Investments in Egypt's large-scale infrastructure build medium-term confidence

 

Several years of instability have brought difficulties for Egypt’s economy, although the impact has varied across sectors. However, the country is experiencing a recovery, with the IMF estimating that GDP will increase by 5.5% in 2019, up from 5.3% in 2018.

The construction industry is poised to remain one of the most dynamic sectors of the economy. This has been apparent in an increase in the number of large-scale projects involving transport, energy, utilities and urban development. This ongoing burst of construction activity is part of an effort to address infrastructure gaps, and improve Egypt’s standing among domestic and international investors.

Construction is a strategic sector, accounting for 5.9% of GDP in 2018. Its full impact, however, extends well beyond its direct contribution to the economy. Amid pervasive infrastructure gaps, strong sector performance and timely project completion can boost other major sectors Infrastructure development plans that had been delayed by the political and economic instability that began in 2011 are finally starting to move forward. In addition, the fast-growing population, which is projected to reach 100m in 2019, continues to put additional pressure on housing and urban development resources. As Lebanon-based Bank Audi stated in its “Egypt Economic Report 2018”, published in February 2019, the non-residential and power segments will be top performers given the degree of demand and the pace of economic diversification.

With this in mind, domestic and foreign companies have been positioning themselves to take advantage of the range of projects set to hit the market over the coming years, and are preparing to meet the operational demands associated with these opportunities.

Performance

Construction is a strategic sector, accounting for 5.9% of GDP in 2018. Its full impact, however, extends well beyond its direct contribution to the economy. Amid pervasive infrastructure gaps, strong sector performance and timely project completion can boost other major sectors. The recent surge in construction activity is improving transport networks, making energy production and consumption more efficient, and providing the necessary base infrastructure for new urban areas. “We are seeing significant investment in infrastructure, driven by increasing demand from population growth. As this trend continues, we expect to see the sector increase its contribution to Egypt’s economic growth and recovery,” Jamal Bahlawan, general manager of Consolidated Contractors Company, told OBG.

The sector’s robust performance is a positive sign for Egypt’s prospects in the medium term. Construction activity expanded by 10% in 2018 and 9.5% in 2017, according to figures by Bank Audi. Construction is also an important engine for the labour market. According to figures from the Ministry of Planning, the construction industry directly employed 3.7m workers as of the first quarter of 2018.

Rising Investment

In 2018 total investment in the construction sector reached LE12.6bn ($708.1m), remaining relatively unchanged from 2017 but representing an 8.6% increase compared to 2016. This increase, however, came in the wake of much more significant growth in 2016, when investment in the sector expanded by over 198%, according to figures by the Central Bank of Egypt.

Although the government’s focus on implementing infrastructure development plans has played a part in rising sector investment, much of the growth has stemmed from private sector activity.

According to the Bank Audi report, 90.4% of investment in construction came from the private sector in 2018, up from 60% in 2016. As this increase suggests, the private sector is becoming more involved in overall development of the industry, allowing the state to better balance its budgetary limitations. A $12bn loan package authorised by the IMF in August 2016 has given the Egyptian government the fiscal room necessary to maintain momentum on its current drive to develop domestic infrastructure.

In addition, this has helped to make the construction sector more attractive to foreign investment, which slowed during recent periods of instability. “In order to attract foreign direct investment, Egypt has to be the preferred place of investment over other emerging markets in the region. The economic fundamentals are here, but changing investor perceptions is a challenge, and bureaucracy continues to be a hurdle” Waleed Abdel-Fattah, senior vice-president for North Africa at US-headquartered construction firm Hill International, told OBG.

Some recent measures have helped bolster investor confidence. In 2017 the government approved executive regulations related to the new investment law, which added new tax incentives, reduced red tape and bureaucratic obstacles, and encouraged long-term investment. “Key construction projects have received government backing and the business environment is improving, which will drive investment and have a positive impact on job creation and the wider economy,” Bahlawan told OBG.

