document of the world bank...hisham el-shiaty (sr. private sector specialist, gfcm1), and mohamed...

Document of The World Bank

FOR OFFICIAL USE ONLY Report No: PGD64

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT FOR A

PROPOSED DEVELOPMENT POLICY LOAN

IN THE AMOUNT OF US$1,000 MILLION

TO THE

ARAB REPUBLIC OF EGYPT

FOR THE

PRIVATE SECTOR DEVELOPMENT FOR INCLUSIVE GROWTH

DEVELOPMENT POLICY FINANCING

November 13, 2018

Finance, Competitiveness, and Innovation Global Practice Social, Urban, Rural, and Resilience Global Practice Middle East and North Africa Region

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This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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The World Bank Private Sector Development for Inclusive Growth DPF (P168630)

ARAB REPUBLIC OF EGYPT

GOVERNMENT FISCAL YEAR July 1 – June 30

CURRENCY EQUIVALENTS (Exchange Rate Effective as of October 5, 2018)

Currency Unit = Egyptian Pound (EGP) US$1.00 = EGP 17.7

ABBREVIATIONS AND ACRONYMS

AML Anti-Money Laundering ASA Accountability State Authority CAPMAS Central Agency of Public Mobilization and Statistics CBE Central Bank of Egypt CDEIEC Central Department for Environmental Inspection and Environmental Compliance CPF Country Partnership Framework DPF Development Policy Financing DSA Debt Sustainability Analysis ECA Egyptian Competition Authority EEAA Egyptian Environmental Affairs Agency EFF Extended Fund Facility EIA Environmental Impact Assessment ESIA Environmental and Social Impact Assessment FDI Foreign Direct Investment FRA Financial Regulatory Authority FSAP Financial Sector Assessment Program GAFI General Authority for Investment and Free Zones GDP Gross Domestic Product GoE Government of Egypt GRM Grievance Redress Mechanism GRS Grievance Redress Service IFC International Finance Corporation IMF International Monetary Fund ISC Investor Service Center IT Information Technology LAU Local Administrative Unit LG Local Government MFI Microfinance Institution MIIC Ministry of Investment and International Cooperation MOF Ministry of Finance MOPMAR Ministry of Planning, Monitoring and Administrative Reform MSMEs Micro, Small, and Medium Enterprises MTDS Medium Term Debt Strategy MTDS Medium Term Debt Management Strategy NAFA Net Acquisition of Financial Assets

NBFI Non-bank Financial Institution NGO Nongovernmental organization PforR Program-for-Results PER Public Expenditure Review PFM Public Financial Management PMAR Planning, Monitoring and Administrative Reform PSIA Poverty and Social Impact Analysis SCD Systematic Country Diagnostic SOE State-Owned Enterprise SMEs Small and Medium Enterprises STRC Second Tranche Release Conditions TA Technical Assistance VAT Value Added Tax

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Regional Vice President: Ferid Belhaj

Country Director: Samia Msadek (Acting)

Senior Practice Director (s): Alfonso Garcia Mora (Acting), Ede Jorge Ijjasz-Vasquez

Practice Manager (s): Jean Pesme, Ellen Hamilton (Acting)

Task Team Leader (s): Ashish Khanna, Mohamed El-Shiaty, Mohamed Nada


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ARAB REPUBLIC OF EGYPT PRIVATE SECTOR DEVELOPMENT FOR INCLUSIVE GROWTH

DEVELOPMENT POLICY FINANCING

TABLE OF CONTENTS

SUMMARY OF PROPOSED FINANCING AND PROGRAM ........................................................................ 3

1. INTRODUCTION AND COUNTRY CONTEXT .................................................................................... 6

2. MACROECONOMIC POLICY FRAMEWORK ................................................................................... 10

2.1. RECENT ECONOMIC DEVELOPMENTS .......................................................................................... 10

2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ......................................................... 13

2.3. IMF RELATIONS ............................................................................................................................ 17

3. GOVERNMENT PROGRAM .......................................................................................................... 18

4. PROPOSED OPERATION .............................................................................................................. 21

4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION .......................................... 21

4.2. PRIOR ACTIONS, RESULTS, AND ANALYTICAL UNDERPINNINGS ................................................. 23

4.3. LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY .......................................... 51

4.4. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS ............................... 51

5. OTHER DESIGN AND APPRAISAL ISSUES...................................................................................... 52

5.1. POVERTY AND SOCIAL IMPACT ......................................................................................... 52

5.2. ENVIRONMENTAL ASPECTS ......................................................................................................... 56

5.3. PFM, DISBURSEMENT AND AUDITING ASPECTS .......................................................................... 58

5.4. MONITORING, EVALUATION AND ACCOUNTABILITY .................................................................. 61

6. SUMMARY OF RISKS AND MITIGATION ...................................................................................... 61

ANNEX 1: POLICY AND RESULTS MATRIX ............................................................................................ 65

ANNEX 2: FUND RELATIONS ANNEX .................................................................................................... 68

ANNEX 3: LETTER OF DEVELOPMENT POLICY ...................................................................................... 70

ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS ............................................................. 76

ANNEX 5: DEBT SUSTAINABILITY ANALYSIS ........................................................................................ 81

ANNEX 6: DETAILED POVERTY AND SOCIAL ANALYSIS ........................................................................ 86

This loan was prepared by an IBRD and IFC team led by Ashish Khanna (Program Leader, MNC03), Mohamed Hisham El-Shiaty (Sr. Private Sector Specialist, GFCM1), and Mohamed Nada (Sr. Urban Specialist, GSURR). The operation was prepared under the guidance of Najy Benhassine (Director, GFCDR), Sameh Naguib Wahba (Director, GSURR), Jean Pesme (Practice Manager, GFCMW), and Ayat Soliman (former Practice Manager, GSURR; now Director, GWADR). The team is grateful for the support received from Paloma Anos Casero (Director, GMTD1), Kevin Carey (Practice Manager, GMTMN), Yolanda Tayler (Practice Manager, GGOPM), Renaud Seligmann (Practice Manager, GGOMN), and Olivier Le Ber (Practice Manager, GTR05).

