Egypt's economic reforms should boost growth prospects

After several years marked by turbulence and uncertainty, Egypt’s economy received two welcome boosts in 2015. The first was the successful conclusion to the Egypt Economic Development Conference (EEDC) in the first quarter of the year, which drew more than 70 senior executives from global firms, the leaders of major financial institutions such as the IMF’s Christine Lagarde, 15 heads of state, and the finance or foreign ministers of nations like Russia, the UK, the US and China, along with more than $72bn worth of commitments. The second was the successful passage of the 2015/16 budget, which builds upon delicate but necessary reforms to improve Egypt’s public finances.

The combination of the two – along with a range of efforts including new economic zones and power plants to improve industrial production and energy output, and a slate of public works projects including an expansion to the Suez Canal – means that Egypt is proceeding along an increasingly smooth, if still occasionally pot-holed, road to growth. There are challenges still to be tackled, but the country’s outlook is brighter than it has been since the 2011 revolution.

Indicators

After expanding 2.2% in 2014, Egypt’s GDP is forecast to grow 4% in 2015 and 4.4% in 2016, according to the IMF. In its “World Economic Outlook” report in April 2015, the IMF said that ,“Egypt’s macroeconomic stabilisation plans and wide-ranging structural reforms were expected to increase confidence, and growth is expected to rise to 4% this year.”

Inflation has been persistently high, with the annual inflation rate accelerating to 10.3% in October 2015 from 9.2% in September, according to the Central Agency for Public Mobilisation and Statistics. Meanwhile, 25.2% of the population was estimated to be living in poverty in 2010, up from 21.6% in 2008, the latest World Bank data shows. The country’s income Gini coefficient – a measure of the deviation of the distribution of income among individuals or households within a country from a perfectly equal distribution where a value of 0 represents absolute equality and 100 absolute inequality – was at 30.8 in 2013 according to the UN Development Programme, based on figures from the World Bank. Unemployment – especially youth unemployment – also remains high. The IMF forecasts the unemployment rate to rise to 13.9% in 2015 from 13.6% in 2014.

Diverse Structure

Since gaining its independence in 1952, Egypt’s economic activity had expanded from its largely agricultural base to include manufacturing, extraction (which includes the mining and oil and gas sectors), construction, tourism and the various segments of the rapidly emerging services sector.

Manufacturing is the largest contributor to Egypt’s economy, accounting for 17.3% of GDP in 2014/15 in constant prices, according to Central Bank of Egypt (CBE) data. As well as the refining of its petroleum products, Egypt has developed large and well-resourced manufacturing industries in areas such as clothing, textiles, furniture, paper, cement and pharmaceuticals. Within the sector, fertiliser manufacturing represents one of the most prominent success stories, with the steady growth in this activity allowing the country to transform itself from a net importer of fertiliser to a net exporter. Elsewhere in the sector, textiles have driven growth, partly as a result of the Qualifying Industrial Zones agreement of 2004, by which Egyptian textile goods are granted tariff-free access to the US market (see Industry chapter).

Working the Land

Agriculture also still plays a central part in the economy, accounting for 15.6% of GDP in 2014/15. The sector, which includes irrigation and fisheries, grew at an average annual rate of 3.45% during the 1990s, accelerating to 4% in 2008/9 before dropping to 3% annual growth in the wake of the global economic crisis. Perhaps its most important economic function within the economy is as a provider of employment opportunities: according to the most recent UN data, in 2011 around 29.2% of the total labour market worked within the agricultural sector (see Agriculture chapter).

According to CBE data, Egypt’s extraction sector, including petroleum, gas and mining activity, is the third-largest contributor to GDP, accounting for 13.9% of the total in the 2014/15 financial year. 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 exploiting its more recent natural gas finds. BP’s “Statistical Review of World Energy 2015” shows that proven oil reserves were 3.9bn barrels in 1994 and fell to 3.6bn barrels as of the close of 2014. Natural gas reserves, discovered in 1967, stood at 65.2trn cu feet as of the close of 2014, the third highest on the African continent behind Nigeria and Algeria.

