SPECIAL REPORT—Political tensions that had been simmering ever since the Muslim Brotherhood-affiliated Freedom and Justice Party (FJP) romped to victory at legislative elections held in late 2011 and early 2012 finally boiled over in early July 2013. In a scene reminiscent of the events that brought the downfall of the entrenched autocratic regime headed by Hosni Mubarak in February 2011, millions of anti-government protestors gathered in Cairo’s Tahrir Square and other cities demanding the resignation of the president.

And, as they did two years ago, the leaders of the armed forces carried out a peaceful coup, although this time they deposed President Mohammed Morsi, the leader of the FJP and Egypt’s first popularly elected president.

Rather than assuming direct control of the government as they did two years ago, the generals have turned over power (nominally, at least) to an interim regime composed mostly of secular liberal political figures and nonpartisan technocrats. The new government, headed by Prime Minister Hazem el-Beblawi, will be responsible for preventing Egypt’s descent into political and economic chaos, while also overseeing preparations for new elections and an overhaul of the controversial constitution that was approved in a referendum held in December 2012.

The challenges facing the new regime are daunting. It inherits an economy badly damaged by chronic political instability and uncertainty. Righting the economic ship will require implementation of unpopular reforms, a task that the interim administration already appears to have decided is too risky for a government that cannot claim a popular mandate.

The early indications are that the Beblawi’s government will make use of the generous funding provided by the Persian Gulf monarchies to finance a spending program designed to buy social peace and prevent a crisis-driven economic downturn. Even if successful, that strategy all but ensures that an elected government coming to power in 2014 will face immediate pressure to obtain budget support from the IMF, which will condition its assistance on the implementation of austerity measures, including deep cuts to subsidies, that are very likely to ignite a powerful public backlash.

Morsi’s removal creates a risk of radicalizing the Muslim Brotherhood.

At the same time, while the military’s action was overwhelmingly supported by non-Islamist political forces in Egypt, Morsi’s removal creates a risk of radicalizing the Muslim Brotherhood, which has accused the deposed leader’s liberal opponents of colluding with the generals to undermine democracy. Consequently, the potential for chronic bouts of unrest is high, as is the risk that popular sentiment will turn against the interim government.

If all goes well, elections will be held no later than early 2014, clearing the way for a new government with a claim to a popular mandate. Unfortunately, numerous stumbling blocks could prolong the transition process. Moreover, as recent events have shown, an election victory by itself is not sufficient to cement a government’s claim to legitimacy.

The military will not long tolerate a civilian regime that lacks the ability to maintain order without resorting to violence. Assuming the Muslim Brotherhood refuses to participate in the country’s second attempt at laying the foundation for democracy, any government formed as the end result of the newly launched transition can expect to confront a sizeable political force committed to promoting disorder.  As such, political risk is likely to remain elevated for some time yet.

External Conflict Warning: Coups Can Become Habit-forming

The reaction of the U.S. and the EU might best be described as pragmatic. Although wary of endorsing military intervention against a regime installed by means of elections that the western democracies judged to be free and fair, neither the U.S. nor the EU is impose punitive measures that could sow even greater instability in Egypt, with negative repercussions for stability and security throughout the region. 

Tellingly, the U.S. government has refused to characterize Morsi’s removal as a coup, as doing so would obligate President Barack Obama’s administration to halt the delivery of military aid amounting to about $1.5 billion per year, and would also prohibit the Obama administration from endorsing the extension of loans and other aid to Egypt by multilateral organizations.

It is difficult to see how the events of early July might be considered anything other than a coup. Morsi’s opponents claimed that the president had overstepped his authority, and was attempting to impose an Islamist theocracy on the Egyptian population. In their view, Morsi’s failure to act as the president “of all the Egyptian people” invalidated his legal claim to the office, and the generals were hailed by Morsi’s opponents as agents of democracy acting according to the will of the people.

In a western context, such an argument would (rightfully) be dismissed as self-serving hogwash. Whatever his failings as a president, and there were many, Morsi won his office by popular election, and he was removed by extra-constitutional means under threat of military force. That is a coup by any definition of the concept.