The team members included Maha Hussein (Sr. Private Sector Specialist, GFCM1), Ellen Hamilton (Lead Urban Specialist, GSURR), Wael Zakout (Sr. Technical Advisor, GSURR), Roland White (Lead Urban Specialist, GSURR), Tracey Marie Lane (Program Leader, MNC03), Peter Ellis (Lead Urban Economist, GSURR), Somik Lall (Lead Urban Economist, GSURR), Aminur Rahman (Lead Economist, GFCMW), Laurent Gonnet (Lead Financial Sector Specialist, GFCAW), Maya Abi Karam (Senior Counsel), Ibrahim Chowdhury (Sr. Economist, GMTMN), Andreja Marusic (Sr. Private Sector Specialist, GMTBR), Mohamed Yahia (Sr. Financial Management Specialist, GGOMN), Hosam Abdel Nasser Hassan (Sr. Financial Management Specialist, GGOMN), Nistha Sinha (Sr. Economist, GPV05), Amal Faltas (Sr. Social Development Specialist, GSURR), Ehab Mohamed Shaalan (Sr. Environmental Specialist, GEN05), Lulwa Ali (Sr. Environmental Specialist, OPSES), Ola Nour (Sr. Financial Sector Specialist, GFCM1), Oya Ardic Alper (Sr. Financial Sector Specialist, GFCFI), Ahmed Faragalla, (Sr. Financial Sector Specialist, GFCFI), Mohammed Ali Khaled (Sr. Operations Officer, CF3A3), Sherif Hamdy (Sr. Operations Officer, MNC03), Concepcion Aisa Otin (Sr. Financial Officer, FABBK), Diep Nguyen-Van Houtte (Lead Transport Specialist, GTR05), Said Dahdah (Sr. Transport Specialist, GTR05), Sohaib Athar (Young Professional, GSURR), Eric Ranjeva (Finance Officer, WFACS), Emily Owen (Urban Specialist, GSURR), Sara Alnashar (Economist, GMFDR), Ghada Ismail (Financial Sector Specialist, GFCMW), Laila AbdelKader Ahmed (Financial Sector Specialist, GFCMW), Tania Ghossein (Sr. Private Sector Specialist, GMTBR), Murat Sultanov (Sr. Financial Sector Specialist, GFCFI), Gabriel Lara Ibarra (Economist, GPV05), Steve Wan Yan Lun (Operations Officer, GFCMW), Salma Rasem El Gammal (Consultant, GSURR), Duru Oksuz (Consultant, GSURR), and Cathie Wissa (Consultant, GSURR). Hanzada Aboudoh (Program Assistant, MNCEG), Enas Shaaban (Program Assistant, MNCEG), and Georgette Ibrahim (IT Officer, ITSCR) provided outstanding administrative support.

The team is grateful for the support and guidance from Samia Msadek (Acting Country Director, MNC03) and for the close and productive cooperation with the IMF team. The team is also appreciative of the excellent collaboration with the Government of Egypt throughout various stages of this operation, including with the Ministry of Investment and International Cooperation which led the project, along with support from the Ministry of Finance; Ministry of Trade and Industry; Financial Regulatory Authority; General Authority for Investment and Free Zones; Ministry of Electricity and Renewable Energy; Ministry of Justice; Ministry of Housing, Utilities, and Urban Communities; Ministry of Local Development; and Ministry of Planning, Monitoring and Administrative Reform.


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SUMMARY OF PROPOSED FINANCING AND PROGRAM BASIC INFORMATION

Project ID Programmatic

P168630 No

Proposed Development Objective(s)

Enabling financial inclusion, private sector development and strengthening fiscal management for inclusive growth in Egypt.

Organizations

Borrower: ARAB REPUBLIC OF EGYPT

Implementing Agency: MINISTRY OF INVESTMENT AND INTERNATIONAL COOPERATION, GENERAL AUTHORITY FOR INVESTMENT & FREE ZONES

PROJECT FINANCING DATA (US$, Millions) SUMMARY

Total Financing 1,000.00 DETAILS

International Bank for Reconstruction and Development (IBRD) 1,000.00

INSTITUTIONAL DATA

Climate Change and Disaster Screening

This operation has been screened for short and long-term climate change and disaster risks

Overall Risk Rating

High .


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Summary Table and Results of Proposed Operation and Program

Borrower Arab Republic of Egypt

Implementing Agency Ministry of Investment and International Cooperation; General Authority for Investment and Free Zones

Operation type Two-tranche operation (with each tranche being US$500 million less applicable front-end fee) Program Development Objective

Enabling financial inclusion, private sector development and strengthening fiscal management for inclusive growth in Egypt.

Pillars of Operation and Results Indicators1

Pillar 1: Financial Inclusion and Access to Finance

Number of microfinance beneficiaries using mobile payment or e-payment (baseline: 0; target: 600,000 in June 2020, of which 40 percent are female and 20 percent are outside Greater Cairo and Alexandria) Number of published collateral registrations used by MSME, corporate, individual debtors and syndicated loans (baseline: 0; target: 20,000 publications by June 2020). Number of new coded investors (baseline: 9,300; target: 12,000 by June 2020)

Pillar 2: Private Sector Development Value of the extent of shareholder governance index (baseline: 6.3 out of 10 in Doing Business Report 2018; target: 7 out of 10 in Doing Business Report 2020) Number of days needed to start a business (baseline: 11 days in Doing Business Report 2019; target: 3 days by June 2020) Average number of firm registrations per month at the new Investor Service Centers (baseline: 0; target: 20 by June 2020) Non-government financing as percentage of total financing under Fekretak Sherketak/Egypt Ventures initiative (baseline: 0%; target: 50% by June 2020) Percentage increase in the number of SMEs participating in public tenders and/or being awarded contracts (baseline: No increase, target: 20% increase by June 2020) Percentage of property registration offices in the “new urban communities” implementing more transparent procedures for deed registration (baseline: 0; target: 10% by June 2020) Increase in number of ride-sharing driver licenses issued (baseline: 0; target: target 100,000 by June 2020)

Pillar 3: Strengthened Fiscal Management

Number of companies filing annual income tax returns electronically (baseline: 0; target: 30,000 companies by June 2020) Energy subsidies as a percentage of GDP reduced from 3.8% in FY17/18 to 2.5% by June 2020 An updated expanded medium-term debt management strategy will be

1 End target date of all results indicators is end-June 2020.


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published (baseline: No; target: Yes) Number of governorates and districts preparing their FY2020/21 capital investment plans in accordance with the formula-based system (baseline: No formula-based system; target: All 27 governorates and 188 districts by June 2020).

Overall Risk Rating High .


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IBRD PROGRAM DOCUMENT FOR A PROPOSED LOAN TO THE ARAB REPUBLIC OF EGYPT

1. INTRODUCTION AND COUNTRY CONTEXT

1. Egypt’s bold and transformative reform program is showing early signs of success. The Government of Egypt (GoE) has implemented major reforms over the past three years to ensure macroeconomic stability, achieve energy security and enhance competitiveness. Real GDP grew at 5.3 percent in FY18, compared to 4.2 percent in FY17, and is expected to be around 6 percent in FY19-FY20. The introduction of a new Value-Added Tax (VAT) and the gradual phasing-out of energy subsidies are helping fiscal consolidation, while energy sector reforms have led to a reduced reliance on gas imports, eliminating power deficits in the country and providing US$14 billion of savings from energy subsidies used for fiscal consolidation and targeted social protection. Accompanying macroeconomic reforms, the GoE has made significant strides to improve the business environment. This has been achieved through a series of reforms that include a modern and comprehensive investment law and a new industrial licensing law. Due to licensing law reform in 2017 and Industrial Development Authority law in 2018, the number of operating licenses and permits have increased nearly 20-fold from 2017 to 2018, while the number of building licenses have increased almost 8-fold during the same period. In addition, private investments have reached US$17.9 billion for fiscal year (FY) 2017/2018 compared to US$12.0 billion for FY2016/2017. Furthermore, there has been a significant increase in the number of newly established companies from 15,371 companies in FY2016/2017 to 19,836 companies in FY2017/2018. Overall, these far reaching economic reforms undertaken with World Bank Group (WBG) support have stabilized the economy providing the underpinnings for a second generation of reforms and opportunities to take better advantage of advances in the digital economy.

