Construction favoured as growth driver in Egypt

The construction sector in Egypt is experiencing the best of times and the worst of times. On the one hand, the government has placed the sector at the heart of its economic agenda, ensuring that there will be plenty of contracts available in the foreseeable future. On the other hand, efforts to reform the economy through the removal of fuel subsidies and the flotation of the Egyptian pound have led to soaring costs and short-term pain for contractors. As such, many firms in the industry are simultaneously faced with the prospect of a massive pipeline of work – and the prospect of bankruptcy.

General Performance

Construction remains one of the most important contributors to the domestic economy. In 2016 the sector’s output increased by 10.3%, a significant uptick after growing at an average of 5.3% in the preceding four years. This growth trend has largely been maintained into 2017, growing at a rate of 7.3% in the first nine months of FY 2016/17. This puts sector growth behind only tourism and communications. In the same period, construction also accounted for the highest share of implemented investments in the country. Of the LE391.7bn ($25.8bn) invested in the first three quarters of FY 2016/17, 18.5% was directed towards construction activities.

Beyond its recent performance, the sector also holds significant strategic value for policymakers, absorbing as much as 40% of the irregular and informal labour in the country. However, the availability of skilled workers is a challenge. “Egyptian contractors face a structural lack of qualified human resources, due in part to the outflow of local builders to the Gulf Cooperation Council markets,” Mohamed Ibrahim Mahlab, president and CEO of Rowad Modern Engineers, told OBG. “However, this exportation of labour will also open the country to greater foreign currency flows.” It is perhaps unsurprising, therefore, that the industry is at the forefront of plans to revitalise the economy. The sector is bucking the trend that is affecting its counterparts across the Middle East: while a sustained drop in the price of oil has led to a retrenchment in public and private spending on construction in many parts of the region, Egypt continues to build. “Generally speaking, construction is moving ahead. It shows no signs of stopping,” Sherif Sweillam, director of business development at Gleeds, told OBG.

Indeed, a large part of the government’s growth strategy in the wake of the post-revolution turmoil revolves around heavy spending on new projects, from the New Administrative Capital to the Suez Canal Economic Development Zone. This government-led stimulus has benefits beyond the potential to boost economic growth: many mooted projects will fulfil a real need within the country, from mitigating the massive housing deficit to improving the domestic transport network.

Demand & Pipeline

As this suggests, there are significant demand drivers for continued construction expenditure. With an estimated 98m inhabitants and an annual growth rate of 2.45%, the population will soon be over 100m. Urban areas are under particular strain, causing significant construction investment. As of early 2018 just over 43% of the population lives in urban areas, but this is growing at 1.8% each year and is likely to be further boosted by plans for new cities. Existing urban areas are feeling the strain from this trend. The capital, Cairo, has nearly 19m residents, while Alexandria, the country’s second-largest city, is approaching 5m. With such growth, there is substantial demand for housing. Top-end estimates suggest that the country has a housing deficit of 3m, with annual demand for an additional 350,000-500,000 units.

Furthermore, it is not only the need for housing that will provide a source of projects and contracts. The same population pressure that has created high housing requirements has also placed a burden on a wide variety of national and local infrastructure. For example, there are $117.4bn worth of power projects in the Egyptian construction pipeline and $57.4bn worth of transport projects. In total, the country has a projects market worth $395.7bn. Construction, narrowly defined as excluding the aforementioned infrastructure areas, takes the largest share of deal values, with $129bn worth of projects. Given all these demand drivers, it is perhaps unsurprising that the Egyptian market is forecast to remain on an upward curve for some time to come. According to a forecast by Timetric, a business information service, the sector was expected to grow at a compound annual rate of 8.03% between 2017 and 2021.

Spending

As such, and despite a 23% decline in the value of contract awards in 2016, Egypt is the third-largest market in the MENA region for project awards, after Saudi Arabia and the UAE. Indeed, on a variety of metrics the domestic construction market is one of the top performers in the wider region. According to a report released by HSBC in the first quarter of 2017, Egypt is home to the most prosperous construction market in the MENA region, not least because the market was set to witness a 95% increase in cash-led construction spending in 2017. This contrasts sharply with Saudi Arabia, which is a larger market but was expected to experience a 15% dip in spending over that same period.