A combination of political unrest and delayed payments to international oil companies resulted in a slowdown in exploration activity over recent years which, combined with increasing domestic demand, has resulted in Egypt becoming a net energy importer. The government’s efforts to pay off its debts, starting in 2014, have rekindled activity in the upstream sector, and how this will play out in Egypt’s complex energy supply and demand dynamics is a pressing question facing the sector (see Energy chapter).

Building Up 

Wholesale and retail activity accounted for around 12.1% of GDP in 2014/15. New malls such as Cairo Festival City have succeeded in attracting international anchor tenants such as Ikea, Marks & Spencer, and Debenhams, despite the recent political turbulence. Construction activity also continues to play an important part in economic activity, making up 4.6% of GDP in 2014/2015, driven by a young population’s demand for housing and the increasing number of commercial, hospitality and industrial projects. The same growth drivers have helped to propel the expansion of the real estate sector, which in 2014/15 accounted for 2.4% of GDP (see Construction & Real Estate chapter).

A main foreign currency earner, tourism remains an important contributor to economy and job creation, although its share of GDP declined to 3.4% in 2014/15, figures from the CBE show. Despite facing a number of challenges, including security concerns following incidents in Sinai, it has significant potential for development and efforts are being made by tourism authorities to enhance the country’s competitiveness internationally (see Tourism chapter).

Trade

Egypt is a major exporter in a number of key segments, although the overall trade balance has remained in negative territory since 2004, as imports demanded by a rapidly expanding economy have outpaced export growth. In the 2014/15 financial year the trade deficit stood at LE284.4bn ($38.8bn). The nation has, however, established itself as a sizeable exporter of oil and other mineral products, chemicals, agricultural products, livestock and food products. Its most significant imports, many of which are primary imports that are later exported as manufactured goods, are mineral and chemical products, agricultural products, livestock and foodstuff, machinery and electrical equipment, and base metals.

The nation’s largest trading partner is the EU, which accounted for 33.8% of exports in the period from July to December 2014, according to Ministry of Finance (MoF) data. Trade with the EU has been greatly facilitated by the 2004 EU-Egypt Association Agreement, which established a 12-year trade liberalisation programme. Egypt has several other well-established trading relationships, and in recent years it has expanded its trading activity with Arab countries. Trade with Arab states has risen from 19.9% of the total in 2009/10 to 20.9% in 2013/14. These links are important to Egypt’s efforts to boost export growth, which has levelled off in recent years. The $26.1bn of total exports recorded for 2013/14 represented a modest decrease on the previous year’s $27bn.

Outward Looking

The successful conclusion of the EEDC held in March 2015 was widely welcomed and for good reason: it represented a significant boost to the country’s economy, both symbolically, in that it attracted a range of global figures, and in terms of concrete commitments. According to the prime minister’s closing statement, the event generated $72.5bn in investments, facilities and loans, including $36.2bn in signed investment contracts, $18.6bn in vendor financed infrastructure contracts and $5.2bn worth of loans from international banks.

In terms of the immediate fiscal scenario, financial packages presented on the opening day by Gulf states represented the most important development. The UAE, Saudi Arabia and Kuwait each pledged $2bn and delivered funds a month later in the form of deposits at the central bank with a maturity of between three and five years and an interest rate of 2.5%.

Longer-term commitments were made by overseas private investors as well. BP used the event to announce its commitment to investing $12bn in the natural gas fields it operates in the West Nile Delta. Further deals signed by Italy’s Eni and the UAE’s Dana Gas will further boost the development of Egypt’s hydrocarbons reserves, which in recent years have fallen short of meeting rapidly expanding domestic demand. Egypt’s electricity minister, meanwhile, signed memoranda of understanding worth around $22bn with global giants such as Siemens as well as regional players such as Saudi Arabia’s ACWA Power International, which will result in the addition of much-needed capacity to the national grid.

Other significant inward investment deals came from Emirati mall operator Majid Al Futtaim, which plans to invest LE5bn ($681.5m) in eight projects over the next five years; the UAE’s Al Swidan Group, which plans to invest $6bn in a grain logistic hub in Damietta; and the private Emirati investment holding, Khalifa bin Butti bin Omeir Group, which plans to invest $2bn in key sectors such as health, waste management, money exchange and renewable energy.