2. While these early gains are impressive, further efforts are needed to accelerate economic inclusion. Some 60 percent of Egypt’s population is either poor or vulnerable, and inequality is on the rise. The national poverty rate is close to 30 percent (2015), and there are striking spatial variations in poverty. Across the 27 governorates of Egypt, poverty rates range from a low of about 7 percent in Port Said and about 18 percent in Cairo to a high of 66 percent in Sohag and Assiout. In fact, Upper Egypt governorates (which includes Sohag and Assiout) have some of the highest incidence of poverty as well as the highest absolute number of poor. Pockets of poverty exist even in governorates with low poverty incidence such as the Cairo governorate, where some districts have poverty rates as high as 44 percent.

3. Private sector-led job creation is the pathway for economic inclusion and a new social contract. Egypt needs to create at least 700,000 jobs every year. Economic exclusion has led to high youth and female unemployment with many without formal jobs. Youth and female unemployment in Egypt has been one of the highest amongst its peers (around 30 percent and 22 percent, respectively, compared to an overall unemployment rate of 10 percent). Between 1998 and 2018, informal private sector employment increased from 31 percent to 76 percent. Stagnation of the private sector is also evident from low level of firm entry density and firm turnover rates. Private sector investment as a share of GDP constituted only 11.4 percent over the period 2000-2016, which is approximately 7 percent lower than in other emerging economies. While Egypt’s private sector share of jobs is 78 percent, 76 percent are informal, low quality, low productivity, and low pay jobs.


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4. Building on recent bold reforms, Egypt has embarked on an ambitious set of second generation reforms to develop a competitive and inclusive private sector. Egypt’s ranking in the latest Global Competitiveness Index (93/137) reflects improvements in the macroeconomic and investment climate and highlights potential areas for improvement. The Government is committed to promoting a private sector-led development model and providing a level playing field. To realize the benefits of Egypt’s already enacted legislative reforms, it will be important to ensure their proper implementation to create a level playing field for the private sector to compete in and thrive.

5. Access to finance is one of the top three investment climate constraints in Egypt. The level of financial intermediation and financial inclusion in Egypt is low. Only 7 percent of firms have access to finance compared to an average of 28 percent in the MENA region, according to the 2016 World Bank enterprise survey. According to the latest FINDEX data, only 14 percent of the population over 15 years old has an account at a financial institution and, in the absence of modern payment systems, Egypt remains a cash-based economy with cash payments constituting 98 percent of payments. Access to finance, particularly for MSMEs and start-ups, needs to be enhanced by developing various channels of funding such as capital markets, venture capital, private equity, and microfinance.

6. A major imperative to effective private sector-led job creation in Egypt is continued growth-friendly fiscal consolidation that reduces crowding out of private sector financing through lower Government borrowing and enhanced fiscal management. Predictability in fiscal management is being complemented in three areas: recognition of a key milestone in the path to energy cost recovery, an impetus to electronic tax filing, and formula-based capital allocations to local governments. In each case, stakeholders are given more assurance about the role of fiscal management in their decisions: a signal that the Government is committed to a debt management strategy, a move to arms-length tax filing, and reduced discretion in local capital spending allocations.

7. More predictable fiscal management facilitates private sector decision-making, while on a parallel track, the ongoing fiscal consolidation underpins market confidence and perceptions of fiscal sustainability. Following an ambitious fiscal consolidation program which has already resulted in an impressive improvement in the primary balance by 3.6 percent of GDP over two years, Egypt needs to lock in these fiscal gains through its medium-term fiscal strategy supported by the IMF Extended Fund Facility (EFF) and technical assistance from the World Bank. The challenge of providing 700,000 jobs annually through the private sector would, however, need a sustained higher growth rate in future while reducing public expenditure (primarily through continued rationalization of energy subsidies), enhancing revenue through reform and use of information technology for tax administration and enhanced transparency and efficiency in government services. Providing public participatory planning through allocation of capital expenditure directly to Governorates would be an effective tool for efficiency and inclusion at Governorate level.

8. The GoE has requested the international community to support its vision of continued fiscal sustainability, improved access to finance and enhanced business environment as essential for boosting economic productivity and private sector development. The GoE has made commendable efforts to develop a comprehensive set of reforms and requires a programmatic approach to support its implementation. In parallel with fiscal consolidation, growth has increased, but the public has had to cope with significant price adjustments, and public sector pay – the source of most formal sector earnings – has been tightened in real terms. The government’s ultimate risk mitigation strategy is private sector-led job creation, and it needs time and financing buffers for the enabling interventions of this operation to bear


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fruit. The proposed operation is part of the overall World Bank Group support to these efforts, both from a financing angle and on the substance of the reform agenda. The government reform program also fits well with WBG priorities of creating jobs for the youth through the Maximizing Finance for Development (MFD) approach, human capital development, and deployment of new technologies.

9. From a financing perspective, the proposed DPF is an important element of the Government’s medium-term financial plan to further enhance macroeconomic stability. The proposed operation is designed to support the authorities in improving macroeconomic prospects, spur private sector led-growth and improve debt management in terms of pricing and maturity of debt. It will provide a strong and timely signal to international markets to support the structural reforms that the Government is undertaking.

10. The proposed US$1 billion DPF operation is part of a programmatic multisectoral engagement to support a second generation of reforms focusing on changing the social contract in Egypt. It aims to support inclusive economic growth through private sector-led job creation, investments in human capital, improved governance, transparency and service delivery while taking advantage of advances in the digital economy. As part of this comprehensive agenda, this DPF seeks to address upstream reforms on legal, regulatory and institutional barriers for unlocking private sector investments across all three pillars of financial inclusion, enabling the private sector and strengthened fiscal management. These second-generation reforms have strong ownership of Egyptians and the World Bank has been supporting them through:

(a) Inclusive growth through enabling private sector-led growth and job creation encompasses a programmatic approach including multiple operations: (i) this DPF operation; (ii) sustainable development of lagging regions through projects and programs in Upper Egypt, the National Rural Sanitation and the planned Sinai engagement; and (iii) proposed operations on promoting entrepreneurship and expanding social housing for the poor.

