include measures to improve Transmission Company, in compliance with the Company. Specifically, the law mandates (i) the energy efficiency of large electricity Electricity Law and the Executive Regulations of Reduced difference between the creation of a competitive wholesale consumers and published said Regulations in the Electricity Law. peak electricity demand and electricity market providing direct access the official Gazette of the Borrower. (ii) the Egyptian Electric Utility and Consumer available peak capacity from between generation companies and eligible Protection Regulatory Agency, has issued the deficit of 5,540 MW in large consumers; (ii) the separation of the regulations on the methodology for public FY2014/15 to a surplus of 1,000 58 Prior Actions and Triggers Results Prior Actions under DPF 1 Prior Actions for DPF 2 Prior Actions for DPF 3 Egyptian Electricity Transmission Company hearings on important regulatory decisions MW by FY2017/18. as an entity independent from the entitled Public Hearing Regulation of the generation and distribution sectors; and (iii) Egyptian Electric Utility and Consumer Protection Public disclosure of tariff the institutionalization of energy efficiency Regulatory Agency, July 2017. methodology for computation of audits across all major consumers. electricity tariffs. 2.3 Accelerating the Low Carbon Energy Transition Prior Action 1.6: The Cabinet has endorsed Prior Action 2.6: (i) The Borrower’s Cabinet Prior Action 3.5: The Borrower, through its Publication of a separate gas a draft gas law that provides for open approved the draft Gas Activities Regulatory President, has assented to the Gas Market transmission tariff, access to the gas infrastructure and the Law and submitted it to the Borrower’s Activities Regulatory Law No. 196/2017, which transmission code, market establishment of an independent gas Parliament for consideration. opens the downstream gas sector to private rules, and approval procedures sector regulator. (ii) The Ministry of Petroleum and Mineral investors, introduces third-party access to the by FY2018/19. Resources of the Borrower issued Decree No. network, and legally establishes the independent 1631/2016 to establish a new Policy and gas sector regulator as evidenced in its official Launching of a dedicated web Strategy Unit detailing the charter, functions Gazette dated August 1, 2017. portal with all gas sector rules and authority to spearhead the and regulations by FY2018/19. modernization of the petroleum sector. Prior Action 1.7 (a) The decree Prior Action 2.7: (i) The Ministry of Prior Action 3.6: The Borrower, through: Financial closure of private promulgating Law No. 203 of 2014 has Electricity and Renewable Energy of the (i) its Cabinet, has issued Cabinet Letters No. sector-owned renewable been issued for the stimulation of Borrower has issued Decree No. 244 of 2016 13181-5 dated June 12, 2017, and 13182-5 dated energy projects from 0 MW producing electricity from renewable to set up an energy efficiency unit with June 13, 2017, which approve the use of (October 2015) to 1,500 MW energy sources. (b) The Egyptian Electric dedicated staff to lead the implementation competitive auctions to procure the next round of (end of FY2017/18). Utility and Consumer Protection of the Borrower’s National Energy Efficiency private-sector-owned renewable energy Regulatory Agency has issued interim Action Plan. capacity. Increase in the number of licenses to ten (10) private developers (ii) The Borrower’s Cabinet issued Decree (ii) the Egyptian Electric Utility and Consumer energy audits performed for pursuant to Law No. 203/2014. No. 2533 of 2016 announcing the revised Protection Regulatory Agency, has issued Circular large consumer and Feed-in-Tariff policy for renewable energy. No. 01/2017 (as amended by Circular No. government buildings from 134 04/2017) notifying the public of the revised net in FY2014/15 to 234 in metering regulations that allow consumers to sell FY2018/19. excess electricity to a third party, or to the distribution company at a price equivalent to the cost of service. Pillar 3: Enhancing the Business Environment 3.1 Improving the Investment Regime and Its Transparency, Particularly for MSMEs Prior Action 1.8: The decree promulgating Prior Action 2.8: The Borrower’s Cabinet Prior Action 