* IMF-style subsidy cuts, tax hikes avoided popular backlash
* Medium-term plan expected by donor conference at year-end
* Cairo stock market rise reflects optimism, challenges remain
By Stephen Kalin
CAIRO, July 23 (Reuters) - Egypt’s new president Abdel Fattah al-Sisi has made a head start on tackling the country’s economic problems, managing to introduce long-awaited subsidy reform without stirring popular unrest.
Sisi’s government, formed in June, announced this month it was raising prices of heavily subsidised energy products by up to 78 percent and slapped new taxes on dividends, capital gains and high-income earners.
The moves are the start of what is expected to be several years of painful austerity for Egyptians as the state aims to eliminate a crippling budget deficit estimated to reach 10 percent of GDP in the fiscal year that began on July 1.
To soften the blow to ordinary Egyptians, the government also unveiled a patchwork of relief measures including free transport in army buses and more heavily subsidised food products. But while investors are impressed with Sisi’s bold start, efforts needed to transform the economy and public finances have barely begun, they say.
With deeper reforms needed, rhetoric and ad hoc palliatives alone may not be enough to contain discontent in a country where public protests have removed two leaders in three years.
“Further subsidy cuts will be harder to digest for the Egyptian population if they do not see at least some of these ‘rewards’ or if they feel these are distributed unevenly,” said Coline Schep, Middle East analyst at international consultancy Control Risks.
She was referring to the government’s pledge to spend the savings from energy subsidy cuts on higher public sector wages, education, healthcare and pensions.
Sisi, who as army chief orchestrated the ouster of Islamist President Mohamed Mursi a year ago following mass protests, has appealed to the public for shared sacrifice as the government tries to revive an economy depleted by a slump in foreign investment and tourism since the overthrow of President Hosni Mubarak in 2011.
Food and energy subsidies typically eat up a quarter of state spending and Schep said future subsidy cuts could trigger “serious social unrest if they are not introduced gradually, with warning, and with appropriate compensatory measures”.
Since being elected in May Sisi has also imposed a restrictive protest law, which has silenced all but the staunchest opposition, mostly supporters of Mursi’s banned Muslim Brotherhood.
But analysts say too much austerity could push ordinary Egyptians back onto the streets, which along with security challenges from militants in the Sinai Peninsula and the border with Libya, could derail the economic reform programme.
Investors note that Egypt was a financial basketcase a year ago. Sisi has at least put the country on the long road to recovery and, in a sign of investor optimism, Cairo’s blue-chip share index has risen 8 percent since early June. But he needs to outline a medium-term recovery plan.
Egypt “was absolutely insolvent. The debt was unsustainable, the deficits were unfinanceable and reserves were gone,” said Bryan Carter, lead portfolio manager for emerging debt at Acadian Asset Management in Boston.
“We’re patient for them to address the crisis moment and look forward to an articulation of medium-term goals when they have time to focus on that.”
Sisi has not publicised a medium-term plan or even revealed who his economic advisors are, leaving observers to speculate how he intends to fix state finances and attract back business.
He has not indicated whether he would favour a return to loan talks with the International Monetary Fund, which collapsed last year under Mursi, who was unwilling to introduce unpopular subsidy and tax reforms.
Christopher Jarvis, the IMF’s mission chief for Egypt said the new government’s moves towards fiscal consolidation were “a home-grown plan and an important step forward.” Rating agencies may revise their outlooks upwards.
However, an IMF loan is still widely seen as a necessary seal of approval to secure a rebound in foreign investment, which has slumped from $8 billion a year before Mubarak was toppled. Ongoing Gulf aid can be used to bridge interim funding gaps.
At home, the response to the austerity measures has been surprisingly muted. Cairo taxi drivers lament their shrunken profit margins and minibus riders grumble about higher fares, some cursing Sisi for what they see as a betrayal. But organised opposition has been virtually non-existent.
Sisi has taken to regularly speaking in simple Arabic familiar to poor Egyptians to explain the need for austerity.
“Sisi is no Mubarak,” said Acadian’s Carter, referring to the veteran ruler who was considered out of touch with the general public.
But Sisi has also moved to squash opposition to his policies from all corners - Islamist or secular.
Businessmen, even if feeling pinched by a government desperate for revenue, have also stayed mostly quiet.
“You cannot threaten (Sisi). If you tell him, ‘If you don’t give me, I’ll leave,’ he’ll tell you to leave immediately,” said Hany Tawfik, chairman of the Egyptian Private Equity Association.
The second half of the year brings two key milestones.
Parliamentary elections could solidify Sisi’s political authority. He has said they are a prerequisite for any IMF deal.
An international conference for donors and investors around the end of the year will be a litmus test for the economy in terms of who attends and how much they invest.
The investment minister said Egypt would announce an investment plan around August, probably a list of large infrastructure projects that could help address unemployment, officially running at 13 percent but in reality much higher.
Despite the optimism, significant economic challenges remain. Fuel subsidies may need to be cut by up to 25 percent annually over the next four years and the government is also looking at a value-added tax.
Subsidy cuts are expected to push inflation into double digits. And even with fiscal reforms, the budget deficit will remain high for years, with a growing debt-to-GDP ratio that reached 89.2 percent in the fiscal year to June 2013. It is still unclear how the savings will be redirected.
Balance of payments have been stabilised by at least $12 billion in Gulf aid in the past year, but are still well below pre-2011 levels, an ongoing concern for investors. (Additional reporting by Anna Yukhananov in Washington; Editing by Michael Georgy and Susan Fenton)