(b) The human capital program encompasses projects on: (i) health sector that seeks to eliminate Hepatitis C and deliver improved health services; (ii) education with a target to train half a million teachers and provide IT enabled education to one million students; and (iii) planned additional financing on social protection that deepens targeted cash transfer programs, and launches skills-based initiatives, fostering social inclusion.

(c) Improved governance, transparency and service delivery are being addressed through: (i) a cross-sectoral program on leveraging private investments across energy, water, transport and agricultural sectors while addressing cross-sectoral issues on land and corporate governance of state-owned enterprises; and (ii) initiating a digital economy operation focusing on improving digital infrastructure and platforms, e-enablement of government services and improvement in performance improvement systems.

11. This DPF operation is hence a part of a second phase of an ambitious program that requires a multi-year government commitment as well as a multi-year World Bank engagement.

12. This US$1 billion DPF operation supports homegrown reforms pursuing financial inclusion, private sector development, and fiscal management. First, it focuses on financial inclusion and access to finance for the growth of the private sector, particularly unconnected small and medium enterprises (SMEs), thus leading to formal employment. Second, the program enables private sector investments by


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promoting entrepreneurship, easing doing business, enhancing transparency and automation, including procurement procedures, and supporting disruptive technologies for job creation. Third, the program supports fiscal management which is essential for unlocking private sector investments through enhanced transparency and buoyancy in tax revenue through online tax filing, continued reduction in energy subsidies in both fuel products and electricity, publicly disclosed medium-term debt strategy, while also initiating fiscal empowerment of local institutions through clearly defined roles of local government bodies in participatory planning while increasing fiscal transfers.

13. Measures supported by the proposed DPF and the broader program will contribute to leveling the playing field by facilitating the entry of new unconnected players, injecting new blood into the private sector landscape, and by promoting transparency and predictability. These reforms will help increase market contestability and complement the IMF program’s structural benchmark to strengthen the Egyptian Competition Authority. These actions supported by the proposed DPF will be complemented by other current and forthcoming WBG interventions contributing to this critical objective, including a digital economy engagement which will also support e-governance and accountability. Ongoing and planned technical assistance and analytical work will also support the authorities in their preparation of still needed policy reforms2 (market contestability, reform of the financial sector, productivity) and their effective implementation of recently adopted reforms.

14. The proposed DPF also contributes to the implementation of the WBG MENA Strategy, addresses the constraints identified in the Systematic Country Diagnostic and priorities of the Country Partnership Framework of Egypt. The operation focuses on addressing climate mitigation and adaptation related to reform of energy subsidies, microfinance, entrepreneurship, public procurement law, online tax filing, land registration, and building resilience through empowerment of local institutions. Climate change threatens inclusive growth in Egypt where low-income, marginalized populations lack the resources to adapt to climate-induced shocks such as floods, droughts, heatwaves, as Egypt is highly exposed to natural disaster risk.3 New disaster risk reduction mechanisms and low-emission development strategies will help shield vulnerable Egyptians from these disruptive impacts. Consequently, the DPF seeks to facilitate the country’s aspiration as articulated in Egypt’s Nationally Determined Contributions (NDCs; 2017) to the UNFCCC which are at the heart of the Paris Agreement and the achievement of these long-term goals, as well as in its UNFCCC Third National Communication (2016). The reforms supported by the proposed DPF are closely linked to: (i) WBG’s twin goals of ending extreme poverty and boosting shared prosperity in a sustainable manner; (ii) the strategic pillars of WBG MENA Strategy related to renewing the social contract and supporting inclusive growth; (iii) all three pillars of Egypt’s Systematic Country Diagnostic (SCD), namely, private sector-led job creation, spatial integration, and inclusion; and (iv) the private sector-led job creation pillar of Egypt’s Country Partnership Framework (CPF) for 2015-2019.

15. This DPF will comprise of two tranches of US$500 million each. The first tranche will be made upon completion and verification of prior actions, adequacy of the macroeconomic policy framework and satisfactory progress on the program.4 The second tranche will be made upon completion and verification

2 Including upcoming Country Private Sector Diagnostic, Financial Sector Assessment, Investment Climate Assessment 3 Egypt country profile, ThinkHazard, World Bank Group (2018). The country is considered highly vulnerable to coastal flooding, urban flooding, river flooding, extreme heat, wild fires, and water scarcity. 4 “Prior actions” refer to the actions completed by GoE before submission of the operation to the World Bank Board for approval, and constitute first tranche release conditions.

http://unfccc.int/files/national_reports/non-annex_i_natcom/application/zip/tnc_report.ziphttp://thinkhazard.org/en/report/40765-egypt


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of specific policy-related second tranche-release conditions as well as the adequacy of the macroeconomic policy framework and satisfactory progress in carrying out the program. This enables stronger monitoring of the reform process and macroeconomic framework.

2. MACROECONOMIC POLICY FRAMEWORK

2.1. RECENT ECONOMIC DEVELOPMENTS

16. Egypt has started to reap the benefits of its ambitious economic reform program. Macroeconomic stability has been restored, economic growth has resumed, and inflation has fallen sharply (Table 1). Real GDP growth has continued to accelerate during FY2017/18 (July to June), rising to 5.3 percent from 4.2 percent in FY2016/17. The acceleration in economic growth was mainly driven on the expenditure side by consumption, with investments and net exports also contributing positively to growth. The sectors that contributed to strengthening economic activity are tourism, natural gas extraction, and construction. Inflation continued to ease, despite upward pressure from recent increases in subsidized energy costs and transport fares. Headline inflation slowed to an annual 16 percent in September 2018 from a record 33 percent in July 2017. Similarly, core inflation fell to single digits in July for the first time in more than two years.

17. The Government’s fiscal consolidation plan remains on track, as illustrated by the continued reduction in the budget deficit. The overall fiscal deficit narrowed by more than 1 percentage point to 9.8 percent of GDP in FY2017/18 from 10.9 percent of GDP the year before. The improvement in fiscal balances was driven by rising tax revenues (in percent of GDP), a further decrease in the wage bill ratio, and a small decline in the energy subsidy. The Government has increased spending on social protection and extended the coverage of key cash transfer programs. The authorities had envisaged a larger pace of fiscal consolidation, but the higher-than-target spending in FY2017/18 was mainly because of an overrun in the fuel subsidy on the back of higher-than-projected global oil prices and higher interest payments. That said, higher taxes paid by the Central Bank of Egypt (CBE) on interest income from government bonds and under execution of other spending helped offset some of the overrun in total expenditure. On the positive side, the primary balance recorded a small surplus of 0.1 percent of GDP after perpetual deficits for more than 15 years.