3.7: The Borrower, through its: Increase in business entry, as Law No. 17 of 2015 and the Prime approved the draft Single-Person Company (i) President, assented to Investment Law No. measured by the average Ministerial Decree No. 1820 of 2015 have Law that includes limited liability protection, 72/2017 and, through its Prime Minister, issued number of company been issued which, respectively, and submitted it to the Borrower’s Prime Ministerial Decree 2310/2017, approving registrations at GAFI Investor introduced and implemented amendments Parliament for consideration. the associated Executive Regulations, which Service Centers per month, of to the Investment Guarantees and enhance certain protections for investors. 65% in FY2017/18 over the Incentives Law defining investor rights and (ii) Cabinet, has issued Cabinet Letter No. 13325- baseline of 867 average improving investment facilitation services. 3 dated June 14, 2017 approving the amendments registrations per month in 59 Prior Actions and Triggers Results Prior Actions under DPF 1 Prior Actions for DPF 2 Prior Actions for DPF 3 This includes: (i) defining conditions and to the Companies Law, which provide limited FY2014/15. procedures for non-approval of licenses; (ii) liability protection for single-person companies, designating GAFI as the sole interface with and submitted said amendments to its Increase in the number of GAFI investors for certain investment activities; Parliament. Investor Services Centers (iii) explicitly granting investor rights to (iii) Ministry of Investment and International offering automated and establish and expand investment projects Cooperation, has implemented institutional integrated registration services and to gain and transfer profits; and (iv) reforms in the Investment Law, including for companies under both the streamlining dispute resolution and improving services to investors such as: (a) Investment and Companies liquidation mechanisms. publication of all licensing and permits Laws, from 0 in FY2014/15 to 4 procedures and requirements for all activities and by the end of FY2017/18. sectors and a complete inventory of available investment incentives and eligibility criteria; and (b) introduction of online automated and integrated registration services, including company incorporation and registration services provided by other agencies, as evidenced by its publication of said measures on the GAFI’s website. 3.2 Reforming Industrial Licensing Prior Action 1.9: The Prime Ministerial Prior Action 2.9: (i) The Borrower’s Cabinet Average number of days to Decree No. 2807 of 2015 has been issued approved the draft Law on Streamlining the issue an industrial license by launching the reform of the industrial Procedures of Granting Licenses for Industrial notification of no more than 7 licensing regime, including setting the Establishments that includes measures for days by the end of FY2017/18. principles of the reform. Specifically (i) simplified licensing by notification for low-risk limiting the scope of industrial licensing to industrial activities, and submitted it to the Reduction in the average risk-based enforcement of health, safety, Borrower’s Parliament for consideration. number of days to comply with security, environment, and land use (ii) The Borrower’s Minister of the Ministry of all industrial licensing requirements by responsible agencies; (ii) Trade and Industry issued Ministerial Decree requirements from 634 days in separating policy making, regulation and number 1071 of 2016 approving the FY2014/15 to 160 days by the facilitation functions; and (iii) further implementation plan of the Borrower’s end of FY2017/18. decentralizing the provision of licensing Industrial Licensing Reform Program. services, beginning with the establishment of an inter-ministerial committee mandated to prepare and submit to the Cabinet a comprehensive reform plan. 3.3 Strengthening the Competition Framework Prior Action 1.10: Draft executive Prior Action 2.10: (i) The Borrower’s Cabinet Prior Action 3.8: The Borrower, through the ECA, Increase in the number of anti- regulations have been submitted to the issued Decree No. 2509/2016 notifying the in its Board session no. 113 on September 12, competitive practices Prime Minister to implement Law No. 56 of Executive Regulations of Protection of 