Egypt's industrial sector a driver of economic activity

In the years since the 2011 revolution, the industrial sector has been put at the forefront of government plans for economic growth. New industrial zones, substantive training programmes and development plans along the Suez Canal corridor have all been committed to paper as part of a strategy to boost the manufacturing sector’s contribution to economic output over the next decade.

The proposals and initiatives are of considerable value, particularly given that Egypt’s industries have had to face headwinds over the past few years, both globally and domestically. In the short term, a range of industries, from building materials to fertilisers, are facing challenges. Nevertheless, the government is working on a number of measures to stimulate the sector and place it at the centre of the country’s economic recovery.

Performance Targets

Industry has long played a significant role in the economy and been a substantial contributor to the country’s growth. The value-added contribution of the manufacturing sector to GDP stood at 16% in 2014, down by one percentage point from levels prior to the Arab Spring, according to the World Bank. While the performance is impressive in light of the recent political uncertainty the country has faced, the recovery is not quite complete. In the first quarter of 2015, the manufacturing sector’s contribution to real GDP decreased by 7% to LE72.3bn ($9.9bn), according to the Ministry of Planning. The ministry’s production index has also dropped by 3.6%.

“Egypt’s non-oil exports are flat at the moment. Production disruptions, whether due to the availability of energy or the availability of dollars, have been a big contributor to the issue,” Ahmed Hafez, co-head of research at HC Securities, told OBG. “Egypt’s non-oil trade deficit widened to $35.1bn in financial year 2014/15 from $30.2bn in 2009/10, but there has been an even bigger swing in the oil trade balance, which registered a deficit of $3.65bn in the last fiscal year, compared to a surplus of $5.1bn in 2009/10. Tourism receipts are still 36% below their pre-Arab Spring levels as well.”

However, in spite of this, Egypt’s industrial base is nonetheless still a key driver of the economy. The sector is one of the largest non-government recipients of bank credit. Loans to industry have been increasing steadily. In June 2014, they stood at LE120.4bn ($16.4bn), up 7.3% on the same period of 2013, according to the Central Bank of Egypt. Since the end of 2011, the year of the Arab Spring, banking credit to the sector has grown by 25% in total.

Government Strategy

To help strengthen the sector, the government has rolled out a broad strategy focused on small and medium-sized enterprise (SME) development, value-added industries and improved financing channels. It is also considering how to improve the alignment between the skills of young graduates and the demands of the industrial workplace. For example, under the medium-term investment strategy of Vision 2030, the Ministry of Planning aims to increase overall economic growth to 7% per annum, with exports set to contribute 25% to this growth.

“The majority of growth in the fast-moving manufacturing segments such as sanitary wares is currently in the Middle East and Africa as opposed to traditional markets like Europe and the US,” Ahmed Hafez, the CEO of Ideal Standard MENA, told OBG. “Egypt is well-positioned, both geographically and logistically, to service these markets.”

Much of this is expected to come from the manufacturing base. The ministry has set an annual growth target of 9% for manufacturing, increasing its share of GDP to 25% by 2020. Under these plans, the sector will create at least 3m jobs by the end of this decade. The vision is decidedly ambitious, but if achieved, it will represent an encouraging rebound from recent travails, as the sector is still shaking off the legacy of the post-Arab Spring turbulence. The goal of job creation is also key. In the first quarter of 2015, the unemployment rate stood at 12.8%, but the problem is particularly acute for youth aged 29 and under, who account for roughly three-quarters of the unemployed. “There is a need for incentives to encourage new industrial investment and increase the rate of employment,” Omar El Maghawry, the CEO of FEP Capital, told OBG.

The government agrees that a rejuvenated industrial sector can help tackle the youth unemployment issue, and has honed in on training as a key vehicle for the change that it is seeking. In 2014 the Industrial Training Council, a body attached to the Ministry of Trade and Industry, launched a joint venture training programme with the UAE, called Beaidak.

The project aims to instill labour market preparedness in young people entering the industrial sector, focusing on applicable manual and technical skills. This is complemented by a number of other schemes, including one for the operation of heavy equipment in the building and construction sector, and a national training programme focusing on the food, chemicals and engineering segments.