Infrastructure Development

Infrastructure projects began to accelerate in 2013, following government efforts to address the economic and political instability that began in 2011. According to the “African Economic Outlook 2018”, a report published by the African Development Bank (AfDB), Egypt was able to channel over LE1trn ($56.2bn) towards building infrastructure between 2013 and 2017. The bulk of this investment – 43.9% – went to the oil and gas sector. The building and real estate sectors attracted 18.4%, followed by the transport sector, which secured 12.9% of total investment in infrastructure over the same period. Additionally, the electricity and the water sectors received 10.7% and 2.3%, respectively, of that sum.

“Construction is driven by infrastructure spending across a number of industries. Rail and roads are priority projects for the transport sector, while a number of desalination and water treatment and power plants are also in the pipeline for the energy sector,” Mohamed Ibrahim Mahlab, president and CEO of local firm Rowad Modern Engineers, told OBG.

In the long term, Egypt’s economic development will be determined by how infrastructure investment is implemented. The “Global Infrastructure Outlook”, a report on the infrastructure needs of 56 countries published by the Global Infrastructure Hub, assesses that under the current level of economic growth, Egypt’s global investment in infrastructure development will reach roughly $445bn between 2016 and 2040. However, the report also estimates that the country’s infrastructure requires investment of $675.4bn over the same period, amounting to a capital funding gap of $117.6bn.

Energy Projects

One of the most dynamic subsectors is energy infrastructure. This has been shaped by several factors, including the growing population, which has put pressure on the supply of energy and other utilities. Additionally, there was an urgent need to make up for years of underinvestment in electricity production capabilities. “Between 2011 and 2013 there was close to zero investment in power generation because of the revolution and the fiscal crunch,” Mohamed Zein, director of research at Beltone Financial, told OBG. “In recent years, however, energy projects have been expedited.”

A significant step was the construction of three combined-cycle power plants, which added 14.4 GW of capacity to the nation’s energy supply. A contract worth $8.9bn was signed between Egyptian authorities and German firm Siemens in 2015. The three new power plants came on-line in mid-2018, and the construction project involved local firms Orascom Construction and El Sewedy Electric. The new plants, located in Burullus, in the Nile Delta; Beni Suef, south of Cairo; and in the New Administrative Capital, will improve electricity reliability for up to 40m people. The contract with Siemens also includes construction of 2 GW of wind generation capacity.

In mid-2018 the government signed another deal to further increase electricity generation capacity: the 6000-MW Hamrawein coal-fuelled power plant, which is worth $5.4bn. The consortium of builders consists of Chinese firms Dongfang Electric and Shanghai Electric, as well as Egyptian contractor Hassan Allam Construction, according to local media.

Significant investment has also been channelled into oil and gas infrastructure, as the country aims to recoup its position as a relevant hydrocarbons exporter in the region and establish self-sufficiency in fulfilling its domestic needs. Roughly one-third of the LE376bn ($21.1bn) invested in infrastructure in FY 2016/17 went to the oil and gas sector. In 2015 energy authorities estimated as much as $70bn would be required to adequately restructure the sector in the years leading up to 2022.

Another large-scale project that may advance in the coming years is the construction of a $1bn gas pipeline that will connect to Cyprus and bring gas from the island’s Aphrodite gas field to be liquefied in Egypt. An agreement between the two countries was signed in September 2018, and, although the project is likely to be both costly and complex, it fits within the government’s ambitions to transform Egypt into an energy hub (see Energy chapter).

Details regarding the project’s timeline were not available as of March 2019, though the minister of petroleum, Tarek El Molla, told Cypriot media in February 2019 that the countries were working to accelerate the approval process, and had secured financial backing from banks and energy companies.

This project is one of several that aims to connect Egypt’s energy sector with those of nearby countries. “We are on the way to becoming an energy hub, with transmission networks under construction linking Egypt to Saudi Arabia, Sudan and Cyprus, which are expected to be completed in the next couple of years,” Ismail Shaker, CEO of electricity consultancy firm Shaker Group, told OBG.

Large-scale construction is also expected to benefit the petrochemicals and midstream sector. For example, in September 2018 the China State Construction Engineering Corporation signed an agreement with Egyptian authorities to build a $6.1bn oil refinery in the Suez Canal Economic Zone.

