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AL-SAFF, Egypt (Reuters) - Hundreds of soot-stained factory chimneys dot the horizon in the industrial city of al-Saff, south of Cairo, but only a few spew black smoke.
Two years after the revolution that overthrew president Hosni Mubarak, Egyptian industry is struggling as political instability has scared off foreign investors and hit domestic confidence and the government has started slashing energy subsidies that eat up a fifth of its annual budget.
"All the chimneys used to discharge smoke before the revolution but now when I look at them the image is depressing ... We started being affected right after the revolution but it got worse after they started raising fuel prices," said Reda Salam, head of the brick industry and craftsmens' union.
The idle factories in al-Saff, the base for most of Egypt's brick makers, are a sign of things to come if the government follows through with plans to reduce subsidies for industries long used to getting energy at a fraction of its real cost.
Cement and brick makers have been the first industries to be hit by reforms this year, part of a gradual government programme to remove energy subsidies to industry over four years.
Gas prices charged to brick and cement makers rose by at least 75 percent after the government cut subsidies in February while their fuel oil prices rose by 50 percent, industry sources said.
Waheed Shokri, who took over his father's brick factory in al-Saff, is selling bricks below cost price just to keep his business going. But he says he won't be able to do that for much longer and the compounding losses could well force him to shut down and lay off his 300 workers.
His factory cut its monthly production by half to 1.5 million bricks in the months after the revolution in 2011 as the economy slumped, and reduced it again to 1 million in March this year after the fuel subsidy cuts.
"We tried to raise prices after the fuel hike but that was not accepted by the market ... We, the factory owners, are carrying the loss in the hopes that there will be change tomorrow. There are plenty of factories that shut down," Shokri said.
The reductions in gas and fuel subsidies in February would have been bigger but were scaled back after protests by workers. The decision underlines the dilemma facing President Mohamed Mursi's government as it attempts fiscal reform. It needs to cut spending to contain a ballooning budget deficit, but it fears stoking more social unrest if it pushes austerity too hard.
Energy subsidies will cost the government more than 120 billion Egyptian pounds ($17.23 billion) this financial year ending in June, its says. That will help push up the budget deficit to around 11.5 percent of gross domestic product, from 8.2 percent in 2011/2012.
The government hopes to reduce the deficit to 9.5 percent of GDP in 2013/14 by cutting subsidies, including a plan to ration subsidised fuel to consumers using a smart card system, but it has repeatedly postponed some measures.
"The government is really in a catch-22," said Oliver Coleman, Middle East/North Africa analyst at Maplecroft. "There is no alternative strategy for long-term economic improvement that doesn't include reducing government spending, but any reforms will provoke instability that will have a deleterious impact on the economy."
Analysts say Cairo needs to move much more quickly to secure a $4.8 billion loan from the International Monetary Fund, a backstop it has been seeking since 2011 to shore up its economy.
"While the value of an IMF agreement alone will not turn Egypt's economy around, it could unlock transformative levels of international assistance and begin to claw back some much-needed investor confidence," said Coleman.
A number of international companies have reduced oil product supplies to the country, fearing the budget crisis means they will not be paid.
Talks on an IMF loan, which would undoubtedly include further subsidy reform, have made slow progress as analysts say the ruling Muslim Brotherhood party does not want to risk unpopular measures that could hit poor and middle-income Egyptians before parliamentary elections expected in October.
"Crucially for industry, the IMF loan would likely pave the way for a boost in currency reserves. This would ease strict capital controls, which are currently stifling Egyptian industries," said Coleman.
Dwindling foreign exchange reserves due to a plunge in revenues from tourism and foreign investment since the revolution have led the central bank to impose restrictions on foreign currency which is making it more difficult for companies to import components needed to produce their goods.
Egypt forecasts economic growth of 2.5 percent this fiscal year and targets a 4.1 percent expansion in 2013/14. But analysts say faster growth is needed to generate jobs.
Unemployment, a cause of the revolution that toppled Mubarak, is running officially at 13 percent but is probably much higher.
Egypt is benefiting from loans from Qatar, Libya and Turkey but they will provide only temporary support for the economy, analysts say. Unlike an IMF backstop, which would probably also demand tax increases, they are not conditional on structural reforms.
"The conditions attached (to an IMF deal) would make policymaking more stable and predictable, thus encouraging companies and consumers to spend," said William Jackson, emerging markets economist at Capital Economics Ltd.
In al-Saff, cement makers that sell to foreign markets have been able to transfer some of the cost rises onto consumers, raising their prices by 20-30 percent this year, said Ghada Alaa, an analyst at Beltone Financial. Brick makers, which depend on the domestic market, have not.
"They raised (prices by) between 50 and 80 percent but could not keep it up. Prices went down again because supply is larger than demand," said Abdulaziz Azzouz, head of a body representing construction material makers in the area.
Even cement companies, and other sectors such as steel that were affected by fuel subsidy cuts last year, would find it difficult to pass on costs if subsidies are reduced again.
"Cement prices have already seen a 50 percent hike and steel companies already have a low profit margin so they can't take more fuel hikes," Alaa said.
($1 = 6.9645 Egyptian pounds)
Editing by Susan Fenton