While Egypt continues to face considerable economic challenges as it confronts the legacy of its recent political history, at the outset of 2017 the nation’s economic planners have room for optimism. A process of fiscal reform is well under way, a long-awaited legal framework aimed at attracting new investment is almost in place, a Mediterranean gas find promises to nearly double the nation’s gas reserves and, other than unrest in the remote Sinai Peninsula, the country has enjoyed a period of political stability after the turbulence of 2011 and 2013. Obstacles to growth, however, remain in the form of a stubborn fiscal deficit and a troubled currency, the flotation of which threatens to raise the cost of living for importers and households, which are already struggling with price increases on basic items.
Egypt GDP per capita of $3615 in 2015, according to the World Bank, is considerably lower than the world average of $10,058, and establishes the country as lower-middle income. A 2016 report by the Central Agency for Public Mobilisation and Statistics (CAPMAS) found that in 2015 some 27.8% of the population lived below the poverty line of LE482 (equivalent to $25.55 as of December 2016) per month, and that 56.8% of those living in Upper Egypt’s rural areas cannot meet their basic needs.
The nation’s transition from an energy exporter to a net importer of gas, have resulted in a stubborn current account deficit, which grew from $4bn in the first quarter of the FY 2015/16 to $4.98bn by the same period in the FY 2016/17. Funding the consequent budget deficits has become a challenge.
Nevertheless, Egypt entered 2016 on the back of some encouraging economic data. According to the Ministry of Planning, real GDP for the FY 2014/15 grew by 4.2% at market prices, the most rapid rate of expansion since the 2011 revolution, according to a 2016 report by Beirut-based Bank Audi.
Even as Egypt grapples with its fiscal deficit and currency issues, it nonetheless benefits from being one of the most diverse economies in the region. Since independence in 1922, its economic activity had expanded from a largely agricultural base to include manufacturing, extraction (which includes the mining, oil and gas sectors), construction, tourism and the various segments of the services sector.
Manufacturing was the largest single contributor to GDP in 2015, accounting for 16.6% of the total. As well as the refining of petroleum products, which currently comprises a large proportion of manufacturing activity, Egypt has developed large and well-resourced industries in areas such as textiles, furniture, paper, cement and pharmaceuticals. Current growth drivers in this segment include plans by the Ministry of Trade and Industry (MTI) to build 21 specialised clusters for small and medium-sized enterprises (SMEs) across 14 governorates, a renewed focus on coal extraction as an alternative to natural gas and the government’s ambition, stated in its five-year plan for 2015-20, to boost domestic industry in its drive to reduce imports. Wholesale and retail activity accounted for around 12.9% of GDP in 2015. Egypt’s large 90m-person consumer market and the emergence of a middle class with disposable income since the turn of the century have underpinned the development of new malls, with international anchor tenants, such as Ikea, Marks & Spencer and Debenhams.
Extraction accounts for the third-largest share of GDP, comprising 12.8% of the total, according to Bank Audi. Oil was first discovered in the Nile Delta in 1886, and since that time Egypt has established itself as the largest non-OPEC oil producer in Africa, as well as successfully exploited its more recent natural gas finds. A combination of political unrest and delayed payments to international oil companies (IOCs) resulted in a slowdown in exploration activity over recent years, and this brought mixed results in 2015. Petroleum industries expanded by a modest 1.7% in 2015, after growing 1.8% in 2014, according to Bank Audi’s report, while gas industries suffered contractions in both 2014 and 2015, of 9.4% and 10.4%, respectively (see Energy chapter).
Agriculture continues to play an important part in the economy, accounting for 11.2% of GDP, according to Bank Audi’s report. As a key provider of employment opportunities, the government has prioritised Egypt’s farming, irrigation and fisheries activity for development. The value of implemented investments in the sector grew by 10.8% in 2015 to reach $1.8bn. Other important contributors to GDP include construction, transportation, storage and tourism. The latter, traditionally an important source of foreign currency, has been particularly adversely affected by Egypt’s recent political turbulence. In 2016 the continuing suspension of Russian and UK flights to Sharm El Sheikh led the Egyptian Tourism Federation to predict in December 2016 that tourism revenues would fall to $3.5bn for the year, a 40% decrease on 2015 levels.
Monetary Policy & Inflation
Egypt’s headline annual urban consumer inflation stood at 14.1% in September 2016, according to figures from the CAPMAS. The principal achievement of the monetary policy committee (MPC) at the Central Bank of Egypt (CBE) has been the creation of an interest rate corridor, the floor and ceiling of which are defined by the overnight lending and overnight deposit rates, respectively. This mechanism has proved an effective inflation management tool in the past; at the onset of the global financial crisis the MPC tackled a troublesome inflationary trend by raising the overnight deposit and lending rates, which delineated the corridor by 50 basis points (bps), to stand at 11.5% and 13.5%, respectively.