18. With higher global oil prices and tighter financial conditions, the CBE has kept policy rates on hold in recent months after rate cuts. After a period of rapid tightening, which saw the CBE increase the main policy rates by a cumulative 700 basis points between November 2016 and July 2017, the CBE cut rates by a cumulative 200 basis points in February and March 2018. With rising international oil prices and tightening global financial conditions, the CBE has left the overnight deposit rate, overnight lending rate, and main operation rate unchanged at 16.75 percent, 17.75 percent, and 17.25 percent, respectively, in recent months. The discount rate was also kept at 17.25 percent. The authorities are currently undertaking a comprehensive review of the CBE Law to strengthen the CBE’s institutional and operational autonomy. To further enhance transparency and communication, the CBE has regularly published a quarterly monetary policy report, starting in March 2017.


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19. The positive impact of macroeconomic and policy reforms have led to a marked improvement in the external financing position. The current account deficit narrowed by over 50 percent to 2.4 percent of GDP in FY2017/18 from 6.1 percent of GDP the year before. The improvement in the current account was driven by a strong recovery in the tourism sector, sharp rise in remittances, and increased Suez Canal receipts. The deficit in the trade balance narrowed by 1 percent of GDP helped by an increase in both oil and non-oil exports, while imports remained broadly unchanged.

Table 1. Key Economic Indicators

Last Updated September 2018

FY2012/13

FY2013/14

FY2014/15

FY2015/16

FY2016/17

FY2017/18

FY2018/19

FY2019/20

FY2020/21

Actual Actual Actual Actual Actual Pre-actual Forecast Forecast Forecast

Real Sector and Prices Real GDP growth rate (y/y) 2.2 2.9 4.4 4.3 4.2 5.3 5.6 5.8 6.0 Population (in millions) 84.7 86.7 89.0 91.1 93.3 96.1 n.a. n.a. n.a. Unemployment rate (last Q of FY) 13.3 13.3 12.7 12.5 12.0 11.3 9.4 9.2 8.9 CPI annual inflation rate, (period average) 6.9 10.1 10.9 10.2 23.3 21.6 14.5 12.5 10.7

Public Finance (in percentage of GDP) Total revenues 18.8 21.4 19.0 18.1 19.0 18.2 18.6 18.5 18.1 Tax revenues 13.5 12.2 12.5 13.0 13.3 14.2 14.6 14.6 14.5 Grants 0.3 4.5 1.0 0.1 0.5 0.0 0.0 0.0 0.0 Other nontax revenues 5.1 4.7 5.5 5.0 5.2 4.0 4.0 3.9 3.6 Total expenditures (excluding NAFA) 31.6 32.9 30.0 30.2 29.7 27.9 27.1 25.6 24.2

Current expenditures 29.5 30.5 27.5 27.6 26.6 25.5 24.5 22.7 21.3 Capital expenditures 2.1 2.5 2.5 2.6 3.1 2.4 2.6 2.8 2.9 NAFA 0.1 0.5 0.5 0.5 0.2 0.1 0.1 0.4 0.3 Overall budget balance, including grants −12.9 −12.0 −11.4 −12.5 −10.9 −9.8 −8.6 −7.5 −6.4

Overall balance, excluding grants −13.2 −16.5 −12.5 −12.7 −11.4 −9.8 −8.6 −7.5 −6.4 Primary balance −5.0 −3.9 −3.5 −3.5 −1.8 0.1 1.8 1.8 1.9 Gross budget sector debt (domestic + external) 88.2 89.4 93.1 102.8 108.0 98.7 93.4 90.4 89.3

External Sector (in percentage of GDP) Trade balance −10.7 −11.2 −11.7 −11.5 −15.8 −14.8 −13.5 −12.6 −12.1 Current account Balance −2.2 −0.9 −3.7 −6.0 −6.1 −2.4 −2.5 −2.5 −2.5 Net FDI inflows 1.3 1.4 1.9 2.1 3.4 3.1 3.3 3.3 3.5 Capital and financial account balance (does not include errors and omissions)

3.4 1.7 5.4 6.4 13.2 8.8 3.2 3.3 3.0

Net international reserves (end of period US$, billions) 14.9 16.7 20.1 17.5 31.3 44.3 46.4 48.0 48.8

in months of merchandise imports 3.1 3.3 3.9 3.7 6.6 8.4 8.4 8.3 7.8 External debt 15.0 15.1 14.6 16.8 41.1 37.2 34.0 31.5 28.0 External government debt 10.7 9.7 8.0 8.0 18.1 17.7 16.5 14.1 11.8 Monetary Sector (annual percentage change) Broad money 13.7 17.8 16.2 18.3 31.9 27.3 20.0 16.5 16.5 Credit to the private sector 8.4 7.3 12.8 15.7 32.3 17.1 15.5 13.0 13.0 Credit to the private sector (in real 1.5 −2.9 1.9 5.5 9.0 −4.5 1.0 0.5 2.3


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Last Updated September 2018

FY2012/13

FY2013/14

FY2014/15

FY2015/16

FY2016/17

FY2017/18

FY2018/19

FY2019/20

FY2020/21

Actual Actual Actual Actual Actual Pre-actual Forecast Forecast Forecast

terms) Source: World Bank and Ministry of Finance (MOF). Note: FY17/18 data reflect pre-actuals as shared by the Ministry of Finance with the World Bank team in September 2018. CPI = Consumer Price Index; FDI = Foreign Direct Investment; NAFA = Net Acquisition of Financial Assets.

20. The capital and financial account remains in a comfortable position, notwithstanding some portfolio outflows in the wake of tighter global financial conditions and a rise in emerging market volatility. In FY2017/18 the capital and financial account registered net inflows of US$22 billion, compared to US$31 billion the year before. Lower borrowing and smaller net portfolio inflows resulted in a lesser surplus in the financial and capital account. In light of the emerging market sell-off, portfolio flows recorded net outflows of US$2.9 billion in the final quarter of FY2017/18 (March to June). Higher frequency data show that portfolio outflows continued in early FY2018/19 with non-resident holdings of Egyptian treasury bills declining by US$2.5 billion in July and August. The net FDI was US$7.7 billion last year and the bulk of this continues to be directed to the oil and gas sector (US$4.5 billion), meaning that the development of other growth and employment generating private sector industries has lagged.

