• Parliament-Govt. compromise means a two-step VAT implementation Parliament finally passed the value-added tax (VAT) law opting for a 13% rate in FY2016/17 and 14% thereafter. The government had been insisting on a 14% tax rate to accommodate a wide list of exemptions that Parliament had expanded. The Ministry of Finance is working on executive regulations with implementation likely sometime in October. The law carried a few surprises, but was largely in line with the initial draft submitted to Parliament a few weeks ago.
• Limited hit on coverage: VAT replaces sales tax, many exemptions Most companies will only see a few percentage points added to their tax rates, which they plan to pass on to consumers. In the case of consumer companies, most of their products remain largely exempt including producers of dairy products and snacks. Healthcare providers are also exempt. Financials, banks and non-banks, are also exempt, while property developers are not part of the VAT regime. Contractors will continue to pay the 5% they were charged under the previous regime.
• Muted direct impact on consumer, but adds to inflationary pressure With a large list of exempt goods and services, nearly 70% of the consumer basket is unlikely to see any price change as a direct impact of VAT. We forecast 2pp will be added to headline inflation in FY2016/17 driven by higher taxes on tobacco and communications, which make up 5.3% of the consumer basket. The fact, however, that VAT is coming amidst elevated inflationary pressure, as the gov’t has implemented other fiscal measures and EGP has weakened in the parallel market, means it is another headwind to disposable income. Thus we continue to forecast real domestic demand will see the weakest growth in nearly a decade in FY16/17.
• Significant boost to fiscal reforms; adjust forecasts on tax rate The VAT is expected to add 1-1.25% of GDP in new revenue, according to the government and IMF, representing the most significant fiscal reform to help achieve the ambitious 5.5% of GDP fiscal consolidation. VAT should also improve tax collection and attract more informal enterprises into the formal economy due to wider invoicing. We now expect additional revenue of 0.6% of GDP in FY16/17 given the lower rate of 13% and only nine months of implementation, and therefore adjust our fiscal deficit forecast to 11.1% of GDP from an earlier 10.7%. Savings are set to rise to their targets in FY17/18 with a higher VAT rate and full year of implementation.

Mohamed Abou Basha