2017, approved the adoption of the following prevented/eliminated from a 2014 which introduced amendments to the Competition and Prohibition of Monopolistic secondary legislation to implement the baseline of 9 (between Competition Law to enhance anticartel Practices Law 1316/2005 for implementing Competition Law, namely, (a) Regulation FY2012/13 and FY2014/15) to a 60 Prior Actions and Triggers Results Prior Actions under DPF 1 Prior Actions for DPF 2 Prior Actions for DPF 3 policy to prosecute the most harmful the Borrower’s anti -cartel policy and Relating to Exemptions, under Articles 6 and 9 of target of 11 decided during the competition offences. strengthening the institutional the Competition Law; (b) Leniency Guidelines, FY16-18 period. independence of ECA. under Article 26 of the Competition Law; (c) (ii) The ECA adopted administrative Guidelines on Fines, Settlements and Damages; regulations dated December 2015 to further and (d) Quick-Guide for Competition Impact strengthen anti-cartel enforcement policy. Assessment of Laws and Regulations. 61 ANNEX 2: LETTER OF DEVELOPMENT POLICY 62 63 64 65 66 67 68 69 ANNEX 3: FUND RELATIONS ANNEX International Monetary Fund Washington, D.C. 20431 USA Press Release No. 17/281 FOR IMMEDIATE RELEASE July 13, 2017 IMF Executive Board Completes First Review under the Extended Fund Facility (EFF) with the Arab Republic of Egypt On July 13, 2017, the Executive Board of the International Monetary Fund (IMF) completed the first review of Egypt’s economic reform program supported by an arrangement under the Extended Fund Facility (EFF). The completion of the review allows the authorities to draw the equivalent of SDR 895.48 million (about US$1.25 billion), bringing total disbursements to SDR 2,865.53 million about US$4 billion. The three-year EFF arrangement in the amount equivalent to SDR 8.597 billion (about US$12 billion at the time of approval, or 422 percent of quota) was approved by the Executive Board on November 11, 2016 (see Press Release No. 16/501) to support the authorities’ economic reform program. The authorities’ reform program supported by the EFF will help Egypt restore macroeconomic stability and promote inclusive growth. Policies supported by the program aim to correct external imbalances and restore competitiveness, reduce the budget deficit and place public debt on a declining path, boost growth and create jobs while protecting vulnerable groups. In completing the review, the Executive Board approved the authorities’ request for waivers of the June performance criteria for the primary fiscal balance and the fuel subsidy bill. These were missed due to higher costs of imported food and fuel products caused by large depreciation of the pound. The waiver was approved in view of the important measures taken in June to contain fuel subsidies and the planned stronger fiscal adjustment in the next two years, which will keep the program objectives on track. Following the Executive Board discussion on Egypt, Mr. David Lipton, First Deputy Managing Director and Acting Chair, said: Egypt’s reform program is off to a good start. The transition to a flexible exchange rate went smoothly. The parallel market has virtually disappeared and central bank reserves have increased significantly. The energy subsidy reform, wage restraint, and the new VAT have all contributed to reducing the fiscal deficit and helped free up space for social spending to support the poor. Market confidence is returning and capital flows are increasing. These augur well for future growth. The authorities’ immediate priority is to reduce inflation, which poses a risk to macroeconomic stability and hurts the poor. The Central Bank of Egypt has taken significant steps to reduce inflation by raising policy interest rates and absorbing excess liquidity. It has also developed a monetary framework with a clearly defined policy anchor and is stepping up its communication with markets and with the public to manage inflation expectations. The CBE has also committed to maintain the flexible exchange rate, which is critical to cushion shocks, preserve competitiveness, and accumulate reserves. The continued fiscal consolidation aims to place public debt on a declining path. Consistent with this objective, the 2017/18 budget targets a primary surplus for the first time in a decade. The main deficit-reducing measures are the increase of the VAT rate, continued reforms of energy subsidies and wage restraint. At the same time, the budget includes a strong social component to ease the burden of adjustment on the poor and the vulnerable. 