Will reforms help Egypt handle the Covid-19 pandemic?

Prior to the onset of the global Covid-19 pandemic an ambitious programme of economic reform had succeeded in accelerating Egypt’s growth and reducing its fiscal deficit. The creation of a more business-friendly environment and the streamlining of the country’s bureaucracy has seen Egypt rise steadily in global rankings. This progress has, however, been disrupted by the effects of one of the biggest international economic shocks in decades. Mitigating the impact of the Covid-19 will be the main focus of government policy over the short term. Nevertheless, with one of the biggest consumer markets in the region and robust fundamentals, Egypt is well positioned to attract international investment and emerge from the crisis in a strong position.

Economic Snapshot

Following a currency crisis in 2016, Egypt has been implementing a process of reform aimed at correcting macroeconomic imbalances and microeconomic distortions. To date, the most significant elements of this process have included: moving to a flexible exchange rate to restore equilibrium in the foreign exchange market; launching a three-year fiscal reform plan to reduce a budget deficit that, at over 10% of GDP, was one of the highest in the region; dismantling an expensive and iniquitous fuel subsidy system; and introducing a more equitable framework of social support. The reform agenda was supported by a $12bn loan from the IMF that reduced the nation’s reliance on ad hoc support from regional allies and opened the door to further funding from development finance institutions, as well as enabling Egypt to issue debt instruments on global markets.

The results of the reform effort are apparent across key macroeconomic indicators: GDP growth rose from 5.3% in FY 2017/18 to 5.6% in FY 2018/19, while unemployment fell to 7.5%, its lowest level in over a decade, according to the World Bank. Meanwhile, foreign exchange reserves reached a historic high, the current account deficit decreased and the inflation rate entered single digits. In July 2019 the IMF announced that it had completed its fifth and final review of its funding programme, allowing Egypt to draw the final $2bn of the loan. The IMF highlighted the marked improvement in the country’s macroeconomic situation since 2016, emphasising the Egypt’s success in meeting its primary budget surplus target of 2% of GDP by FY 2018/19.

Covid-19 Pandemic

Egypt, therefore, faces the challenges of 2020 from a relatively robust macroeconomic position. Nevertheless, the global pandemic has impacted Egypt’s economic stability in a number of significant ways. Travel restrictions have negatively impacted the tourism sector, which provides employment for millions of Egyptians and is a key source of foreign currency. In addition, a global reduction in shipping movements has reduced revenue from the Suez Canal, which is another important source of foreign currency. Furthermore, remittances from Egyptians working abroad have fallen as workers across the world have had their jobs temporarily suspended, their working hours reduced or faced outright dismissal (see analysis).

The Egyptian Exchange’s benchmark EGX30 index lost 31.4% of its market capitalisation in the first quarter of 2020, declining from LE401.4bn ($24.7bn) to LE275.5bn ($17bn) over the period. This prompted the government to lower its stamp duty and earmark LE20bn ($1.2bn) to support the exchange (see Capital Markets chapter). The market turbulence caused by the Covid-19 pandemic also led the government to temporarily halt its privatisation programme – a key element of its economic reform strategy.

The financial sector has faced business disruption in the form of quarantine periods for travellers, reduced working hours and a request from the Central Bank of Egypt (CBE) to cancel fees for the late payment of loans, ATM usage and other activities (see Banking chapter). The effects of the pandemic have led to a series of revisions of the projected growth rate. In April 2020 the Ministry of Finance (MoF) downgraded its growth forecast for FY 2020/21 from 4.5% to 3.5%, before reducing this further to 2% in May 2020. This projection was supported by the IMF, which announced in April 2020 that it expects GDP to grow by 2% in 2020 and 2.8% in 2021. Although the IMF adjusted Egypt’s 2021 forecast to 2% in June 2020, the country is still the only Arab state expected to see positive GDP growth in 2020.

Covid-19 Response

In responding to the pandemic, the government has sought to balance public health concerns with economic imperatives. While it introduced a curfew and closed mosques, cafes and other places of entertainment, it stopped short of imposing a complete lockdown in a bid to sustain economic activity. It has also taken steps to actively support the economy over the medium term. In May 2020 the Cabinet approved a draft law that would require companies to deduct 1% from the salaries of employees during FY 2020/21 to help fund the government’s Covid-19 mitigation efforts. The funds will be held by the CBE and used to support small and medium-sized enterprises (SMEs) and strategic industries that are adversely affected by the pandemic, in addition to providing aid to vulnerable individuals and paying for the improvement of health care facilities. Both public and private sector employees are subject to the tax.

In addition, a separate 0.5% tax is set to be applied to state pensions during 2020. In April 2020 the House of Representatives approved the government’s request to allocate an additional LE10bn ($616.3m) to the FY 2019/20 budget in order to help it manage the economic fallout from the pandemic. The government has also secured external assistance, with the IMF approving a $2.8bn funding package, aimed at supporting spending on health care and welfare, while also supporting affected business sectors and limiting the decline in Egypt’s international reserves.

