Small businesses form the backbone of Egypt's economy and workforce

 

Since the election of President Abdel Fattah El Sisi in 2014, Egypt’s economic policy has been centred on reducing public sector costs and boosting private sector growth. Five years later, the issue of revitalising private enterprise remains prominent. In a 2018 assessment of the challenges and opportunities facing the country, the IMF highlighted the need for private entities to provide additional employment opportunities for the estimated 3.5m young Egyptians entering the labour force by 2023. Recent years have seen an array of government initiatives aimed at encouraging businesses to invest in their own growth, but these efforts have been hampered by a challenging economic backdrop and a number of structural hurdles to private sector activity.

Public to Private

The state’s recently revived project to divest itself of its assets is one of a number of ways in which it is attempting to tilt the economy towards a more private sector footing. The new strategy was formally launched in 2017, when plans for the partial sales of 23 state companies were first revealed (see Capital Markets chapter). Unfavourable market conditions in 2018 slowed the progress of the initiative, and local press reports in early 2019 suggested that there might be some changes in the state-owned firms that will be offered to the public. Nevertheless, reports in January 2019 that an EFG Hermes and Citi consortium won the mandate to run the sale of an additional stake of Alexandria Container and Cargo Handling were widely welcomed as a positive step. This went some way in allaying the fears of some investors that the state’s attempts to offload part of its sizeable roster of interests had stalled.

SME Drive

While the privatisation of state assets promises valuable short term gains, over the long run small and medium-sized enterprises (SMEs) – which account for some 80% of the economy – offer the most significant rewards in terms of job creation. In 2016 the government introduced a four-year initiative aimed at providing LE200bn ($11.2bn) in loans to SMEs through the Central Bank of Egypt (CBE), while at the same time the CBE ordered banks to boost the share of SME loans in their total loan portfolios to 20%. The regulator also sought to make funding more affordable for Egyptian firms by capping rates for SME lending at 5% for small businesses and at 12% for mid-sized firms (see Banking chapter).

Banks were given until 2020 to align their loan books with the new target, which – although not unique as a concept in the region – is one of the highest in emerging markets. Additionally, the CBE has announced that it intends to place a requirement on banks to gain an entrepreneurship certification, the details of which will be finalised with the cooperation of the International Labour Organisation, the Frankfurt School of Finance and Management, and the Egyptian Banking Institute. A number of Egyptian banks have already started to provide a range of ancillary services to SMEs, beyond their core lending function. Those that are part of broader financial groups are particularly well positioned to use their subsidiaries to provide SMEs not only with financing options, but also a host of non-lending products and services to support their expansion.

Formal Focus

As well as unlocking funding for SMEs, authorities are attempting to formalise the sector. Bringing the large number of informal businesses under the umbrella of the financial system will allow them to access funding more easily and ensure the government can better manage this important segment. In May 2018 President El Sisi announced a five-year tax exemption for SMEs that register their business in the formal economy, and at the close of 2018 the government was working on the final draft of a new SME law that will establish a new tax framework for smaller businesses. The legislation is aimed at encouraging more companies to formalise by offering them a relatively lenient regime whereby those with annual top lines of less than LE500,000 ($28,100) would pay just 1% value-added tax (VAT) and also have access to other incentives, including reduced electricity bills and rebates when paying for various government services.

Investment Law

Another key pillar of the government’s attempts to support the private sector is the promulgation of the 2017 investment law. The new law establishes a number of guarantees for private companies, such as equal treatment for foreign and national investors, the granting of residence rights for the duration of projects, a protection against nationalisation or the seizure of funds without a court order, and the right to transfer profits abroad. The new legislation is also cognisant of some of the difficulties in securing suitable local labour, allowing for a 10% quota of foreign workers, which can be increased to 20% in the absence of national labour with the necessary qualifications.

A range of incentives is also outlined, divided into three categories: general benefits for all projects not in free zones, including stamp duty exemptions on loans and a low Customs duty rate of 2% on machinery and equipment; specific incentives for some qualifying investment projects, which includes tax deductions of up to 50% on investment costs for certain developments such as those which are established in labour-intensive sectors or geographical areas in need of employment opportunities; and a number of additional incentives which can be applied on an ad hoc basis, including the establishment of special Customs points for a project’s exports and imports, and financial assistance from the government for the cost of technical training of employees.

Challenges

A number of factors, however, combine to challenge the government’s broad-based effort to increase the private sector’s share of economic activity. Of the economic concerns, high inflation – which has remained in double-figure territory since the government allowed the currency to float in 2016 – is viewed by many observers as the most problematic hurdle. Despite receding from its 2017 high of around 33% to 12% in December 2018, January and February of 2019 saw consecutive rises, which reached 12.7% and 14.4%, respectively. This recent trend has negatively affected businesses in a number of ways, including raising inventory costs, pushing up the cost of borrowing, acting as a disincentive to investment, placing upward pressure on employee wages and reducing consumer purchasing power.

Recent years have also seen an expansion of military-directed economic activity: according to the Ministry of Military Production the operating revenues of its companies will reach LE15bn ($843m) in FY 2018/19, around five times higher than in FY 2013/14. The range of sectors in which military-owned firms operate has also expanded and now includes activities as varied as paint and kitchen utensil manufacturing, road building, cement production, date farming, solar panel manufacturing and hotel operation.

Supporters of the military’s role in the economy point out its ability to organise efficiently and quickly, as it successfully did in 2016 when a shortage of baby formula prompted the body to import large quantities of formula and develop plans to construct a production plant. Some private sector interests, however, are concerned by some of the advantages that the military enjoys. For example, a provision in the VAT law that exempts the military from taxation on goods considered as necessary for armament, defence and national security.

Moving Forwards

Despite these challenges, recent employment data suggest that a private sector expansion is generating more opportunities for Egyptians. The Central Agency for Public Mobilisation and Statistics reported in early 2019 that the unemployment rate fell to 8.9% in the fourth quarter of 2018, down by 1.1% on the previous quarter and 2.4% year-on-year. One of the most important bellwethers of private sector sentiment, the Emirates NBD Purchasing Managers’ Index, has shown more mixed results over the past year. In July 2018 Egypt’s position on the index reached an eight month high of 50.3, exceeding the neutral 50 level which delineates contraction and expansion in the non-oil private sector – compared to a 2017 average of 47.5 and a first-half 2018 average of 49.6. The start of 2019, however, showed less favourable results: the index fell from 49.6 in December 2018 to 48.5 in January, its lowest level in more than a year. Despite the decline, there were also some positive trends in the broader data, particularly in the area of costs: according to the monthly report, input prices fell to a series low in January, led by a slowdown in purchasing costs. As a result, firms were able to cut output prices, which showed a sub-50 reading for the first time – a significant development in the context of inflation, as a sustained lowering of costs would help to lower the consumer price index, and allow the loosening of monetary policy, which may help spur private growth.

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The Report: Egypt 2019

Economy chapter from The Report: Egypt 2019

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