70 Significant progress has been made on structural reforms. An industrial licensing law and a new investment law have been passed, and a new insolvency law is in the Parliament. These are critical pieces of legislation necessary to strengthen the business climate, attract investments, and promote growth. The government’s reform agenda is now directed at improving public finance management, promoting competition, encouraging female participation in the labor force, and strengthening the financial sector. These reforms will further improve the business environment and support private sector development. Macroeconomic stability is still fragile and the reform agenda is difficult, but the authorities have demonstrated a strong resolve to contain the risks. A flexible exchange rate regime, a strong monetary policy framework, and a commitment to a continued fiscal adjustment will help rebuild policy buffers. Strong ownership of the program will support implementation of the reform agenda. 71 ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE Significant Poverty, Social or Significant Positive or Negative Distributional Effects Prior Actions Environment Effects (yes/no/to be Positive or Negative determined) (yes/no/to be determined) Pillar 1: Advancing Fiscal Consolidation Prior Action 3.1: The Borrower, through its Ministry Adverse environmental effects are Adverse poverty and social of Finance, has issued a wage bill report entitled not expected. impacts are not expected. Note on Key Reforms and Development of Wages dated August 2017 notifying that at least seventy percent (70%) of the wage bill is automated and that an action plan for the completion of the automation process has been developed. Prior Action 3.2: The Borrower, through its Ministry Adverse environmental effects are Adverse poverty and social of Finance, has: not expected. impacts are not expected. (i) issued Ministerial Decree No. 290/2017, which establishes an internal audit dedicated unit with adequate staffing, budget and procedures aligned with international guidance related to independence, audit planning, risk assessment and periodic reporting. (ii) issued Ministerial Decree No. 201/2017, which establishes a Sovereign Guarantees Committee entrusted to develop policies for issuing sovereign guarantees, review the applications for issuing such guarantees, and evaluate periodically the financial stability of the recipients of the guarantees. (iii) begun publishing a section in the FY2017/18 Budget Statement on economic risks to the implementation of the national budget. Pillar 2: Ensuring Sustainable Energy Supply Prior Action 3.3: The Borrower, through its: Positive environmental effects are Adverse poverty and (i) Ministry of Electricity and Renewable Energy, has expected. distributional impacts are issued Ministerial Decree No. 312/2017 on annual Tariff adjustments (that is, expected. The government’s electricity price adjustment; and Prime Minister, has increases) through the price reform program with respect issued Prime Ministerial Decrees No. 1435/2017, elasticity mechanism will lead to a to fuel and electricity is 1436/2017 and 1437/2017 for the fuel price reduction in demand and estimated to have an adjustment for FY2017/18 consistent with the consumption of electricity, aggregate impact of 5.6 FY2017/18 Budget Statement. ultimately resulting in positive percent on household (ii) Cabinet, has issued Cabinet Letter 14724-5 dated environmental effects through welfare. To mitigate these July 5, 2017 approving the extension to achieve full reduction in emission of air impacts, the Government is cost recovery in the power sector by FY2021/22. pollutants and lower GHG providing additional (iii) Ministry of Finance and the Ministry of emissions. resources to its social safety Petroleum and Mineral Resources, has approved a net system, leading to joint policy proposal for periodic fuel price increases in transfers to indexation, which has been submitted to the Prime social pensioners, food Minister for consideration. smartcard program