New Legislation

The EEDC in 2015 also provided a platform for the government to showcase a new investment law, ushered in just prior to the event. While not without its critics, the new law has made some important rationalisations to the Investment Law of 1997, the Companies Law of 1981, the Sales Tax Law of 1991 and the Income Tax Law of 2005.

The broad ambition of the law is to attract new investments to Egypt by removing legislative obstacles, streamlining bureaucratic procedures and offering incentives and guarantees. To this end, sales tax and Customs duties have been trimmed, senior executives have been given protection from prosecution for actions taken without their knowledge, the bids and tendering process streamlined, exit procedures made more straightforward, the process by which state land is allocated clarified, and greater provision made for the resolution of disputes between the investor and the state. The law also authorises the General Authority for Investment to act as a one-stop shop at which investors in designated sectors can obtain the licences and approvals necessary to establish and run their businesses. While the law largely pertains to major developments, its introduction nevertheless goes some way to improving Egypt’s general business environment – an area in which the country has struggled in recent years. Egypt was ranked 131st out of 189 economies in the World Bank’s “Doing Business” 2016 report. The nation improved in its protection for minority investors, but declined in ease of starting a business, registering property, and the time and procedures required to pay taxes.

Foreign Investment

The EEDC, the new investment law and the apparent return to political stability all contribute to Egypt’s efforts to restore the high levels of foreign investment it once enjoyed. The global economic crisis saw total foreign net investment in the country fall from a peak of nearly $13.2bn in 2007/8 to $8.1bn the following year, according to the MoF, and by 2010/11, the year in which Egypt’s domestic tensions were translated to revolution, foreign direct investment (FDI) had fallen to a new low of $2.2bn. However, more recently the trend has reversed and foreign investment levels are once again beginning to expand. By 2013/14 net FDI had staged a partial recovery to reach $4.1bn.

In terms of origin, the UK is the largest source of FDI, accounting for 47% of total inflows in 2013/14, followed by the US (20.5%), the UAE (3.7%) and France (3.2%). As the range of deals signed at the EEDC demonstrated, the energy sector, including oil, gas, electricity and renewables, is likely to be the biggest beneficiary of FDI, although the Ministry of Investment has also identified infrastructure and small and medium-sized enterprises in garment manufacturing and food processing as other key destinations.

Fiscal Matters

Egypt’s changing fortunes are most obvious in terms of the country’s balance sheet. Egypt’s recent fiscal history has been one of increasing deficits resulting from the revolution of 2011 and the subsequent fallout. In the years leading up to the January 25 revolution, Egypt had made considerable progress in reducing the nation’s structural deficit, cutting it to a relatively modest 6.8% by the 2007/8 fiscal year. The collapse of the administration of Hosni Mubarak unsurprisingly resulted in lower revenues and rising expenditure, as business activity and investment decreased. The result was a deterioration in the nation’s current account – by 2012/13 the nation was running a fiscal deficit of 13.7%, a level considered to be unsustainable in the long term.

The economy began to improve with the May 2014 election of President Abdel Fattah El Sisi and a jump in short-term assistance from regional allies. Foreign grants, primarily from Saudi Arabia, the UAE and Kuwait, amounted to LE23.4bn ($3.2bn) in 2014/15, or 4.3% of the budget. This enabled the nation to shore up its foreign reserves, cover a portion of its import obligations and position itself to honour a bond maturing in the third quarter of the year.

The new administration subsequently turned its attention to its chief budgetary challenge: the reduction of the structural deficit was established as a strategic priority by President Sisi, and in 2014 he returned a draft 2014/15 budget to the MoF with instructions to make further reductions in state spending. As a result, the proposed 2014/15 budget envisaged a deficit of LE240bn ($32.7bn), or 10% of GDP, down from the 12% outlined in the original proposal. By July 2015 it appeared that the government had come close to its target. The MoF forecast the overall deficit for the 2014/15 financial year to run to 10.8%, while the IMF expects an 11% deficit to emerge by the budget’s closure.

The first draft of the 2015/16 budget was, like its predecessor, sent back to the MoF as the projected 9.9% deficit was considered too high. The Cabinet did not approve the amended version of the budget, which envisages an 8.9% deficit, until the first day of the new financial year – with the president ratifying it the day after, on July 2, 2015.