Table 2. Key Fiscal Aggregates (Percentage of GDP)

FY2012/

13 FY2013/

14 FY2014/

15 FY2015/

16 FY2016/

17 FY2017/

18 FY2018/

19 FY2019/

20 FY2020/

21 Last updated September 2018 Actual Actual Actual Actual Actual

Pre-Actual Forecast Forecast Forecast

Total Revenues 18.8 21.4 19.0 18.1 19.0 18.2 18.6 18.5 18.1 Tax revenues 13.5 12.2 12.5 13.0 13.3 14.2 14.6 14.6 14.5 Grants 0.3 4.5 1.0 0.1 0.5 0.0 0.0 0.0 0.0 Nontax revenues 5.1 4.7 5.5 5.0 5.2 4.0 4.0 3.9 3.6

Total Expenditures 31.6 32.9 30.0 30.2 29.7 27.9 27.1 25.6 24.2 Wages and salaries 7.7 8.4 8.1 7.9 6.5 5.4 5.2 4.9 4.9 Purchase of goods and services 1.4 1.3 1.3 1.3 1.2 1.1 1.0 1.0 1.1

Interest payments 7.9 8.1 7.9 9.0 9.1 9.9 10.4 9.3 8.3 Subsidies, grants, and social benefits 10.6 10.7 8.1 7.4 8.0 7.5 6.5 6.0 5.6

Energy subsidies 6.9 6.5 4.0 3.0 4.2 3.8 2.5 1.1 0.4 Other expenditures 1.9 1.9 2.1 2.0 1.8 1.6 1.4 1.5 1.4 Investments 2.1 2.5 2.5 2.6 3.1 2.4 2.6 2.8 2.9

Cash Deficit 12.8 11.5 11.0 12.0 10.7 9.7 8.5 7.1 6.1 NAFA 0.1 0.5 0.5 0.5 0.2 0.1 0.1 0.4 0.3 Overall deficit, including grants 12.9 12.0 11.4 12.5 10.9 9.8 8.6 7.5 6.4

Overall deficit, excluding grants 13.2 16.5 12.5 12.7 11.4 9.8 8.6 7.5 6.4

Primary balance −5.0 −3.9 −3.5 −3.5 −1.8 0.1 1.8 1.8 1.9 Sources of financing of projected overall budget deficits (percentage of GDP) External borrowing 3.8 2.0 0.9 0.8 Domestic sources of financing 6.0 6.6 6.6 5.6

Note: FY17/18 data reflect pre-actuals as shared by the Ministry of Finance with the World Bank team in September 2018.


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Source: World Bank and MOF.

21. While international reserves remain at comfortable levels and the exchange rate remains broadly stable, erosion of competitiveness is a concern. Following the 2016 flotation, the Egyptian pound fell by 50 percent against the U.S. dollar, reflecting some overshooting, but it has since remained broadly stable notwithstanding portfolio outflows. Net international reserves increased to US$44.4 billion at end-August 2018 (8.5 months of merchandise import coverage), up from US$19 billion on the eve of the exchange rate flotation in October 2016. In addition, the CBE holds other foreign currency assets in the amount of US$12 billion, in part reflecting the repatriation mechanism (a dedicated holding account for foreign exchange based on exit guarantees for investors). With rebuilt international reserves, the authorities repaid arrears to international oil companies, which were reduced to US$1.9 billion in June 2018 from US$3.5 billion at end-2016. Nevertheless, with inflation repressed before 2016 by currency market distortions and then materializing due to the flotation and energy price reforms, the real exchange rate has appreciated significantly. While the level of reserves provides a strong signal of credibility, exchange rate flexibility and a return of inflation to single digits will be needed to enable an export-led response to reforms.

22. Although the banking sector remains profitable and well capitalized, the sector’s net foreign asset position turned negative in July. The average capital adequacy ratio stood at 15.7 percent at end-March 2018, well above the Basel- and CBE-mandated floor. The share of nonperforming loans in total loans declined from 6 percent in 2016 to 4.5 percent in March 2018, with loan-loss provisioning coverage of 98 percent. The banking system remains liquid as evidenced by an overall loan-to-deposit ratio at about 45 percent. Following the flotation, the banks’ net foreign asset position improved during 2017, but with heightened global market volatility the net foreign asset position has been declining since May 2018 and has moved into a negative position in July. As the main financial intermediary in the country, the banking sector is exposed to sovereign risk, owing to heavy borrowing by the Government in recent years to finance its fiscal deficits. The Government accounts for 57 percent of the total domestic credit in FY2017/18, compared with about one-third in 2010. However, the growth in credit extended to the Government has fallen to 4 percent (year-on-year), compared to above 20 percent in FY2016/17.

2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

23. Egypt’s near-term growth outlook remains favorable. With improving macroeconomic conditions, the Government is increasingly shifting the focus to the structural reform agenda. Recent legislations, such as the investment and insolvency laws and a new procurement law—the latter being part of the program supported by this operation—would support private investment, including FDI in non-energy sectors, and sustain GDP growth at higher rates over the medium term. The projected growth path is gradual and assumes real GDP growth to increase to 5.6 percent in FY2018/19, up from an estimated 5.3 percent in FY2017/18, driven by private consumption, a pick-up in private investment, and a further recovery in net exports. Real GDP growth is projected to rebound to 5.8 percent in FY2018/19 and to increase further to 6.0 percent thereafter, as economic reforms progress and key sectors continue to recover, especially manufacturing and oil and gas extractives.

24. Inflation is projected to decline in FY2018/19 but remains high by historical standards at an average of 14.5 percent, contributing to real appreciation given the stability of the nominal exchange rate. This is partly because of further increases in domestic energy prices (which remain low in level


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terms), starting in July, and increased global oil prices, which will push up the cost of imported fuel. The CBE has set a target for overall inflation to average 13 percent (plus or minus 3 percentage points) in the fourth quarter of 2018 and remains committed to reduce inflation to single digits over the medium term.

25. With the continuation of the Government’s fiscal consolidation strategy, the fiscal deficit is set to narrow further. The overall budget deficit is projected to decline to 8.6 percent of GDP in FY2018/19, driven by further revenue augmentation and continued rationalization of expenditures. The implementation of fiscal reforms offers the prospect of a return to sustained primary surpluses, projected at 1.8 percent of GDP this fiscal year. Total revenues are projected to increase by 0.4 percentage points to 18.6 percent of GDP in FY2018/19 because of larger tax revenues which will benefit from increased VAT collection, the full-year impact of higher excises on tobacco products, and higher stamp duties. Total expenditure is expected to decrease by 0.8 percentage point to reach 27.1 percent of GDP in FY2018/19, primarily driven by energy price adjustments and wage bill restraint, notwithstanding large debt servicing costs. The FY2018/19 budget also targets increased spending on social protection programs. Following increases in fuel prices in 2016 and 2017, the Government raised fuel prices by an average 44 percent in July 2018, which raised the pre-tax price-to-cost ratio to about 73 percent for key fuel products. Additional increases are envisaged to achieve full cost recovery by end FY2019, although this could prove challenging given the developments in international oil markets. In June 2018, the Prime Minister approved the principle of an automatic fuel price indexation with implementation mechanism planned to be adopted by June 2019.