beneficiaries, and Takaful and Karama recipients. Gender-related impacts have 72 Significant Poverty, Social or Significant Positive or Negative Distributional Effects Prior Actions Environment Effects (yes/no/to be Positive or Negative determined) (yes/no/to be determined) been examined. Prior Action 3.4: The Borrower, through: Adverse environmental effects are Adverse poverty and social (i) its Prime Minister, has issued Prime Ministerial not expected. impacts are not expected. Decree No. 1959/2017, which establishes the new General Assembly of Egyptian Electricity Transmission Company, in compliance with the Electricity Law and the Executive Regulations of the Electricity Law. (ii) the Egyptian Electric Utility and Consumer Protection Regulatory Agency, has issued regulations on the methodology for public hearings on important regulatory decisions entitled Public Hearing Regulation of the Egyptian Electric Utility and Consumer Protection Regulatory Agency, July 2017. Prior Action 3.5: The Borrower, through its Adverse environmental effects are Adverse poverty and social President, has assented to the Gas Market Activities not expected. impacts are not expected. Regulatory Law No. 196/2017, which opens the downstream gas sector to private investors, introduces third-party access to the network, and legally establishes the independent gas sector regulator as evidenced in its official Gazette dated August 1, 2017. Prior Action 3.6: The Borrower, through: Positive environmental effects are Adverse poverty and social (i) its Cabinet, has issued Cabinet Letters No. 13181- expected. impacts are not expected. 5 dated June 12, 2017, and 13182-5 dated June 13, An improved enabling environment 2017, which approve the use of competitive auctions for investments in renewable to procure the next round of private-sector-owned energies will lead to the accrual of renewable energy capacity. environmental benefits emanating (ii) the Egyptian Electric Utility and Consumer from the reduction in emission of air Protection Regulatory Agency, has issued Circular pollutants and the associated No. 01/2017 (as amended by Circular No. 04/2017) decrease in health risks and the notifying the public of the revised net metering decrease in GHG emissions. regulations that allow consumers to sell excess electricity to a third party, or to the distribution company at a price equivalent to the cost of service. Pillar 3: Enhancing the Business Environment Prior Action 3.7: The Borrower, through its: Negative environmental effects are Adverse poverty and social (i) President, assented to Investment Law No. not expected conditional upon the impacts are not expected 72/2017 and, through its Prime Minister, issued implementation of mitigation Prime Ministerial Decree 2310/2017, approving the measures per current environmental associated Executive Regulations, which enhance regulatory framework. certain protections for investors. The approval of the investment law (ii) Cabinet, has issued Cabinet Letter No. 13325-3 and its executive regulations with dated June 14, 2017 approving the amendments to specific benefits to specified group the Companies Law, which provide limited liability of industries could potentially lead protection for single-person companies, and to negative environmental impacts submitted said amendments to its Parliament. by virtue of the expected ease and (iii) Ministry of Investment and International subsequent increase in investments Cooperation, has implemented institutional reforms across industries. However, the in the Investment Law, including improving services current environmental regulatory to investors such as: (a) publication of all licensing framework and institutional capacity 73 Significant Poverty, Social or Significant Positive or Negative Distributional Effects Prior Actions Environment Effects (yes/no/to be Positive or Negative determined) (yes/no/to be determined) and permits procedures and requirements for all in Egypt is believed to be sufficient activities and sectors, and a complete inventory of to ensure that the necessary available investment incentives and eligibility mitigation measures are in place to criteria; and (b) introduction of online automated avoid, reduce, and/or mitigate any and integrated registration services, including negative environmental impacts