His secular opponents have justified their rise to power by identifying themselves as the true guardians of the democratic promise made possible by the overthrow of Mubarak (who never won a free or fair election). However, the fact remains that the secular parties performed woefully in both the legislative and presidential elections, and by their actions have helped to push the political transition back to square one. By enthusiastically participating in yet another political transition guided by the generals, they have legitimated the military’s use of force to topple a duly elected president, and in doing so they have created a precedent for removing a liberal government (even an elected one) under similar conditions in the future.

The generals are concerned about their own power and economic interests.

It is comforting to believe that the military brass is motivated by a commitment to democracy and a sense of fair play. But that belief is badly misguided. The generals are concerned about their own power and economic interests (which are substantial), and they will back any regime they believe is willing to protect those interests and is not so weak that it is incapable of doing so.

There was a time when the military was prepared to work with Morsi. The president’s August 2012 announcement that the top leaders of the Supreme Council of the Armed Forces (SCAF) had been “retired” took many people by surprise, and the ease with which the reshuffle of the top members of the military establishment was accomplished fueled speculation that Morsi had cut some sort of deal with the officers who were promoted as a result. Recent events only lend credence to those suspicions, and the fact that the military turned on Morsi less than a year later underscores the risks for the new regime.

Not-So-Inclusive Regime

The transitional government is now in place, but the process of forming it was not entirely smooth. One of the opposition’s main criticisms of Morsi was that he did not provide an opportunity for secular political forces to play a meaningful role in shaping the content of the constitution.  Having applauded the military’s move against Morsi, the people who now occupy key positions in the government must pursue inclusive policies or risk being tagged as partisan opportunists.

Unfortunately for liberal politicians who are now cooperating with the generals, the leaders of the Muslim Brotherhood have stated that the group will not participate in the political process unless and until Morsi is returned to the office to which he alone holds legal claim.  Consequently, maintaining the appearance of inclusiveness has left them no choice but to consult with leaders of the conservative Islamist (Salafist) Al Nour Party, who far more than Morsi and the FJP view democracy purely as an instrument for attaining power, rather than a philosophy for governing once they attain it.

Al Nour has already flexed its muscles. Egypt’s new leaders initially proposed Mohamed ElBaradei, a leading liberal political figure, to fill the prime minister’s slot. However, he was withdrawn from consideration after the Salafists objected to his appointment. Although the military relented on that point, Gen. Abdul Fatah el-Sisi, who replaced Mohamed Hussein Tantawi as chairman of the SCAF in 2012, issued a pointed warning that he would not tolerate calculated attempts to sow division among political factions.

Significantly, the interim regime includes no representatives from either the FJP or Al Nour, which won a combined 65.3 percent of the vote at the parliamentary elections, and held a total of 356 seats in the 508-member People’s Assembly, the lower parliamentary chamber that was dissolved by order of the Supreme Constitutional Court (SCC) shortly before Morsi’s victory in the run-off president election in mid-June 2012. The 34-members of the Cabinet are a collection of liberals, leftists, and technocrats, the last group including people who held government posts under Mubarak.

Predictably, the Defense portfolio is held by Gen. Sisi, who is also the first deputy prime minister.  Other key ministers include Foreign Minister Nabil Fahmy, who previously served as Egypt’s ambassador to the U.S. under Mubarak, and Ahmed Galal, who, as finance minister, will be the government’s point man in negotiations for a loan agreement with the IMF, but who will mainly focus on ensuring that a delay in securing a deal with the IMF does not trigger a full-blown economic crisis. Three members—Interior Minister Mohamed Ibrahim, Electricity Minister Ahmed Imam, and Tourism Minister Hisham Zaazou—are holdovers from Morsi’s government, but all are technocrats with no ties to the FJP.