Cutting Expanses

Central to the budget reforms has been a more austere expenditure plan, reducing what had in prior years grown heavy with current spending. For the 2014/15 budget, a number of significant expense reductions were made, including a cut in fuel subsidies, which saw diesel price grades rise between 64% and 78%, natural gas (which most of the nation’s taxi fleet relies on) increase by 175% and 92-octane petrol made 40% more expensive; a rise in electricity prices and the introduction of a five-year liberalisation programme aimed at trimming the state’s subsidy of the sector by 67%; and the establishment of a maximum wage of LE42,000 ($5730) per month for public sector salaries.

Combined with foreign grants from Gulf allies, this cost-cutting exercise enabled Egypt to approach its targeted 10% budget deficit. For the 2015/16 budget the pace of consolidation has slowed as the government has sought to balance the need to reduce its outgoings with the challenge of protecting an economically vulnerable population. As a result, reforms to the fuel subsidy system have been postponed and the implementation of a fuel card system delayed, while planned electricity price rises for the lower three consumption segments have been put on hold.

Boosting Revenues

Of course, balancing a budget requires efforts on the other side of the ledger as well. This trend builds on earlier work commenced during 2014/15, although some of the revenue-building efforts undertaken in the past year have been put on hold. A capital gains tax implemented in March 2015 was postponed for two years as a result of objections from traders and brokers – a decision which prompted the IMF to publicly state its disappointment. Similarly, a 5% wealth tax on individuals and corporations with an annual income of over LE1m ($136,000), decreed by President Sisi in 2014, was also shelved to avoid negatively affecting the country’s investment attractiveness.

The government did succeed, however, in activating a long-anticipated real estate tax, even if the projected gains of LE3.5bn ($477.1m) in revenues for the financial year were recalibrated to LE900m ($122.7m) by mid-2015. Looking to the current budget, the government anticipates a significant rise in tax revenues, the realisation of which is crucial if it is to meet its new deficit target of 8.9% for 2015/16.

Some of these gains are expected to come from an anticipated improvement in the nation’s economic condition, headlined by what the MoF expects will be a GDP growth rate of 5% for the period, compared to 4.2% for 2014/15. Yet more tax revenue growth is expected to come from the planned transition from the general sales tax to the value-added tax system, which is thought to bring in extra revenues worth 1% of GDP. In total, the government has ambitious aims to take in a third more in tax during 2015/16 than it did in 2014/15. The state also envisages a 19% increase in its non-tax revenues, despite the significant drop in grants it is likely to receive from its Gulf partners, expected to decline to just $2.2bn.

The anticipated increase will be derived from a number of sources: the direction of a larger share of profits from public authorities, like the Suez Canal and the central bank, to the state budget; the resolution and financial settlement of cases relating to violations on agricultural lands; and the full implementation of a new Mining Law, which is expected to raise revenues derived from the exploration and production activities.

Monetary Policy

The government’s approach to strengthening the economy can also be seen in its execution of monetary policy. The CBE has made numerous interventions to stabilise the value of the Egyptian pound, which has helped to slow its drop against the dollar. Recent strategies have come at a price: in June 2013 Egypt’s foreign reserves dropped to $14.5bn, below the critical threshold of three months of import cover. To ration dollars, the CBE began a set of foreign exchange auctions held three times a week, which helped to limit the decline in hard currency, but did constrain access to dollars for importers. The result was a large parallel market used by individuals and businesses to meet the currency needs that the banking system was not able to satisfy (see Banking Chapter). The situation appears to be stabilising on the back of the government’s improved focus and a rosier macroeconomic outlook. The influx of capital, combined with sovereign ratings upgrades from agencies such as Fitch at the close of 2014 have allowed the CBE to let the pound trade more freely.

Outlook

As Egypt continues to rebuild its economy it faces a number of risks. External challenges include regional unrest and a slowdown in exports due to muted global growth, although the nation’s limited exposure to Asian markets lends it some degree of protection. The possibility of unrest also features in the domestic risk matrix and security remains a national concern. Nevertheless, Egypt’s economy has continued to expand, with the IMF forecasting GDP growth of roughly 4% for 2015 and 4.4% for 2016.