company incorporation and registration services arising from the increase in provided by other agencies, as evidenced by its industrial production, in general. publication of said measures on the GAFI’s website. Prior Action 3.8: The Borrower, through the ECA, in Adverse environmental effects are Adverse poverty and social its Board session no. 113 on September 12, 2017, not expected. impacts are not expected. approved the adoption of the following secondary legislation to implement the Competition Law, namely, (a) Regulation Relating to Exemptions, under Articles 6 and 9 of the Competition Law; (b) Leniency Guidelines, under Article 26 of the Competition Law; (c) Guidelines on Fines, Settlements and Damages; and (d) Quick-Guide for Competition Impact Assessment of Laws and Regulations. 74 ANNEX 5: DEBT SUSTAINABILITY ANALYSIS 1. The World Bank team conducted a DSA to assess the trajectory of the budget sector debt-to-GDP ratio. The baseline scenario assumes: (i) economic growth to increase from 4.2 percent in FY2017/18 to 6 percent over the medium term, (ii) the fiscal consolidation plan to remain on track, with the deficit in the primary balance shifting into a surplus in FY2017/18, and (iii) inflation to decline to single digit territory from its current highs (Table 5.1). Under these assumptions, the debt-to-GDP ratio is projected to reach 81.6 percent of GDP by FY2021/22, down from 108.7 percent of GDP in FY2016/17, supported by the projected path of fiscal consolidation as well as negative real interest rates, along with the favorable growth outlook (figure 5.1). Table 5.1. Egypt Budget Sector DSA - Baseline Scenario (in percent of GDP unless otherwise indicated) 1/ Debt, Economic and Market Indicators Actual Projections As of March 26, 2016 2/ 2006-2014 2015 2016 2017 2018 2019 2020 2021 2022 Sovereign Spreads Nominal gross public debt 86.7 93.1 102.8 108.7 99.9 96.9 91.5 86.6 81.6 Bond Spread (bp) 3/ 426 5Y CDS (bp) 393 Real GDP growth (in percent) 4.4 4.4 4.3 4.2 4.5 5.3 5.8 6.0 6.0 Ratings Foreign Local Inflation (GDP deflator, in percent) 11.6 9.9 6.3 23.7 22.5 13.3 10.1 7.2 7.2 Moody's B3 B3 Nominal GDP growth (in percent) 16.6 14.7 10.8 28.9 28.0 19.3 16.4 13.7 13.7 S&Ps B B- 4/ Effective interest rate (in percent) 8.1 10.1 10.7 23.3 17.3 14.3 11.3 9.9 9.3 Fitch B B Figure 5.1. Egypt’s Debt Dynamics: Contributions to Debt-to-GDP Ratio 15 20 Debt-Creating Flows projection 10 (in percent of GDP) 10 5 0 0 -10 -5 -20 -10 -30 -15 -20 -40 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 cumulative Primary deficit Real GDP growth Real interest rate Exchange rate depreciation Other debt-creating flows Residual Change in gross public sector debt Stress Tests 2. To check the sensitivity of these projections, the World Bank team undertook basic stress tests. A real GDP growth shock scenario assumes a 2-percentage point drop in the real growth rate, compared to the baseline scenario. Under this scenario, the debt-to-GDP ratio would decline at a considerably slower pace reaching only 97 percent by FY2021/22 compared to 81.6 percent under the baseline. Slower growth will be associated with a lower momentum of fiscal consolidation, with adverse implications for the cost of debt servicing and government revenues. 75 Table 5.2. Real GDP Growth Shock Figure 5.2. Real GDP Growth Shock 120 Real GDP Growth Shock 2017 2018 2019 2020 2021 2022 108.7 97.0 Real GDP growth 4.2% 2.5% 3.3% 3.8% 4.0% 4.0% 100 Inflation (GDP Deflator change) 23.7% 22.0% 12.8% 9.6% 6.7% 6.7% 80 81.6 Non-interest revenue-to-GDP ratio 18.2% 18.3% 18.2% 17.9% 18.4% 18.4% 60 Non-interest expenditure-to-GDP ratio 20.1% 18.9% 17.8% 16.5% 16.7% 16.8% 40 Primary Balance -1.9% -0.6% 0.5% 1.9% 2.2% 2.2% 20 Interest rate shock (bps) compared to baseline 0 50 50 50 0 0 Baseline Real GDP Growth Shock 0 2017 2018 2019 2020 2021 2022 3. A primary balance shock assumes a slowdown in fiscal consolidation efforts, with the deficit in the primary balance narrowing at a slower pace and remaining in deficit through FY2017/18 (compared to a surplus under the baseline). Similar to the real GDP growth shock outlined above, the debt-to-GDP ratio declines slowly and reaches only 90.7 percent in FY2021/22, some 9 percentage points higher than under the baseline scenario. Table 5.3. Primary Balance Shock Figure 5.3. Primary