New Budget

The MoF faced challenges in drafting the country’s FY 2020/21 budget, given the rapidly changing global situation. In the first quarter of 2020 – when the global effects of the Covid-19 pandemic were first being felt – global production and consumption was in a steep decline and the international oil price dropped to $20 per barrel. In its draft budget, which was approved in March 2020, the MoF allowed for an average oil price of $61 per barrel to protect its fiscal strategy from a price rebound later in the year.

The budget was an expansionary one, with public spending set to rise by 9% to LE1.71trn ($105.4bn). The amount allocated to health care increased by onethird to LE95.7bn ($5.9bn), while that earmarked for education rose 70% to LE132bn ($8.1bn). In addition, the draft budget outlined a 64% increase in government investment to LE280.7bn ($17.3bn), along with a 16.7% increase in spending on export subsidies to LE7bn ($431.4m). In spite of these increases, the MoF forecast an overall reduction in the budget deficit to 6.3% of GDP, down from the 7.2% target for the FY 2019/20 budget, supported by an 18.2% increase in government revenue to LE1.3trn ($80.1bn). If these targets, which are based on the expectation that the Covid-19 pandemic will continue until the end of 2020, are met, then Egypt is set to emerge from the crisis in a comparatively strong fiscal position, with a lower deficit than the 8.2% of GDP recorded in FY 2018/19.

Fiscal Reform

Egypt has undertaken a process of fiscal reform over recent years, cutting costs where possible and pursuing opportunities to raise revenue. Energy subsidies have been a target for cost reductions since 2014. As a result, in FY 2014/15 prices for diesel grades rose by between 64% and 78%, natural gas – which most of the country’s taxi fleet relies on – increased by 175% and 92-octane petrol was made 40% more expensive. Further cuts to energy subsidies followed in 2017, and by mid-2019 subsidy support on most fuel products had been completely abolished, bringing further price increases of between 16% and 30%. In July 2019 a fuel price mechanism that connects domestic prices with global indices was introduced. The MoF almost halved spending on fuel subsidies in the FY 2020/21 budget, reducing them from LE52.9bn ($3.3bn) to LE28.1bn ($1.7bn). In addition, subsidies for electricity were eliminated over the same period, and in May 2018 a uniform LE2 ($0.12) ticket price for the Cairo metro system was replaced with fares ranging from LE3 ($0.18) to LE7 ($0.43), depending on the number of stops and the metro lines used.

Revenue-raising measures, meanwhile, were spearheaded by the introduction of a new value-added tax (VAT), applied at a rate of 13% in late 2016 and subsequently adjusted to 14% in 2017. The government has also sought to widen the tax base by tackling the country’s large informal sector. In 2019 the parallel economy was estimated to account for 40% of GDP, according to consultancy PwC. In a bid to formalise the sector, the government has drafted a new SME law, which was approved in principle by the House of Representatives in April 2020. This legislation offers tax and non-tax incentives aimed at encouraging small companies to formalise their operations and engage with the financial system. In the non-banking financial services segment, the government is driving microfinance growth as a means to boost formalisation. Since 2019 these efforts have intensified further, signalling a shift towards the establishment of a nano-finance segment. In January 2020 the Financial Regulatory Authority revealed terms and conditions for the concept, including a maximum loan of $190 per individual, to be repaid over a threemonth period (see Banking chapter).

Increasing the efficiency of the taxation system provides another route to increasing government revenue. A revised income tax law, proposed by the MoF in late 2019, makes no significant changes to pre-existing rates but aims to close loopholes through which foreign companies have previously avoided the payment of tax. According to the draft law, all Egypt-based subsidiaries of foreign firms will be subject to the 22.5% income tax rate. The law also establishes a legal framework for the taxation of e-commerce activities.

Bridging the Gap

Despite the advances made in its fiscal reform strategy, Egypt is expected to face a funding gap of around $10bn by end of 2020, according to estimates from investment banks EFG Hermes and Goldman Sachs. While foreign reserves were at a record high prior to the outbreak, they declined by around $8.5bn between March and April 2020 to reach $37bn. Bridging the funding shortfall without further depleting reserves will likely require an increase in government borrowing. According to the MoF, the bulk of the funding gap will be covered by local Treasury sales, but loans from foreign financial institutions are also likely to play a significant role in addressing the shortfall. This point was echoed by the IMF in May 2020, when it stated that support from multilateral and bilateral creditors would be needed to address the country’s balance of payments and ensure macroeconomic stability. Following the receipt of a $2.8bn package from the IMF in May 2020, the government requested an additional $5bn loan from the organisation and announced it was seeking further financing from other institutions.