Secretary of State John Kerry has stated that the U.S. will “support an open, inclusive, tolerant democratic process” to restore civilian government, and has called upon Egyptian authorities to refrain from political motivated reprisals against the Muslim Brotherhood and to open a dialogue with all political parties. The Muslim Brotherhood does not appear to be interested in dialogue, except on its terms (i.e., following Morsi’s restoration), a stance that will help to shield the new government from foreign criticism over its lack of inclusiveness. However, the heavy-handed response of the security forces to pro-Morsi demonstrations, especially the swiftness with which they have resorted to armed force when protests have escalated into clashes, creates a risk of alienating both the Egyptian Islamists (including members of Al Nour) and western donors.

The EU is already growing impatient with the new regime, which has ignored European calls to release Morsi, who is being held by authorities without charge and has not been seen since the coup. Prosecutors are reportedly conducting investigations into possible crimes committed by the former president, including incitement to violence, complicity in the killing of protesters, damaging the economy, and even espionage. If released, Morsi would undoubtedly lead a campaign to reclaim his office. However, his indictment on specious charges will only deepen the divide between the Islamists and the new military-backed regime.

Economy on the Precipice

Before it was pushed from power, Morsi’s government was engaged in off-and-on negotiations with the IMF for a deal that would provide Egypt with $4.8 billion in loans. Chaotic domestic conditions have contributed to a significant decline in tourism receipts, a crucial source of hard currency. The depletion of foreign-exchange reserves has resulted in a slide in the currency, contributing to high inflation and driving up the cost of imports, which has perpetuated the drain on reserves. The country is dependent on loans to cover the cost of imports of basic goods, and domestic borrowing has left the local banking system vulnerable to a sovereign debt crisis.

The IMF has been ready to sign a deal, but officials in Cairo balked at the demands attached to a loan agreement, which include the implementation of an austerity program and the privatization of state-owned enterprises. Those terms were unacceptable to the Islamists on ideological grounds, and represent a threat to the economic interests of the military, which the generals have strived to protect throughout the transition process.

The interim government has signaled that it will attempt to keep the economy afloat without support from the IMF. Shortly after he was sworn in, Finance Minister Galal declared that IMF support was “only part of the solution,” suggesting that the interim regime will continue to engage with the Fund, but that sealing a deal will not be a top priority in the near term.

Real GDP growth will be held below 2 percent in 2013.

Saudi Arabia, the United Arab Emirates, and Kuwait have pledged a total of $12 billion in loans, and can probably be counted on to provide additional billions if needed as a short-term, stop-gap solution. However, that is not a long-term fix.  Even if the Gulf monarchs are prepared to keep the funds flowing, the government will still need to rein in a budget deficit that is growing out of control.

The government’s immediate priority will be easing the economic hardship that contributed to the groundswell of opposition to Morsi’s government, and high levels of spending, supported by loans from the Gulf kingdoms, may be enough to prevent an economic downturn in 2013. However, unstable conditions will disrupt productive activity and discourage private investment, and stimulus-induced demand will provide a weak basis for spurring a recovery. Consequently, real GDP growth will be held below 2 percent in 2013, and downside risks to the forecast are significant.

Despite a relatively favorable base effect, inflation remained high in the first half of 2013, as a sharp slide in the pound drove up the cost of food and fuel imports. The interim government will avoid taking steps to slash subsidies, which act as a brake on inflation, but consumer price increases are forecast to hit double digits on average this year.

The improvement in the external balances had been one of the few bright spots for the economy prior to the political crisis. The deficit for the July 2012-March 2013 period shrank to $3.9 billion (compared to a $7.1 billion shortfall in the same period a year earlier, a reflection of the narrowing trade deficit and a pickup in both tourism revenues and remittances from overseas workers. The recent upheaval will produce a reversal of those favorable developments, resulting in a significant expansion of the external deficits that will reinforce downward pressure on the pound and increase the risk of destabilizing balance-of-payments difficulties.

About The Author Christopher McKee [Full Bio]

Christopher McKee is CEO and owner of the PRS Group, a leading global provider of political and country risk forecasts and analysis, with offices in Syracuse, New York, and Mt Pleasant, South Carolina.