Balance Shock Primary Balance Shock 2017 2018 2019 2020 2021 2022 120 108.7 Real GDP growth 4.2% 4.5% 4.5% 4.5% 4.5% 4.5% 100 90.7 Inflation (GDP Deflator change) 23.7% 22.5% 13.3% 10.1% 7.2% 7.2% 80 81.6 Non-interest revenue-to-GDP ratio 18.2% 18.3% 18.4% 18.3% 18.8% 18.9% 60 Non-interest expenditure-to-GDP ratio 20.1% 19.6% 17.8% 17.0% 17.3% 17.3% 40 Primary Balance -1.9% -0.8% 1.1% 1.8% 2.1% 2.2% 20 Baseline Primary Balance Shock Interest rate shock (bps) compared to baseline 0 57 36 4 8 0 0 2017 2018 2019 2020 2021 2022 4. Under the assumption that both the gradual increase in real GDP growth and fiscal consolidation efforts are maintained, an additional real exchange rate depreciation of 25 percent in FY2017/18 (on top of the large depreciation that already took place in FY2016/17) will lead to a gradual decline in the debt-to- GDP ratio, reaching 90.2 percent of GDP in FY2021/22. Initially interest rates increase sharply given the exchange rate pass-through to inflation, but real interest rates may remain negative in the medium-term. Since the pace of growth remains favorable, together with the projected path of fiscal adjustment, the debt outlook is expected to continue improving, albeit at a slower pace than under the baseline scenario. 76 Table 5.4. Real Exchange Rate Shock Figure 6.4. Real Exchange Rate Shock Exchange Rate Shock 2017 2018 2019 2020 2021 2022120 108.7 Real GDP growth 4.2% 4.5% 5.3% 5.8% 6.0% 6.0%100 90.2 Inflation (GDP Deflator change) 23.7% 27.5% 13.3% 10.1% 7.2% 7.2% 80 81.6 Non-interest revenue-to-GDP ratio 18.2% 18.8% 18.7% 18.4% 18.9% 18.9% 60 Non-interest expenditure-to-GDP ratio 20.1% 18.5% 16.9% 16.5% 16.7% 16.8% 40 Primary Balance -1.9% 0.3% 1.8% 1.9% 2.2% 2.2% 20 Baseline Real Exchange Rate Shock Interest rate shock (bps) compared to baseline 0 500 100 0 0 0 0 2017 2018 2019 2020 2021 2022 Downside risks to debt sustainability 5. A combined macro-fiscal shock can lead to the disruption of the downward trajectory of the debt- to-GDP ratio. Under this scenario fiscal consolidation occurs at a slower pace and the primary balance remains in deficit through FY2017/18 and reaches a smaller surplus thereafter, while interest rates increase. In addition, this scenario also assumes a lower growth trajectory (2 percentage points lower than the baseline). Under the combined macro-fiscal shock, the debt-to-GDP ratio is projected to increase to 118.4 percent of GDP by FY2021/22. Table 5.5. Macro-Fiscal Shock Figure 5.5. Macro-Fiscal Shock 150 Combined Macro-Fiscal Shock 2017 2018 2019 2020 2021 2022 118.4 108.7 Real GDP growth 4.2% 2.5% 3.3% 3.8% 4.0% 100 4.0% 81.6 Inflation (GDP Deflator change) 23.7% 22.0% 12.8% 9.6% 6.7% 6.7% 50 Baseline Non-interest revenue-to-GDP ratio 18.2% 18.3% 18.2% 17.9% 18.4% 18.4% Non-interest expenditure-to-GDP ratio 20.1% 19.6% 17.8% 17.0% 17.3% 17.3% Macro-Fiscal Shock 0 Primary Balance -1.9% -1.3% 0.4% 0.9% 1.2% 1.2% 2017 2018 2019 2020 2021 2022 Interest rate shock (bps) compared to baseline 0 500 396 396 396 396 6. Similarly, a policy slippage scenario is expected to lead to an unsustainable debt to GDP trajectory. In this scenario, growth first drops in FY2017/18 before it increases gradually and stagnates at 4 percent throughout the forecast horizon, and fiscal consolidation efforts fade resulting in a primary balance that remains in deficit through the forecast period. This leads to an increase in the debt-to-GDP ratio to 114.5 percent by FY2021/22. 77 Table 5.6. Policy Slippage Scenario Figure 5.6. Slippage Scenario Policy Slippage Scenario 2017 2018 2019 2020 2021 2022 140 120 Real GDP growth 4.2% 2.5% 3.3% 3.8% 4.0% 4.0% 108.7 114.5 100 Inflation (GDP Deflator change) 23.7% 22.5% 13.3% 10.1% 7.2% 7.2% 80 81.6 Non-interest revenue-to-GDP ratio 18.2% 18.8% 18.7% 18.4% 18.9% 18.9% 60 Non-interest expenditure-to-GDP ratio 20.1% 21.8% 21.7% 21.4% 21.9% 21.9% 40 Primary Balance -1.9% -3.0% -3.0% -3.0% -3.0% -3.0% 20 Baseline Policy slippage Interest rate shock (bps) compared to baseline 0 100 100 100 100 1000 2017 2018 2019 2020 2021 2022 7. While there are considerable risks to debt sustainability these risks are mitigated by a captive domestic investor base, buffers in form of government deposits of around 10 percent of GDP, and a moderate external debt ratio, which is largely long-term and on concessional terms. 78