Sovereign bond issuance is likely to provide a third major source of funding over the second half of 2020. The country is well positioned to tap global bond markets. In May 2020 international credit ratings agency Moody’s affirmed Egypt’s long-term foreign and local currency issuer ratings at “B2”, with a stable outlook, citing the positive impact of the nation’s economic, fiscal and monetary reforms. In the same month, Egypt raised $5bn in its largest-ever issuance on the international bond market. The offer was more than four times oversubscribed, with interest shown by investors from Europe, the Middle East, Africa and Asia. According to the MoF, the proceeds of the bond sale will help cover Egypt’s funding needs for FY 2020/21, as well as the financing needed to mitigate the effects of Covid-19. Egypt’s successful approaches to the debt market have, however, raised concerns regarding the nation’s external debt burden. Interest spending is now the single biggest budget item, accounting for around a third of total projected expenditures in FY 2019/20. Since 2019 Egypt has therefore been following a strategy that aims to reduce the cost of its interest payments by increasing the average tenor of its issuances to 4.4 years by the end of FY 2020/21. More relief may come from any continuation of the government’s monetary easing policy – for every 100-basis-point cut to policy rates the Treasury makes around LE10bn ($161.3m) to LE12bn ($739.6m) in interest savings.

Inflation & Monetary Policy

Egypt’s decision to float its currency in November 2016 may have been a macroeconomic necessity, but one of its consequences was a high-inflation environment. A rapid rise in consumer price inflation had a negative effect on both household consumption and business growth, prompting the CBE to tighten its monetary policy. As the inflation scenario stabilised the CBE was able to relax its stance, and since early 2018 it has been able to deploy a looser monetary policy. An overnight deposit rate that stood at nearly 19% in January 2018 was reduced to below 17% at the start of 2019 and just over 12% by January 2020. At the start of 2020 headline inflation was broadly stable at 7.2%, compared to 7.1% in December 2019. As a result, the CBE decided to leave policy rates unchanged in January and February 2020. However, the Covid-19 pandemic prompted a swift policy response, with the CBE cutting the overnight deposit rate was cut by 300 basis points to 9.25% in a bid to support domestic economic activity against a challenging external backdrop. In March 2020 the CBE announced that the inflation outlook remained consistent with the goal of achieving an inflation target of 9%, plus or minus three points by the end of 2020. The beneficial effects of Egypt’s lower interest rate environment include lower input costs for businesses and, as a corollary, an increase in the competitiveness of Egyptian products in global markets – a positive development for the nation’s trade balance.

Trade Deficit

Hopes that Egypt’s currency depreciation would result in a boost in exports and a reduced trade deficit have yet to be realised. The nation last posted a trade surplus in 2004, after which the trade deficit gradually deepened to reach an all-time low in 2016 of just over $5bn. Since then it has followed a broadly sideways trend, narrowing to less than $2bn in 2017 before widening again in 2018.

However, this was followed by a marked improvement in the trade balance between 2019 and 2020. In May 2020 Egypt’s trade deficit declined by 51.4% to $1.95bn, compared to $4.01bn in the same period of 2019, according to the Central Agency for Public Mobilisation and Statistics. This strong performance was attributed to an increase in exports in areas such as pastries and food preparations, which rose by 11.4%, fresh fruits (65.3%), pharmaceuticals (32.4%), and frozen or chilled vegetables (25.6%).

Further boosting exports remains a key priority for the government. In late 2019 the CBE revealed details of a proposed export credit risk company, the establishment of which is intended to boost the nation’s intra-Africa trade activity. A starting capital of $600m has been earmarked for the company, some of which may be provided by African Export-Import Bank, a pan-African financial institution headquartered in Cairo. The government is also seeking to settle overdue payments promised by the Export Subsidy Fund since 2012, either through direct cash transfers or the writing-off of taxes or Customs duties owed. At the close of 2019 Prime Minister Mostafa Madbouly also ratified a revised framework for export subsidies. The framework, which will be administered by the Export Subsidy Fund, covers three industries – engineering, food processing and furniture manufacturing – and offers subsidies up to 10% of the value of exports where companies can show that the value added in terms of local content exceeds between 60% and 80%, depending on the sector. The framework offers a number of other incentives, including further subsidies for companies that increase the volume of their exports by 20-30% in a given year.

Investment

Egypt is working to establish itself as a more desirable location for investment. An investment law promulgated in 2017 has yet to turn around a declining trend in foreign direct investment, prompting the government to remove the investment brief from the Ministry of Investment and International Cooperation in December 2019 and place it with the General Authority for Investment and Free Zones.