Renewables Push

Electricity generation is getting a similar boost from renewable energy projects. In line with the Egypt Vision 2030 strategy, which was inaugurated in 2016, the production of sustainable, cleaner energy has been underlined as a priority for the country’s future. A renewable energy law was approved in 2014 that has enabled the country to sustain private investment over the long term. The law has opened the door for private firms to build, own and operate renewable energy plants, then sell their output to the Egyptian Electricity Transmission Company at regulated prices.

In October 2017 the World Bank’s International Finance Corporation (IFC) announced that it had secured a $653m loan package to finance the construction of 13 solar power plants near the southern city of Aswan. The project will add 752 MW of electricity generation capacity to the national total, and serve roughly 350,000 people in Upper Egypt. The construction phase of the project is expected to employ around 6000 labourers.

The solar power plants are part of the larger Benban Solar Park project, which is expected to bring 1650 MW of new capacity through the establishment of 32 power plants. According to the IFC, the project will create 10,000 jobs, and the electricity generated at Benban will enable Egypt to reduce its annual greenhouse gas emissions by around 2m tonnes.

Hydroelectric generation capacity is also being expanded. German firm Voith won a €30m contract to build several small-scale hydroelectric plants in the Delta and Al Qanater regions. The power plants will add another 80 MW of capacity.

Water Sector

Although Egypt has been able to significantly increase access to potable water, especially in urban areas, rural regions still lack sufficient water infrastructure. According to the AfDB, in 2018, 2700 water treatment plants secured a daily output of 25m cu feet of potable water, while some 370 wastewater plants handled an additional 12m cu feet of water. Most of this infrastructure, however, serves urban areas, and the AfDB has estimated that sanitation services service only 15% of rural areas.

Bridging the urban-rural divide will require major funding to build sufficient water infrastructure. Between 2013 and 2017 just 2.3% of total infrastructure investment in Egypt went to the water sector, leaving considerable room for new sector investments in the foreseeable future. As many as 600 new sanitation clusters will be required across the country by 2040. Water access is especially critical, where large swaths of desert impose water scarcity on many rural communities that rely upon agriculture for their livelihoods.

Egypt’s rapid population growth and urbanisation are magnifying the role that desalination will play in securing long-term water access. In October 2018 the Ministry of Housing signed a $7.6m deal with US-based Fluence for the construction of three desalination plants on the North Coast, with construction set to begin in mid-2019. Once fully operational, the plants will reportedly have a daily capacity of around 12,000 cu metres. “Water management in new cities and villages offers a range of business opportunities for the construction sector, which will be of great interest to both Egyptian and international companies over the medium term, particularly as population growth brings the need for efficient water usage to the fore,” Tarek Adel, chairman of Egypt Engineering Company, told OBG.

Transport Networks

Along with utilities, transportation networks around the country have been deemed a priority for infrastructure investment, and the government is directing significant levels of funding towards new roads, ports and railway projects. In 2018 the Alexandria Port Authority and the Suez Canal Port Authority set up a joint-venture agreement to build a $450m multipurpose platform at the Port of Alexandria. In addition to the recently completed enlargement of the Suez Canal region, other ports are undergoing expansions. A project to build a new $73.6m multipurpose terminal at Damietta Port was launched in mid-2018 and is slated for completion in late 2020 or early 2021.

Logistics networks writ large will benefit from this infrastructure investment. In mid-2018 the Ministry of Transport announced a $100m project to establish a dry port in 6th of October City, which should improve the transport of goods to and from Cairo.

Meanwhile, to revamp the railway segment, the authorities are planning to spend roughly $3.1bn between 2018 and 2023 on a range of improvements, including renovating rolling stock and modernising security and signalling infrastructure.

Home Building

The construction sector has also seen significant activity in more traditional segments. Long considered a preferred investment destination, real estate development has maintained a strong overall growth dynamic. Amid fears that the Egyptian pound would depreciate further after its flotation in 2016, the property market has secured a reputation as a safe investment bet. In past years, the real estate sector was mainly driven by high-end developments and gated communities; however, current economic strains have led developers to prioritise smaller and more affordable units, and to ease payment conditions for prospective buyers.

The market nonetheless remains heavily skewed towards high-income buyers. “Most developers focus on delivering housing for the high-income segment of Egyptians, accounting for around 20% of the population. This generates more profit than housing that is primarily targeted at poor and low-middle-income groups,” the Centre for Affordable Housing Finance in Africa stated in a recent report on Egypt.