In The Zone

Another central component of the government’s plan for industrial growth is the promotion of special economic zones and industrial areas. It is currently reviewing the special economic zones law to improve the tax and investment incentives offered to investors in these zones.

The newly expanded Suez Canal will play a crucial role in the government’s economic zone strategy, and access to this primary trade route should provide a strong incentive for export-oriented manufacturers. In August 2015 the government announced plans for a new special economic zone on the banks of the canal. This is the second stage of the development project after the government completed an $8.2bn expansion of the waterway that is projected to cut vessel waiting times by up to seven hours and more than double revenues to $13.2bn by 2023. The new industrial zones will stretch 460 km, covering six ports and the establishment of 1000 factories, according to government plans. As a result of the zones’ development, there will be 18 industrial projects with a combined value of $40bn offered to investors. The plans are expected to be executed over three to five years, and will see the Suez Canal corridor become the new industrial engine of the country.

“Free zones encourage international firms to enjoy the strategic advantages Egypt provides and offer tax and Customs duty advantages that promote the development of export-oriented operations. Egypt’s manufacturing and industrial sector should take greater advantage of them,” Mounir Shehfe, chairman of Shehfe Casings, told OBG.

Share Production

Egypt has already had some success with the development of its industrial infrastructure, not least under the Qualified Industrial Zones (QIZs) protocol. Signed in 2004, this allows Egyptian companies to take advantage of Israel’s free trade agreement with the US through special zones based in Egypt. Local manufacturers, mainly in the textile segment, gain tariff-free access to the US market, as long as a minimum input of the finished product (10.5%) was made in Israel. This has provided a strong platform for Egyptian exports.

In 2014, the QIZ framework was responsible for 280,000 Egyptian jobs and the generation of $845.3m of Egyptian exports. In the first decade of their operation, the QIZs helped to boost Egyptian textile and clothing exports to the US by 54.2%.

Processed agricultural products are the other major beneficiaries of the QIZ programme, accounting for 6.2% of the companies operating out of the zones. In 2014, exports of frozen fruits and vegetables through the QIZs grew by 86.8%, while preserved fruits and vegetables had a growth rate of 62.5% in the same period.

Given the successes in these sectors, the government is eager to capitalise on the QIZ model. The governments of Egypt and Israel have set a target of doubling textiles exports to the US under the programme to $2bn in the next three years, and they have also agreed to look into expanding the initiative into other sectors, including food and plastics.

Hungry For Growth

Fast-moving consumer goods (FMCG) are another segment that has significant potential and is a well-established and rapidly growing component of Egypt’s industrial output (see analysis). As of 2014, for example, there were 3390 food and beverage factories in the country. Many of these companies could undoubtedly benefit from tariff-free access to the US.

However, there is already great potential given domestic consumption. The local food and agriculture market is expected to grow at an annual rate of 15.5% up to 2017. Even in the difficult period of instability and economic stagnation in 2012 and 2013 following the Arab Spring, many sectors from dairy to beverages were continuing to register double-digit growth. For its part, the vegetable processing sector was growing at 34% in 2014.

Plastics

The plastics industry has also seen fundamental growth that should support the sector’s development (see analysis). Egypt experienced an annual increase in plastics demand of 6% between 2006 and 2012, with polyethylene and polypropylene growing by 7%. However, given that the local industry only supplies 28% of domestic plastic consumption, there is substantial room for growth.

Indeed, in certain sub-segments, such as engineering plastics, which accounts for 11% of total plastics demand, almost all supply is imported. This suggests strong growth potential. However, the industry is constrained in the short term by access to energy. While many petrochemicals companies are able to access the natural gas liquids market, there remain concerns over the broader issue of power outages and natural gas allocations.

Building Materials

Energy issues are a familiar story for many of Egypt’s heavyweight industries. One of the country’s oldest standing industries, the building materials segment, has been the hardest hit. In the cement segment, for example, the major players are having to convert to coal-fired operations because of the lack of natural gas allocation. In the short term, this has led to production shortfalls and increased clinker imports (see analysis). In the longer term, the picture looks a lot brighter. The government’s commitment to infrastructure development and housing provision, coupled with a highly active private real estate market, should ensure high demand for cement moving forward.