A substantial portion of the domestic construction drive is spurred by government spending. In FY 2015/16 public spending on building and construction increased by 16.3%, reaching LE23.9bn ($1.57bn), according to the Central Agency for Public Mobilisation and Statistics (CAPMAS). The largest share of spending was on road, bridge and tunnel projects, with implemented projects reaching a value of LE8.7bn ($573m), a 12.3% increase on the previous year. Sewage and water projects accounted for a further LE4.9bn ($323m) and LE3.3bn ($217m), respectively, while the value of implemented residential building projects hit LE2.5bn ($165m), an increase of 5.7% on FY 2014/15. This continued into FY 2016/17, with budgetary spending on housing increasing by 276% during this fiscal period. Other segments also saw a jump in spending, with electricity projects increasing by 45%, water by 44%, sanitation by 21%, and transport by 10%.

Risks & Delays

While heavy spending is good news for the sector, it is not without its risks. Indeed, although improvements have been made as the government embarks on an IMF-backed reform programme, the country is still running a sizeable budget deficit. At the end of the last fiscal year in June 2017, the deficit fell to 10.9% of GDP, down from 12.5% the year before. The primary deficit, which excludes interest payments, fell to 1.8% of GDP, down from 3.5% in June 2016. Although the deficit has been improving on the back of revenue growth of 28% and a significant reduction in recurring expenditure, including a range of subsidy programmes and public sector wages, the administration, under President Abdel Fattah El Sisi, will continue to be constrained by interest payments.

Indeed, funding arrangements have already proven a sticking point in one of the government’s flagship construction projects. Plans for the New Administrative Capital outside of Cairo have shifted several times as a result of complications over the funding and pricing of construction. The $45bn project was first announced in 2015 with plans for Emaar Properties, a UAE-based real estate firm, to be the lead developer. However, the parties could not reach an agreement over financing and the government then turned to the China Fortune Land Development and the China State Construction Engineering Company (CSCEC). As part of these negotiations, CSCEC secured a $3bn loan in September 2016.

In February 2017 this agreement fell apart over proposed costs for the project, and the Egyptian Ministry of Housing, Utilities and Urban Development announced that the new capital will be built by local citizens. “No agreement that satisfies both parties in terms of price per sq metre was reached,” Ayman Ismail, chairman of the government-owned company charged with developing the new city, told Reuters. Despite difficulties, CSCEC will ultimately be building part of the new city. This is not the first time that funding and rising costs have challenged a large-scale, government-backed project: in 2014 UAE builder Arabtec signed a $40bn deal to build 1m homes in Egypt, but the deal fell apart as disagreements arose over the actual scope of the project.

As such, the attitude of construction firms and international investors towards many of these flagship government projects is one of caution. David Lee, an infrastructure analyst told The National, a UAE-based newspaper, that “extensive government control of and intervention in the Egyptian economy leaves the delivery of projects exposed to abrupt policy changes, and fails to align with the long-term clarity required by international investors looking to commit capital over a multi-year time horizon.”

Chinese Funding

While there are difficulties over the scope and funding of government-initiated projects, this does not appear to have completely deterred foreign companies from supporting local construction. For example, in July 2017 President El Sisi reportedly met with a coalition of Chinese construction firms to discuss the development of a light rail system for Cairo, despite the earlier impasse over construction of the new administrative capital.

By the end of 2017 once-stalled projects seemed to be back on track. An official inauguration was held in October 2017 for the New Administrative Capital, with China committing $11.2bn, and targets and deadlines had been set by early 2018. It is expected that the first stage will be completed in 2019, at a cost of LE130bn ($8.56bn). A total of 36 buildings are planned for the site, including one for Parliament.

CSCEC has said that it will be building the Central Business District for the New Administrative Capital, an investment totalling about $3bn, according to press reports. The plan includes the highest building in Africa (a 345-metre tower), 12 commercial buildings, two hotels and five residential structures. This part of the project will be completed by 2020.

In early 2018 the New Administrative Capital Company reported that it was in negotiations with a Chinese company to develop a 5666-ha industrial zone. The foreign investor and the terms have not been disclosed, but negotiators say the company is looking for the right to use the area and profit from it for 25 years. Two other companies are negotiating for plots of more than 405 hectares.

Other Foreign Partnerships

While much of the attention is focused on Chinese interests in Egypt, other states have also displayed a willingness and eagerness to deploy capital in the country. For example, in July 2017 regional news reported that the Abu Dhabi Fund for Development awarded $1.1bn worth of grants and loans for 64 development schemes in Egypt. These projects touched on many strategic sectors from transport and housing to energy and health care, and will provide funding for a raft of construction contracts.