Between 2010 and 2015 the MPC followed its guiding principle, which is focused on maintaining price stability. With inflation increasing in 2016, the MPC raised the benchmark overnight deposit rate from 10.75% to 11.75% at its June meeting. It maintained this rate in September, when it was widely expected to make a 100-bps hike; however, in November 2016 the committee decided to increase the deposit rate to 14.75% and the lending rate to 15.75%. The MPC also stated in its press release that it expected annual inflation to be affected by cost-push factor before narrowing.
Higher inflation stems in large part from the changes Egypt has made to its monetary policy. The CBE’s managed float monetary policy has resulted in the bank expending a considerable portion of its foreign reserves. By June 2013 Egypt’s foreign reserves dropped to $14.5bn, below the critical threshold of three months of import cover, according to IMF figures. A significant drop-off in tourism numbers and a slowdown in foreign investment has led to a US dollar shortage in the country, which has made it difficult for Egyptian importers to meet their dollar invoices and foreign investors to repatriate profits. This scenario has undermined Egypt’s attempts to position itself as an attractive investment destination, and resulted in a number of high-profile difficulties with global companies. In September 2016 KLM Royal Dutch Airlines announced it would indefinitely suspend flights to Cairo, citing the decision by the CBE to impose restrictions on the transfer of foreign currency from Egypt. Lufthansa Airlines, meanwhile, stated it was considering the option of restricting ticket sales to US dollars or credit cards, for the same reason.
A lack of hard foreign currency has also added to the problem of Egypt’s arrears with IOCs, which stood at $3.6bn at the close of the first quarter of FY 2016/17, up from the $3.4bn at the end of FY 2015/16. according to local media sources. Further payments to IOCs are contingent on the ability of the Ministry of Finance (MoF) and the CBE to make foreign currency available. The situation has compelled the authorities to explore creative solutions to the currency dilemma.
In October 2016 it was reported that the Suez Canal Authority was meeting with container ship operators Denmark-based Maersk, France’s CMA CGM and the Swiss-based Mediterranean Shipping Company to discuss a proposal that would see the operators pay the authority nearly $4bn in advance for three years of access to the canal, in return for which they would be granted a 3% discount on transit expenses.
In August 2016 President Abdel Fattah El Sisi indicated that Egypt was ready to significantly devalue the pound and allow a more flexible exchange rate, stating in an interview with three state-run papers that the country had waited too long to act and that the piecemeal measures taken over recent years were no longer tenable. In the fourth quarter of 2016, following much deliberation by the CBE, the flotation of the currency saw the pound fall to a rate of around $1:LE15 and settle at $1:LE18 on November 29. Prior to the float the price was closer $1:LE9.
Potential benefits of a significant depreciation and a more flexible exchange rate include the possibility of making Egypt’s exports price competitive, closing the trade deficit and establishing the country as a desirable target for investment in manufacturing. The immediate downside, however, has been increased inflation, with a headline rate of 29.6% in January 2017, at a time when Egyptian households are already facing subsidy reductions and new taxes. If the government can manage to skilfully handle the transition, there should also be benefits from the currency flotation (see analysis).
Egypt’s recent fiscal history has been one of increasing deficits resulting from revolution of 2011 and subsequent political unrest. The collapse of the Hosni Mubarak administration ushered in an era of lower revenues and rising expenditure, as business activity and investment decreased, and the government set about meeting the demands from both state employees and the wider population for social justice. By FY 2012/13 the nation was running a fiscal deficit of 13.7 % of GDP, a level considered to be unsustainable in the long term. The government’s subsequent attempts to rein in the deficit have met with moderate success. The national budget approved by the president in March 2016 envisioned a 9.9% deficit, but the problem remains a structural one. An overall budget deficit, which stood at 8.1% in 2010, the year before the revolution, has remained in double-digit territory ever since, standing at 11.5% in 2015. The nation’s current account situation is of particular concern.
Reducing the twin deficits of the budget and current account is, other than the currency challenge, the single biggest obstacle facing Egypt’s economic planners. To this end, Egypt began a concerted effort to reduce its fiscal deficit in 2014, combining expenditure cuts with attempts to boost revenue, which is continued in the budget for the FY 2016/17.