The same narrative holds for the steel sector, where annual production is running at some 6.5m tonnes, although this is as much as 3.5m tonnes below the overall capacity of the industry by some estimates. The sector has also been hit by the gas shortage affecting the country.

Imported steel currently accounts for about 20% of the local market and is making life particularly difficult for smaller local players. Even including the 8% import tariff on steel, domestically produced steel sells at a premium of up to 13% to the most expensive imported steel from Turkey. Indeed, Egyptian steel is selling at $560 per tonne, compared to a maximum import price of $490 per tonne.

Automotive

Another of Egypt’s industrial mainstays is the automotive sector, though competition has been fierce here too due to trade liberalisation. Along with Morocco and South Africa, Egypt’s automotive industry is one of the largest in Africa, producing more than 100,000 vehicles a year and employing 75,000 workers. However, under the terms of a free trade agreement with the EU, Egypt has begun gradually phasing out import tax on European vehicles. The annual reduction of 10% will mean that European cars can enter Egypt tariff free by 2019. The move is expected to have an impact on local producers and assemblers (see analysis).

This feeling has been heightened by the April 2015 decision of Mercedes Benz to close down its local assembly plants. The company stated that it would no longer be economically feasible to produce the cars in Egypt in the longer term. In spite of this, the sector remains a major contributor to the country’s economy and Egypt continues to be an important source of inexpensive regional expertise and capacity close to the key European markets and situated along major international trade routes.

The solution for the segment may well be one that the government has identified for the industrial sector more broadly. It may require moving up the value chain and away from a reliance on assembly. A move into greater local content production could lessen the reliance on intermediate imports, produce better-paying employment and develop a sustainable production chain from auto-parts manufacture through to assembly.

However, as with the broader industrial sector, much still needs to be done to achieve this goal, including improving the skills of the labour force and helping the development of SMEs.

Energy

One key issue that industrial producers have had to work to offset has been a shortage of power, a challenge common to many emerging markets. The country’s peak demand saw a high of 27,700 MW in 2014, 20% above the capacity of the national grid. As such, load shedding has become more prevalent. Although the industrial sector accounts for no more than 30% of power use, the difficulties across the energy sector have had a sizeable impact on a range of industries.

Cement, for example, accounts for 51% of primary energy use among energy-intensive industries, and in May 2014 at least 10 cement plants, which account for 70% of the country’s output, came to a complete halt. Almost a year later, in April 2015, the fertiliser and steel industries were facing similar problems. As a result of these measures, the supply of reinforcing iron dropped by around 40%.

Nonetheless, the government has committed to resolving the energy crisis. In August 2015 it signed a five-year agreement for a second floating storage and regasification unit (FSRU) with the Norway-based BW Group. The floating unit began operations in November 2015 and has a regasification capacity of 750m standard cu ft per day. This followed a July 2015 government tender to buy 45 cargoes of liquefied natural gas to cover the period from October 2015 to December 2016.

The Long Term

The government is also looking at longer-term solutions to the energy shortage, including new concessions and agreements to boost domestic hydrocarbons production. For example, in March 2015, the British oil major BP committed to $12bn of investments in the country, which will lead to additional production of 3bn barrels of oil equivalent. The first $4bn will be invested in the next two years. Similarly, Eni signed a deal to invest $5bn in the sector over the next four to five years.

Ahmed Helmy, the CEO and chairman of Sidi Kerir Petrochemicals Company, told OBG, “It is important for industrial companies to focus on managing energy consumption, as it raises the standards in the sector in terms of cost reduction, energy requirements and much more.”

These moves should help ease fuel shortages in the country. At the same time, the government has also been signing power generation agreements to help address the outstanding supply shortage. In June 2015 Siemens announced the largest single order in its history, providing 14.4 GW of power in three gas steam power plants and up to 2 GW of wind power as part of a €8bn agreement. The first gas-fired plant, with a capacity of 4.8 GW, will be operational by the summer of 2017.