26. Egypt’s fiscal financing needs are projected to be met in FY2018/19 without recourse to significant central bank financing. The projected fiscal deficit is expected to be financed through primarily domestic and some external borrowing. On the domestic side, elevated borrowing costs led the Ministry of Finance to cancel several domestic debt auctions. Despite a challenging interest rate environment, the government will to some extent tolerate higher borrowing costs to avoid the debt profile from moving toward the shorter end, which could lead to rollover risks. The government can also opt for private debt placements. Risks of monetary financing of the deficit are limited by the existence of an arrangement that limits the CBE to extend financing to the government. According to this arrangement, the Ministry of Finance caps the overdraft account to 10 percent of the previous three years’ average revenues as per the CBE law. This in turn minimizes the risk of Central Bank liquidity injection through direct credit to government. On the external side, disbursements under the International Monetary Fund (IMF) Extended Fund Facility (EFF) will contribute to financing the budget deficit and to lengthening the debt maturity. In addition, some of the Central Bank deposits made available by Gulf states, were recently rolled over. The government also plans to issue Eurobonds provided global financing conditions improve.

27. The deficit in the external current account is expected to remain broadly at current levels going forward. Export recovery is expected to continue, while the steady inflows of capital inputs for infrastructure projects means that non-oil imports are likely to remain elevated. The coming on stream of the Zohr gas field has reduced the need for costly gas imports, although these savings will likely be offset by a higher oil import bill. Meanwhile, a stronger tourism sector and robust remittances will continue to support the external account. As a result, the current account deficit is projected to reach 2.5 percent of GDP in FY2018/19. In view of the improved economic outlook, FDI inflows are expected to recover gradually. Despite an improved external position, a small external financing gap will prevail in FY2018/19.


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28. The external financing gap is estimated at US$1.2 billion and expected to be met through largely IFI financing. The existence of a financing gap despite successful stabilization is related to Egypt’s risk profile, with a large overall budget deficit, and exposure to emerging market spillover risks such as currently in play for Turkey and Argentina. Following successful debt issuances in international capital markets in the previous two years, the authorities have not tapped international debt markets in FY2018/19 given heightened volatility in global financial markets. Egypt’s sovereign debt is still rated 4 to 5 notches below the lowest investment grade category and Egypt has a high reliance on domestic debt, including at the short end of the yield curve, with more than 50 percent of domestic debt of less than 1-year maturity and where yields are highly sensitive to monetary policy rates. If Egypt opted for a 5-year Eurobond to replace the DPF, in current market conditions, it would move towards shorter maturity. The higher interest costs compared to DPF averages at about US$100 million per year.5 If bond market conditions remain volatile, it is likely that government would issue more domestic debt, given its captive investor base.

29. Reduced reliance on domestic debt, enabled by Bank financing, builds policy credibility by mitigating interest rate risks to fiscal sustainability. The budget is already in primary surplus, with the large overall deficit due to interest payments. Therefore, the big gain to Egypt’s risk profile from DPF compared to other sources of financing is the lengthening of maturity of debt, the crowding in of other longer maturity flows, and lessened reliance on short-term domestic debt. Given the high share of short-term domestic debt, debt service costs rise when the central bank tightens policy rates in response to shocks. In other words, an appropriate central bank policy response to a shock worsens the fiscal situation because of the link through rising debt service costs. The risk of a spiral between monetary tightening and debt is lessened when the government is able to shift debt financing to external debt, longer maturity and more favorable terms –as the DPF would enable. Bank financing is not just “filling a gap,” but rather part of the path towards easing the risk of fiscal dominance of monetary policy.

Table 3. External Financing Requirements and Sources

Preliminary Actual Forecast (US$, millions) FY2016/17 FY2017/18 FY2018/19 FY2019/20 Gross financing requirements 23,896 20,344 12,960 14,200 External current account deficit 14,394 5,962 7,350 8,400 Maturing short-term debt 7,017 12,274 3,110 3,200 Amortization of medium- and long-term debt 2,484 2,108 2,500 2,600 Available Financing 23,896 20,344 11,760 14,200 Foreign direct and portfolio investment (net) 23,951 19,522 8,200 10,000 Medium- and long-term disbursement 7,641 8,846 5,600 5,600 Other 7,321 5,364 910 1000 Change in reserves ('-' indicates an increase) (13,717) (12,788) (2,150) (1,600) Other sources of financing (for example, arrears) (1,300) (600) (800) (800) Financing Gap — — 1,200 —

Source: World Bank.

30. After large increases in previous years, the GoE’s debt ratio fell sharply and will continue on a downward path, although significant risks arising from size, composition, and policy reversal remain. 5 Average of first 5 years interest rate profile on a 6.5 percent Eurobond.


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The total budget sector debt6 dropped by almost 10 percentage points to 98.7 percent of GDP in FY2017/18 from 108 percent of GDP the year before, helped by the ongoing fiscal consolidation and strong economic growth. The share of foreign currency debt, which increased sharply because of the devaluation in FY2016/17, also declined, and at about 37 percent of GDP, the risk stemming from debt denominated in foreign currency is moderate. The Debt Sustainability Analysis (DSA) shows that under the baseline scenario, which assumes a gradual pickup in economic growth and a continuation of the fiscal adjustment program, the debt-to-GDP ratio is projected to decline to about 84.6 percent by end-FY2022/23. Despite the improved debt outlook, the debt ratio remains high and the envisaged decline in the debt-to-GDP path over the medium term could be reversed if the projected economic recovery is not sustained and fiscal consolidation efforts lose momentum. These risks are mitigated by a captive domestic investor base and a moderate external debt ratio, which are largely long term and on concessional terms. The Government is also in the process of finalizing an updated medium-term debt management strategy which may contain provisions to set a limit on both internal and external borrowing. Additional details about the DSA and stress tests to the baseline scenario are presented in Annex 5.

31. Egypt’s macroeconomic policy framework is adequate for the purpose of this operation. This assessment is based on the following assumptions reflected in the macroeconomic framework: a substantial macroeconomic adjustment: (1) a rapid decline in the public debt ratio from a peak of 108 percent of GDP in FY17 to an estimated 93 percent in FY19 and just below 90 percent by FY21, (2) a large primary balance adjustment from -5 percent of GDP in FY13 to +1.8 percent in FY19, during which time growth is expected to accelerate, and (3) a disinflation from year-on-year monthly peaks over 30 percent during FY18 to 14 percent in FY19 and moving down to the 10 percent range by FY21. The primary deficit reduction is associated with the reduction in energy subsidies.

32. While the overall macroeconomic outlook is favorable, macroeconomic risks are high. The downside risks to the baseline are related to concerns that the key drivers of the post-2016 adjustment may be weakening and not locked-in as sustained policy commitments: a difficult currency adjustment unraveled by inflation and continued management of the exchange rate, and subsidy adjustment not institutionalized to reduce fiscal vulnerabilities. It is worth noting that one previous current account vulnerability, to gas imports, has been eliminated due to the rapid turnaround of the gas sector to be an exporter. Egypt is highly exposed to a tightening of global financial conditions and/or currency pressures. The risk profile of the country contributes to a potentially rapid pass-through of exchange rate or oil price spikes to fiscal outcomes. In the absence of government’s renewed commitment to maintain key monetary and fiscal anchors, Egypt could face a deteriorating debt outlook. The key anchors are: exchange rate flexibility as a critical shock absorber and fiscal sustainability through steady implementation of the fuel subsidy reform, specifically, fuel indexation. The latter is critical to lock-in government commitment to the fiscal consolidation path required to maintain debt sustainability. In addition to these short-term macro risks, the structural risk to Egypt’s economic outlook is the limited private sector supply response to the substantial macroeconomic adjustment that the economy has undergone over the last two years.