The government used an international investment conference held in Sharm El Sheikh in March 2015 to unveil a five-year macroeconomic strategy, which runs to the FY 2018/19. Cost-cutting is a central theme of the economic masterplan, and since its publication the government has made significant progress in pruning public expenditure. Its first target was the inefficient fuel subsidy system: cuts in the 2014/15 budget saw diesel grades rise by between 64% and 78%; natural gas, which most of the nation’s taxi fleet relies on, increased by 175%; and 92-octane petrol was made 40% more expensive. Electricity subsidies were also targeted, with the introduction of a five-year liberalisation programme in 2014 aimed at trimming the state’s subsidy of the sector by 67% by 2018/19.
Even the difficult issue of spiralling public sector salaries, traditionally a taboo, has been addressed with the 2014 establishment of a maximum wage of LE42,000 ($2230) per month for those working in the governmental sector, municipalities, national authorities, and other state-owned services and economic institutions. The budget for 2016/17 includes a further cut to the state subsidy bill of 14%, although local media reported in July 2016 that it was only passed by the Egyptian Parliament with considerable opposition from members who found some targets unfeasible.
According to the government’s strategy, the coming years will include continued reform that will bring the prices of fuel products to full cost recovery; increased efficiency of energy use and the diversification of the energy mix, such as connecting households to natural gas to reduce dependence on expensive liquefied petroleum gas; the rollout of a smart card system for fuel distribution to eliminate smuggling and ensure only eligible customers have access to subsidised product; and the continued reform of the public sector wage system, such as the rationalisation of an expensive bonus system. How quickly the government will be able to implement its cost-cutting strategy, however, is uncertain, as recent legislative developments have shown. A new Civil Service Law, approved in July 2016, was initially rejected by Parliament due to two articles that regulated salaries, and it was only passed after a lengthy period of debate and compromise. The new law is intended to better regulate the performance of the 6.3m public servants by incentivising efficiency and good service, as well as punishing corruption.
Another key focal point, with a mixed record of success, is raising revenues. The 10% capital gains tax, promulgated in July 2014, was implemented in March 2015 and then swiftly postponed for two years as a result of objections from traders and brokers – a decision which prompted IMF concern. In November 2016 the postponement was extended to three years. Similarly, a 5% wealth tax on individuals and corporations with an annual income of over LE1m ($53,000), decreed by President El Sisi in 2014, was shelved as the country set about polishing its image as an investment destination. However, the introduction of the long-awaited real estate tax in late 2014 was a victory in principle, given the initial opposition to it, but its impact on the balance sheet has been limited by its generous exemption level and challenges surrounding its implementation, particularly with regard to the time-consuming valuation process and collection.
The unification of the corporate income tax system at a standard rate of 22.5%, which also covers new companies in free zones, was widely welcomed as a positive step. Egypt’s rate of personal income tax is low compared to corporate tax, based on a progressive rate of up to 22.5%, which is below the average in emerging markets, according to the IMF. Moreover, the high-income threshold for the highest tax bracket means that only those earning at least 10 times the per capita income are subject to it.
However, Egypt’s five-year macroeconomic strategy commits the country to an income tax rate freeze in the medium term, and so the attention of the government for the past year has been on the introduction of a value-added tax (VAT) to replace the general sales tax. As a broad-based consumer tax, VAT offers gains in terms of efficiency and revenue, while the ability of the government to define the exemption list enables it to protect the most vulnerable segments of the population from its effects (see analysis). The timing of the VAT introduction in late 2016 is driven by both the government’s desire to continue with its reform programme, as well as the fact that its implementation is tied to an IMF funding package (see below).
Bridging The Gap
Egypt’s fiscal reform efforts are a long-term undertaking, and therefore the government has been compelled to seek external assistance to bridge its fiscal gap in the short term. Much of the funding necessary to meet the government’s expenditure commitments has come from the hydrocarbons-rich economies of the Gulf Cooperation Council, and Egypt has secured around $23bn in cash grants and deposits for the CBE from regional allies since the ousting of President Mohamed Morsi in 2013, according to a November 2016 report from local media. With donor countries now facing headwinds of their own, however, 2016 has seen a shift away from cash grants and towards loans and investment packages. One such deal is a $23bn agreement with Saudi Arabia’s Aramco to import 700,000 tonnes of petroleum products each month at preferential rates for a period of five years, although non-delivery of the shipment in October 2016 may prompt a revision of that arrangement.
