Moody's Investor Services has commended Egyptian parliament's approval for the long-delayed value-added tax (VAT). Although the 13% VAT rate is lower than the government's proposed 14% rate, and the list of exempted goods and services is 57 versus the proposed 52 items, the VAT is credit positive, Moody's said in a statement. The VAT forms an integral part of the government's reform program over the coming three years and together with reforms to tax administration, will gradually increase Egypt's low tax receipts and support its fiscal consolidation efforts. Implementation of VAT will also unlock external funding from multilateral sources such as the World Bank (Aaa stable) and the African Development Bank (Aaa stable). The VAT takes effect 1 October and replaces the current 10% goods and services tax. The VAT's lower 13% rate and the higher number of exempted goods and services will result in a revenue shortfall of EGP12 billion, equal to one third of the VAT revenue increase assumed in the current budget for fiscal 2017 (which ends 30 June 2017). However, some of the shortfall will be made up in fiscal 2018 when the VAT rate increases to 14%. As a result, we expect the government to underperform its revenue and fiscal deficit targets. Our fiscal deficit forecast is 12% of GDP for fiscal 2017, compared to the government's target of 9.9%. Our forecast takes into account potential slippages in revenue targets, reflecting both difficult implementation of revenue-raising measures and our GDP growth projection of 3.5% in fiscal 2017, which is lower than the official growth projection of 4.0%. In addition, along with widely discussed currency devaluation, introducing the VAT will exacerbate already high inflation. Egypt's inflation rate increased to 14.8% year on year in June and was broadly unchanged in July. Nevertheless, we think that VAT is an important step to increase Egypt's tax revenues. As Exhibits 1 and 2 below show, Egypt has one of the lowest tax takes among its peers given the size of its economy and total government revenues, and it has a declining share of tax revenues over time. The three-percentage-point difference between the VAT's 13% rate and the 10% goods and services tax will be the main source of additional revenues. Wider participation from Egypt's large non-tax-paying informal sector and stiffened penalties against tax evasion will also add revenues.