“In order to solve the power outages problem, there has been significant effort to boost capacity, but this will mostly be gas-fired,” Hafez told OBG. Although gas dependency could be risky, the situation has certainly improved over the course of 2015. “With the arrival of the second FSRU, the picture is somewhat different. Based on our calculations, we believe that we should have enough gas to meet power demand as well as contractual volumes for steel and fertiliser producers next year, with the exception of a slight shortfall in the third quarter,“ Hafez continued. “This, of course, assumes that production remains stable and that we do not face any issues bringing in the liquefied natural gas shipments. Going into 2017, it is difficult to have a definitive view, but with a potential third FSRU and with the North Alexandria and Zohr fields possibly starting production, we should not face any major shortfalls.” In the longer term, the government hopes to diversify the country’s generation mix and has existing plans for 5 GW of renewable energy.

Inputs

As with the power sector, a combination of factors, including population growth and underinvestment, have led to an acute gas shortage in the country, which can result in challenges for segments that rely on gas for feedstock, including fertiliser and plastics. Consumption outstrips this supply by some margin. Depending on peak load, the power sector requires between 3bn cu ft and 3.2bn cu ft per day, while the estimated non-power demand stands at 2.7bn cu ft per day. This results in is a natural gas deficit of at least 1bn cu ft per day. Some estimates put the number of energy intensive industries in the country at more than 30. In 2014 the government redirected natural gas allocated to cement and fertiliser production, which together accounts for 81% of gas demand from energy-intensive industries, to power generation. The move reduced the flow of feedstock for these industries from 940m cu ft per day to 350m cu ft per day.

The government has taken steps to remedy this by redirecting gas earmarked for export to the domestic market. Supply is currently at 4.35bn cu ft per day, with a further 0.5bn cu ft provided through a new five-year FSRU agreement with Hoegh Gallant of Norway that began in April. All this bodes well for a subsequent recovery in the country’s manufacturing base.

Currency

The volatility among emerging market currencies, caused in part by the strengthening US dollar, has also impacted Egypt, although a persistent shortage of foreign currency – a legacy of the post-Arab Spring turbulence that disrupted investment – has complicated the issue. This has contributed to a depreciation in the Egyptian pound of nearly 10%, which has helped make exports more competitive. However, it has also created some challenges. With many exporters reliant on intermediate imports, exports have been negatively affected and the country has been suffering from a trade imbalance. In June 2015 the country’s trade deficit stood at $3.49bn, despite the fact that imports had declined by 2% in that month.

To help limit the rise of a parallel market and improve the transmission of monetary policy changes, the government has also sought to control the subsequent black market in dollars by introducing a monthly cap of $50,000 on dollar-denominated bank deposits in February 2015. This has led to a shortage of available dollars for the country’s manufacturers. Although the central bank is making occasional foreign exchange sales to cover industrial backlogs, the priority for the country is foodstuffs. Raw materials and capital equipment come a distant second. “The industries that have export potential are less affected. The higher the import component for intermediate goods and the more you produce for the local market, the more you have problems,” Mohamed Maher, vice-chairman and CEO of Prime Holding, told OBG.

Labour

Labour issues also remain a key concern for manufacturers. Inflation has been driving up costs for industrialists, including labour costs. However, in real terms, wages in the country have actually been depreciating, according to the “Salary Trends” report of human resources consultants ECA International. Indeed, Egypt is one of the lowest-ranking countries on the index of real wage increases around the globe, ranking ahead of only Ukraine and Venezuela. Thus, by international standards the country is actually a comparatively cost-competitive market for multinationals.

Outlook

Undefined In the shorter term, industrial growth is likely to be constrained by electricity and dollar shortages, but the government is working to address these issues and conditions should ease over the medium term. This would clear the way for more robust industrial expansion, as the growing population and rising incomes ensure that demand in segments from building materials to FMCGs remains strong. This will, in turn, result in significant opportunities for growth over the next decade.

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The Report: Egypt 2016

Industry chapter from The Report: Egypt 2016

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