International financial institutions are also playing a crucial role in supporting the economy, and in November 2016 Egypt and the IMF reached an agreement on a $12bn funding package that promises to restore the confidence of foreign investors, underwrite a significant portion of the government’s expenditure and provide a much-needed infusion of foreign currency. In October 2016 the IMF’s managing director, Christine Lagarde, stated that Egypt would need to cut subsidies further and devalue its currency before the fund’s executive board could approve the facility; plans to strengthen the social safety net for the economically vulnerable were also part of the deal. The package was dependent on Egypt securing a further $6bn in commitments from its bilateral creditors. The UAE was the first to respond, agreeing to deposit $1bn with the CBE.
Securing the IMF loan would also greatly assist Egypt in securing development finance from other organisations, some of which are already engaged in talks with the country. By the second half of 2016 Egypt was holding separate negotiations with or had already secured funding from international lenders regarding funding worth as much as $1.6bn, the bulk of which targets the SME sector. The World Bank was negotiating $400m worth of new loans to support smaller businesses and labour-intensive industries. In 2015 the African Export-Import Bank planned to extend $800m in financing to Egyptian financial institutions, $500m of which is destined for SME projects. Meanwhile, the National Bank of Egypt was considering a $30m facility with the European Bank for Reconstruction and Development for SME lending.
Egypt’s burgeoning links with China may also play a part in the government’s future funding plans. In December 2016 Bloomberg reported that the two countries had signed a $2.6bn currency swap deal. The three-year agreement covers RMB18bn ($2.6bn), against the equivalent in Egyptian pounds. The conclusion of the IMF deal is also likely to reduce Egypt’s borrowing costs and prompt the government to return to the international markets for more funding. The country is rated “B-” by Standard & Poor’s ratings agency, six levels below investment grade; however, its outlook was upgraded from negative to stable in November 2016, following news of support from the IMF. In late January 2017 the CBE also held a eurobond sale, with Reuters reporting that the bank had raised $4bn.
According to Bank Audi, Egypt’s exports dropped by 25% in the first nine months of 2015, compared to the same period of the previous year, mainly due to the drop in the value of petroleum exports. While the effect of the export slowdown was mitigated by a 10.4% fall in imports, Egypt’s current account deficit nevertheless more than tripled to reach $11.9bn in the first nine months of 2015, compared to $3.3bn a year earlier. According to the bank’s report, the country’s external accounts recorded a mixed performance over the past few years. In the first nine months of 2015 total exports fell by 25% to $14.5bn, far exceeding a currency depreciation of 8.8% year-on-year (y-o-y). This drop is largely explained by the decrease in the value of petroleum exports, which mostly consist of crude oil. Not including hydrocarbons, exports declined by 11.7%. The EU was Egypt’s top trade partner, accounting for 34% of exports, followed by other Arab countries (27%), Asia (13%) and the US (9%).
In terms of imports, the country saw a 10.4% y-o-y drop to $43.1bn in the first nine months of 2015, largely on the back of weaker private consumption. Petroleum imports fell by 24.2% in that same period, with non-hydrocarbons items still accounting for 84% of total imports, despite decline by 7.1%. The largest share of imports originated from other Arab countries, at 30%, followed by the EU (21%), Asia (21%), the Russian Federation and CIS nations (7%), and the US (6%). As a result, the export-to-import coverage ratio shrank from 40.7% in the first nine months of 2014 to 33.6% during the same period in 2015. The trade deficit remained nearly constant, dropping by 0.5% to $28.6m.
The size of the Egyptian market and the broad base of Egypt’s economy grant it significant potential as an investment destination. The global economic crisis saw foreign net investment in the country fall from a high of nearly $13.24bn in 2007/08 to $8.11bn the following year, according to the MoF and CBE, and by 2010/11, the year in which the January revolution took place, the level of foreign direct investment (FDI) had fallen to a new low of just $2.08bn. More recently, a return to political stability has attracted larger investment inflows. In 2015 net FDI rose nearly 55% to reach $6.37bn. However, this figure was well below the target of $10bn announced by Ashraf Salman, then-minister of investment, and the shortfall adds to the sense that Egypt is not fully capitalising on its investment strengths. The central bank’s monthly bulletin for December 2016 showed that net FDI had increased only marginally to $6.93bn.
Despite these issues, opportunities for investment abound in the Egyptian market. The October 2016 inking of a $20bn agreement with a Chinese development company to construct the second and third phases of Egypt’s New Administrative Capital demonstrates the country’s ability to attract large-scale capital inflows. According to government statements, the project will attract $15bn in FDI, and will include accommodation for around 5m employees and residents. The current administration has stated its intention to initiate similar mega-projects, such as mass housing developments and new desert cities linked by a north-south highway running in parallel to the Nile, but to date the successful completion of the Suez Canal extension is the only one to have been implemented.