Russian interests have committed to building a 5m-sq-metre industrial zone at the Suez Canal Economic Zone. In early 2018 the Al Tayyar Group, a Saudi company, was offered the opportunity to invest in the New Administrative Capital and new Al Alamein City. Mostafa Madbouly, the minister of housing, utilities and urban development, mentioned possibilities related to tourism facilities and hotels, adding that Marriott Hotels has already expressed interest in new Al Alamein City.

Other tourism-related construction on the boards include plans for a $3.3bn Disney-style amusement park to be opened on more than 2023 ha in the governorate of Matrouh. The investor is Entertainment World, a Saudi-US joint venture. Built in stages over a decade, the project will include a zoo, hotels, a water park and sport facilities. In early 2018 the demolition of the Grand Continental Hotel in Cairo began. It will be replaced by a LE1.2bn ($75.1m) hotel and shopping complex.

Project Areas

These sources of funding, which often have a strategic motive and are offered on favourable terms, should provide some reassurance to contractors and construction firms that the steady flow of capital running to the industry is not going to dry up any time soon. Although there are concerns over the funding and execution of some large-scale projects, the pipeline is so large that there will be plenty on offer even if some plans are reduced in scope or cancelled. “Construction in Egypt is expected to boom, thanks to the upcoming development of big government-related projects, such as the new capital city,” Ismail Shaker, CEO of the Saudi Arabian firm Shaker Group, told OBG.

The government’s plans for city and home building alone should provide a steady diet of contracts to many local firms. The New Urban Communities Authority (NUCA), a newly established government body tasked with overseeing the development of Egypt’s new cities, has already started work on LE37bn ($2.44bn) worth of projects, including developments in Al Alamein City, Assiut Hill, the New Administrative Capital and West Qena. Indeed, despite funding problems, the New Administrative Capital is still under piecemeal construction. There are 11 Egyptian contractors working at the site, including national heavyweights Orascom Construction and Arab Contractors. NUCA is overseeing the completion of 17,000 units at the new site. Moreover, Madbouly confirmed to a local construction conference in March 2017, Bonat Misr, that there are more than LE1trn ($65.9bn) worth of projects scheduled for completion in the lead-up to 2022.

The private sector is optimistic about several areas in the country. In addition to New Administrative Capital and new Al Alamein, it sees considerable potential at New Cairo and Sixth of October. Real estate developers are anticipating growth of 7-8% in 2018, with much activity driven by investors seeking to profit from the high demand for housing units.

High-end developers have been especially active, noting that the revaluation of the currency has helped. Egyptians with dollar savings now have more local buying power, while domestic prices are considered relatively low on an international scale.

Transport Infrastructure

Beyond housing and city building, there is also a concerted push to improve transport infrastructure in the country. At the aforementioned March conference, Hesham Arafat, the minister of transport, announced that the government seeks “to develop at least 180 km of metro lines to accommodate 7m passengers”. Indeed, the government has made urban transport – incorporating metro, light rail and river transport – a key priority of Vision 2030, the government’s longterm planning document. A new light rail system has received the most attention. The discussions with Chinese companies over the execution of this project include plans for 66 km of track with 11 station stops. The network will connect the New Administrative Capital with Cairo’s outer suburbs, including Al Salam City, Ramadan 10 City, Shorouk City and Badr City. It will be linked to the third line of the capital’s metro network at Al Salam City. In July 2017 President El Sisi called for this light rail initiative to be completed within two years, although details over cost and execution have not been finalised.

China Railway Group reported that work was commencing on the $1.24bn project at the end of 2017. Daily capacity is estimated to be 340,000 passengers, and the system is expected to reduce traffic in targeted areas by approximately 30%. Egypt is also planning to develop a number of high-speed rail lines. Total investment is reported at €13bn. A Cairo to Luxor line will run 700 km and cost an estimated €6bn. A Luxor to Hurghada line will run 300 km and cost an estimated €4bn, while an Alexandria to Cairo line will run 210 km and cost an estimated €3bn.

Arafat has outlined a number of other projects on the boards. These include a 34-km underground rail running from Imbaba to the airport, with a total investment of €934m, a passenger and freight line running from Mansoura to Damietta and a freight line from Abu Tartur to Safaga.

Road & Air Projects

In addition to urban transport schemes, the Ministry of Transport is focusing on road improvements and expansions. Since 2015 the country’s road network has been expanded by over 23% – more than 5000 km – with most focusing on major highways and transport corridors.