Government-led housing construction has emerged to partly bridge this gap. In 2015 the World Bank estimated that between 12m and 20m Egyptians lived in informal housing, and the country would need to build over 500,000 homes per year to keep up with demand and resolve the current shortage.

In 2014 the Egyptian government launched a housing programme aimed at building 1m new homes and improving conditions in informal dwellings. Support for lower- and middle-income housing will also come through a government programme to increase access to financing by subsidising part of mortgages.

Urban Development

The government’s plan to establish a new capital city will also mobilise resources and generate a large volume of financing over the coming years. The new city will be located to the east of Cairo, towards the Suez Canal, and will become the seat of Parliament and the centre of government. The project, which will spread over an area of 70,800 ha, was estimated to require up to $45bn in funding when it was launched in 2015.

The state company in charge of developing the new city, Administrative Capital for Urban Development (ACUD), is a joint venture between the Ministry of Housing and the Ministry of Defence. It has divided the project into three different phases, the first of which is expected to require up to $15bn in funding and span an area of 16,200 ha. According to ACUD, it will include a government district, the new Parliament building, the presidential palace, a central business district, and eight residential districts. The initial residential districts are expected to include an average of 25,000 residential units each. The government expects that after the first phase of construction the city will house around 1.5m people.

Another project, New Alamein City, aims to construct housing for 400,000 people on the Mediterranean coast. Although the area is well known as a destination for people on summer holiday, developers intend for New Alamein City to be permanently inhabited. It will occupy an area of almost 20.2 ha and cost up to $112m to construct.

Costs

Several elements related both to government policy and the depreciation of the Egyptian pound are expected to raise the costs of construction inputs, requiring companies and developers to showcase flexibility in the development of largescale projects. “Despite overall economic improvement, the sector is challenged by higher costs in building materials, as well as value-added tax and subsidy cuts, and adaptability and efficiency are important for competing successfully in the market,” Mohamed Ibrahim Mahlab, president and CEO of Rowad Modern Engineers, told OBG. Over the medium term, the import costs will be central to assessing construction projects, as firms and developers try to mitigate the effects of a weaker pound.

Costs have risen in part due to the government’s removal of energy subsidies, which drove up the price of electricity. This has made it more expensive to manufacture materials, and producers have passed those costs on to consumers. According to the Chamber for Building Materials (a division of the Federation of Egyptian Industries), prices for construction materials rose by 30% between 2017 and 2018. For example, one tonne of construction steel, which cost $504 in 2017, cost $719 in 2018. Over the same period, cement prices increased from $36 per tonne to over $50. Keeping costs under control will be of critical importance for sector players.

Despite these structural difficulties, the impressive volume of projects undertaken in the sector in recent years is likely to attract new firms to the construction market in the near term. “There are several local companies competing in the top tier with international players in the market, but there is significant opportunity to fill the gap in the market below that, so the next few years will see the entry of new private sector players and increasing competition,” Bahlawan told OBG.

Outlook

Due to the large volume of projects in the pipeline across several key areas of the economy, Egypt’s construction sector is likely to enjoy a dynamic level of activity over the coming years. The medium-term outlook for the sector is promising, as the government continues to spend on key infrastructure and mega-projects.

“The need for infrastructure, new cities, housing and power generation is constant, and should be a part of the public and private sector’s daily efforts to sustain population growth and provide better quality of life,” Osama Bishai, CEO of local construction company Orascom, told OBG. Although the country has yet to see a noticeable pattern of large-scale international investment, due mostly in part to a persistent perception of risk associated with operating in Egypt, the involvement of international donors and multilateral financing institutions will help to improve the country’s overall reputation in the eyes of potential foreign investors.

Some challenges linked to the country’s current economic situation are to be expected in the implementation of large-scale construction projects. Given the decreasing value of the pound since late 2016, the financial calculations underlining some large-scale projects are likely to be reassessed.

A significant proportion of the country’s infrastructure needs are likely to be addressed within the current volume of construction projects. Looking to the future, an expanded energy supply, improved water systems and more diversified transport routes, among other major projects, will help to support the long-term development of the Egyptian economy.

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The Report: Egypt 2019

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