The government unveiled a new Investment Law in 2015, which replaced legislation first put in place in 1997. However, the new framework has yet to be implemented, and in early 2017 uncertainty persisted regarding the introduction of a revised version. The local media reported in 2016 that, after consulting with a range of stakeholders, the General Authority for Investments and Free Zones (GAFI) had decided to introduce a new law rather than amend the current one, and that this framework would include new tax and non-tax incentives, as well as introduce free zones. The legislation will also reportedly address the issue of how land is tendered to the private sector, which has long been a point of contention for investors.
In the meantime, both domestic and foreign investment is hindered by a range of obstacles and inefficiencies in the wider business environment. The World Economic Forum (WEF) “Global Competitiveness Report 2016-17” ranked Egypt 115th out of 138 countries, an improvement of just one place from the previous year. While the report acknowledged Egypt’s natural advantages – including the size of its market, which ranked 25th globally, and its proximity to Europe – the WEF urged the nation to “step up its reform efforts and address the major rigidities that plague goods, labour and financial markets, on which the country ranks 112th, 135th and 111th, respectively”. Policy and government instability, access to funding and foreign exchange regulations, were cited as the biggest challenges to doing business in the country.
The government’s need for funds has opened up another potential channel for large-scale investment in the form of the privatisation of state assets, after the 2008 global economic downturn stalled a previous process of divestment. In September 2016 Bloomberg reported that the state aims to raise up to $10bn within three to five years as part of an initial public offering programme, the proceeds of which will be used to narrow the budget deficit. Dalia Khorsid, the minister of investment at the time, revealed that the process would start with government-owned companies operating in the oil sector, while state-owned electricity companies will be restructured in the short term to prepare them for share offerings on the bourse.
Looking further down the business scale, the government has placed a particular emphasis on boosting investment in Egypt’s SMEs. An array of SME development programmes target the sector, the most notable being the Social Fund for Development (SFD). Established by presidential decree in 1991 with a mandate to reduce poverty, the SFD also acts as the principal coordinating agency for government SME policy. To that end it has been granted an explicit mandate to support SMEs in terms of access to finance, establishment of businesses, licensing and similar matters. One of its most successful programmes saw it partner with local banks, both state-owned and private, to provide development financing to Egypt’s smaller businesses. These channels carry the bulk of the organisation’s SME financing; in 2015 it disbursed LE2.27bn ($120.3m) in loans to 15,211 small enterprises and LE1.17bn ($62m) for 152,891 micro-businesses.
The MTI also plays a significant role in the government’s efforts to boost SME growth, carrying out its mandate through the Industrial Modernisation Centre, the Industrial Development Authority, and the Egypt Technology Transfer and Innovation Centres. Elsewhere across the public sector, the MoF operates an SME development unit, tasked with policy formulation and research, while GAFI, the Ministry of Investment and International Cooperation’s promotion agency, has been implementing its Small and Medium-Sized Investment Strategy since 2008. In early 2016 it was the CBE that garnered the most headlines after establishing definitions for Egypt’s micro- and small businesses for the first time. It has directed banks to increase the proportion of SME lending in their portfolios to 20%.
Improving Egypt’s investment credentials will remain a key concern for the government over the coming year, as it seeks to shift the burden of development from the state to the private sector. This effort is likely to be headed by a new Supreme Council for Investment, established by President El Sisi in late 2016. The promulgation of the new Investment Law will bring much-needed clarity to important investment factors such as free zones, tax exemptions and the purchase of state-owned land. In the short term, however, the government is likely to continue to face considerable economic challenges. In the fourth quarter of 2016 the IMF estimated that consumer prices in Egypt will rise by 18.2% in 2017, compared to 10.2% in 2016.
Such a rise is likely to present a political challenge to the government, as it seeks to justify subsidy cuts and the imposition of new taxes. At the same time, the IMF cut its projection for Egypt’s GDP growth in 2017 from its previous estimate of 4.3% to 4%. However, over the longer term the IMF anticipates that Egypt’s GDP will continue to expand, rebounding to around 6% in 2021. The possibility of Egypt establishing a functioning foreign exchange market after a currency flotation also promises to bring a number of substantive improvements to the business environment.
Lastly, the country also stands to substantially benefit in terms of energy and revenues from the 2015 discovery of the Zohr natural gas field. If estimates regarding its size prove accurate, this find will almost double the country’s natural gas reserves, which raises the possibility of Egypt regaining its status of a gas exporter in the MENA region (see Energy chapter).
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