Between 2014 and 2017 the country invested an estimated LE22.5bn ($1.48bn) into roads and bridges, including 10 new roads and work on 2000 km of existing roads, according to a published statement from the Ministry of Transport released in early 2018. Four interchange hubs crossing the Nile were completed at the cost of LE1.9bn ($125m), while investment in bridges came to LE2.1bn ($138m). It was also noted that the national roads project would involve the investment of LE16bn ($1.05bn). At the time of the statement’s release, the country was in the midst of upgrading 2500 km of roads, at a total investment of LE7bn ($461m), and constructing eight more interchange hubs (LE8.5bn, $560m), and 10 bridges (LE1.4bn, $92.2m) .

Investment continues, with the Ministry of Transport overseeing a number of further road expansion and improvement projects, including the Suez Road expansion, the development of the Shubra Road and the Regional Ring Road. Arafat said at the Bonat Misr conference, “The country is on track in regards to implementation; however, obstacles that delay national roads projects include the time consumed by state in providing landowners ownership rights before they give up their agriculture lands to the state for road development.”

Airports remain a priority for the country, and while major projects have taken some time, progress continues. Sphinx International Airport is planned to open in the summer of 2018. The project, which cost an estimated LE300m ($19.8m), is located in Giza, allowing for easy access to the major sites nearby. Katameya International Airport, which is located in New Cairo and will serve the New Administrative Capital, has also been inaugurated.

COST FACTORS: The investment environment is likely to improve further from government reforms and an investment law that includes tax incentives for private investment, the re-establishment of private sector free zones and subsidies for industrial land acquisition. This should ensure that construction projects continue to be brought to market.

However, government policy has not been completely good news for the industry. Indeed, there have been significant cost factors affecting the sector, including the devaluation of the Egyptian pound, the new value-added tax (VAT) law and reductions in the fuel subsidy rate (see analysis).

Although headline problems perhaps give the impression of turmoil, the general outlook for the sector is extremely positive The currency float in November 2016 created significant inflationary pressure on basic building materials too. The Egyptian pound fell from its pegged rate of LE8.8:$1 and began to stabilise around LE18:$1 in the first quarter of 2017. As a result, inflation began to increase, reaching 28.1% by January 2017. In the same month, the price of certain steel and cement prices had increased by almost 100%. This has been compounded by various other factors. Cement prices have also been affected by the introduction of VAT. A decision to increase VAT from 13% to 14% in June 2017 led to a jump in prices. Abdul Aziz Qassim, secretary of the Building Materials Division at the General Union of the Egyptian Chambers of Commerce, told Al Shaab newspaper in June 2017 that dealers had already been notified that there would be a new increase in cement prices at the start of July as a result of the increase in VAT. Prices were forecast to break LE800 ($52.70) per tonne.

Building Materials

The reduction in fuel subsidies has also impacted the building materials sector. In June 2017 the government announced fuel price increases of as much as 50%, the second increase since the currency flotation in November 2016. Under the latest round of subsidy removal, fuel prices for the cement industry were set to increase by 40%, reaching LE3500 ($231) per tonne (see analysis). These price pressures have a detrimental effect on contracting firms, squeezing margins and leading to the bankruptcy and closure of many smaller firms (see analysis). The government has tried to address this issue by introducing a compensation law in June 2017. Under the new regulation, contractors can seek redress and compensation for cost increases and losses on public contracts stemming from government legislation introduced between March and December 2016. As such, contractors should be able to ease their cash flow difficulties that have arisen as a result of the government’s reform agenda.

Outlook

While the legislation will offer some respite, 2017 was a difficult year for many contractors. Unexpected input cost increases and uncertainty around price risk management has left some firms vulnerable and required government intervention to provide insurance against mass bankruptcies.

Although these headline problems perhaps give the impression of turmoil, the general outlook for the sector is extremely positive. There is strong impetus for investment in construction projects, as the government looks to boost the economy and improve living conditions and infrastructure reliability across the country. Indeed, in terms of project values – both under way and in the pipeline – Egypt has emerged as one of the hottest markets in the MENA region. Although not every project, whatever its size, will see the light of day, there are enough contracts across a range of segments to make up for any delays and cancellations. Therefore, as the government’s reform agenda beds in, the currency stabilises, and inflation subsides, the Egyptian market will become an attractive proposition for both domestic and international construction firms.