More broadly, the government has attempted to boost both domestic and foreign investment by improving the general business climate. Between 2017 and 2019 Egypt rose by 50 places in the World Bank’s “Doing Business” report, and in 2020 it improved by a further six places to 114th out of 190 countries. Areas where Egypt performs well include obtaining credit, securing electricity, dealing with construction permits and protecting minority investors. Areas where there is still room for improvement include the legal frameworks and bureaucracy surrounding paying taxes, trading across borders and enforcing contracts. Egypt’s performance on the annual Global Innovation Index, jointly published by Cornell University, INSEAD and the World Intellectual Property Organisation, has also gradually improved over recent years. In 2019 the country ranked 92nd globally, a gain of three places over the previous year, that was largely attributable to improvements in the ease of obtaining credit, minority investor protection, market capitalisation and the state of cluster development. Other areas in which Egypt has advanced, according to the report, include ICT services and its patent framework. Remaining areas of vulnerability include the provision of formal training by companies and the quality of its regulatory framework.

Growing Sectors

Egypt’s emergence as a centre of innovation is underpinned by a vibrant start-up environment which, like others in the region, is largely focused on tech and services. A recent study carried out by MAGNiTT, the largest online community for start-ups in the MENA region, found that in 2019 Egypt was home to the largest number of start-up investment deals in the region. The nation accounted for around one-quarter of completed deals, drawing a combined investment of $704m. The number of start-up investments increased by 31% compared to 2018, while the value of the investments in start-ups increased by 12%.

However, while technology and innovation is driving investment dynamism, the bulk of capital investments in the country directed towards more established industries. In May 2020 the Ministry of Planning and Economic Development (MPED) released its “Seven Years of Building” report, detailing the projects implemented between 2014 and the end of 2019, along with those currently under development. The report showed that more than 16,000 development and services projects were carried out between July 2014 and December 2019, at a value of LE2.2trn ($135.6bn). Combining completed projects with those still under development, the petroleum and mineral resources sector claimed the largest share, with 326 projects and a total value of LE1.1trn ($63.8bn). The next-biggest project pipeline belonged to housing and utilities, which saw investment of LE830bn ($51.2bn), and the transport sector, which saw investment of LE175bn ($10.8bn).

Geography

The differing internal economies of each of Egypt’s 27 governorates make for a diverse national investment landscape. Important regional economies include Aswan, which is home to major solar power facilities; the cotton centre of Gharbia; the agricultural governorates of Kafr El Sheikh, Damietta, Fayoum, Ismailia, Minya and Sohag; the industrial centres of Qalyubia and Manoufia, the tourist regions of South Sinai, Red Sea and Luxor; the trading and logistics hubs of Assiut, Beheira, Port Said and Suez; as well as Cairo and Alexandria, which are two of the fastest-growing cities in the world. The country is also home to nine public free zones, each providing utilities, integrated Customs units and security services to investors. The 2017 investment law also enables the establishment of private free zones where no suitable site for project activity can be found in the public free zone network. Over recent years much of the government’s investment promotion activity has targeted the Suez Canal Economic Zone. The multi-modal zone is made up of six ports and four industrial centres distributed along the Suez Canal waterway, through which 18,800 vessels and 10.3bn tonnes of cargo passed during 2019, according to the Suez Canal Authority. As part of the development of this project, the government has provided tunnels and bridges across the canal, as well as electricity, water treatment and desalination infrastructure. Ongoing projects in the zone include the upgrade of West Port Said, Adabiya, Al Tor and Al Arish, and the construction of new cargo terminals at East Port Said and Ain Sokhna.

In January 2020 the Suez Canal Authority announced its intention to accelerate development by establishing an investment arm. While full details had yet to be revealed as of mid-2020, early plans envision a financial arm that would be able to form partnerships with developers to pursue large projects in the Suez Canal Economic Zone. The zone has already been working with banks and other financial institutions to monetise land, infrastructure and cash flow.

Outlook

In October 2019, prior to the outbreak of Covid-19, the IMF projected that the Egyptian economy would grow 5.9% in 2020 assuming a continuation of macroeconomic reforms and a gradual improvement in the business environment. While this forecast was cut to 2% in June 2020 this nonetheless makes Egypt the only Arab economy expected to experience positive GDP growth in 2020 and one of the few countries worldwide not to be set to enter recession. Nevertheless, how the Covid-19 pandemic will affect Egypt’s macroeconomic position over the coming years remains to be seen. A key concern is a potential decline in private sector investment from both domestic and foreign sources, with MPED forecasting in May 2020 that it would drop by 30% in FY 2020/21 if the global pandemic persists until December. The government has moved to mitigate the effect of reduced private sector investment by boosting government investment by 64% to LE280.7bn ($17.3bn) in the draft budget for FY 2020/21. This increase brings the total projected investment in the coming year to LE740bn ($45.6bn). Over the longer term, however, the country will return to its ambitious Egypt Vision 2030 strategy, the nation’s roadmap to a competitive and diversified economy (see analysis).