33. Risk-mitigating factors include:

6 ‘Budget sector debt’ is the term used by the MOF to define government debt which includes: (a) central administration, (b) local governments, and (c) public service authorities.


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• Large reserves of US$44 billion, acting as a buffer against shocks; plus an additional US$12 billion held under the repatriation mechanism;

• In the current external environment of tighter financing conditions for emerging markets, the CBE’s commitment to a flexible exchange rate policy will help enhance competitiveness and cushion against external shocks;

• As the recent IMF staff-level agreement notes Egypt’s fiscal policy in 2018/19 and beyond, will continue to aim at keeping general government debt on a clearly declining path;

• Revenue mobilization: Ministry of Finance requested World Bank assistance to improve the efficiency of tax administration and assess tax expenditures; Partially offset higher subsidy spending by reducing “non-priority” spending (e.g. re-phasing of investment projects and tighter controls on new recurrent costs);

• Tighten further interest rates to tackle any upturn in inflation whether caused by further subsidy adjustments or a disorderly depreciation of the exchange rate;

• Ongoing efforts to broaden the debt investor base (e.g. to Asia and private placements) could be accelerated, as can plans for hedging of oil price import risk;

• Adopt a more comprehensive debt management and monitoring (including for SOEs).

2.3. IMF RELATIONS 34. On June 29, 2018, the IMF Executive Board completed the third review of Egypt’s economic reform program, supported by an arrangement under the three-year US$12 billion EFF, which was approved in November 2016. Total disbursements under the EFF amount to about US$8.06 billion. Strong program implementation and generally positive performance have been instrumental in achieving macroeconomic stabilization, with external and fiscal deficits narrowing, inflation and unemployment declining, and growth accelerating. In completing the third review, the Executive Board approved the authorities’ request for waivers for the performance criteria for the primary fiscal balance, which was missed by a very small margin, and the fuel subsidy bill. The latter was missed due to higher-than-programmed oil prices during 2017/18.

35. The recent IMF mission reached a staff-level agreement for completion of the fourth review of the EFF; key focus areas for completion of the review are exchange rate flexibility and continuing energy subsidy reforms.7 Developments since the completion of the prior (third) IMF review point to a slightly slower pace of overall deficit reduction than programmed, which is reflected in the macroeconomic framework presented here. This is due to a combination of higher actual spending on energy subsidies and interest payments. For the fourth review, the IMF noted that in the current external environment, a flexible exchange rate helps enhance competitiveness, protect reserves, and cushion against external shocks. The IMF also noted the government’s commitment to continuing energy subsidy reforms so that fiscal policy for the current fiscal year and beyond can keep general government debt on a clearly declining path. As indicated in the completed programmatic DPF series and previous IMF staff reports, fuel price indexation would institutionalize the fiscal gains from the energy sector reform program.

7 The press release is available at < https://www.imf.org/en/News/Articles/2018/10/31/pr18405-imf-team-reaches-staff-level-agreement-on-the-fourth-review-for-egypts-eff >.

https://www.imf.org/en/News/Articles/2018/10/31/pr18405-imf-team-reaches-staff-level-agreement-on-the-fourth-review-for-egypts-effhttps://www.imf.org/en/News/Articles/2018/10/31/pr18405-imf-team-reaches-staff-level-agreement-on-the-fourth-review-for-egypts-eff


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3. GOVERNMENT PROGRAM

36. On July 3, 2018, the Prime Minister delivered to Parliament the policy statement for Egypt’s newly formed government and launched the Egypt Government program—'Egypt Takes Off’. In his address, the Prime Minister identified the following main priorities for Egypt: (i) national security, (ii) improving living standards, (iii) continuing economic reform, (iv) human development, and (v) foreign policy. The Parliament endorsed the Government program that aims to achieve the vision of the Egypt ‘s development strategy. It states that Egypt will achieve a competitive, balanced, and diversified economy through innovation and knowledge development. It will be based on justice, social integrity, participation and investment in physical and human capital to achieve sustainable development and improve all Egyptians’ quality of life.

37. The key objective of the government program is to address inclusive growth and job creation in the next four years (2018–2022). The government program aims to build a competitive and diversified knowledge-based economy and promoting inclusion. It seeks to implement a package of structural policies to rationalize and directly support beneficiaries; strengthen social safety nets; and develop human capital. The program covers five main themes: (1) Protecting National Security and Egypt’s Foreign Policy, (2) Developing Human Capital, (3) Economic Development and Improving Government Performance, (4) Job Creation, and (5) Improvement of Standard of Living. To allow the Cabinet to regularly assess the program’s progress, success, and impact, the implementing agencies are required to follow regular performance-based monitoring.

38. Pillar 1: Protecting National Security and Egypt's Foreign Policy. National security is to be provided in a comprehensive manner to ensure citizens’ sense of safety based on security for the following dimensions: citizens, water, food, and energy security. The program requires investments of around US$28 billion to increase electricity generation by 26 percent and US$2 billion in oil and gas exploration work to increase self-sufficiency of petroleum production up to 88 percent and increase natural gas production by 98 percent. It will provide natural gas to about 3.4 million housing units, saving up to US$350 million.

39. Pillar 2: Developing Human Capital. The following activities are envisaged by the GoE under this pillar: (a) development of cultural, religious, and media institutions and education systems under a new education strategy; (b) establishment of a charitable endowment fund for education and scientific research, various new colleges, public universities, and sporting fields for youth development; and (c) implementation of the first phase of a new health insurance system in the Suez Canal region.

40. Pillar 3: Economic Development and Improving Government Performance. This pillar aims to achieve the following targets: (a) real GDP growth rate of up to 8 percent by FY2021/22 to cope with rapid population growth and curb inflation, (b) reduction of budget deficit to 4.1 percent of GDP, and (c) improvement in efficiency of tax collection. The government program also includes an explicit commitment to implement policy packages to accelerate economic growth. Among these are mobilizing savings and providing financial resources to achieve the targeted rate of investment of 25 percent of GDP in FY2021/22, requiring a steady increase from 16 percent of GDP currently (FY2017/18).

41. This pillar also supports efforts to improve financial inclusion through the following measures: (a) developing new and innovative savings vessels and financial instruments, (b) promoting a savings


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culture among households and firms, (c) encouraging remittances from Egyptians abroad, (d) expanding investment and entrepreneurship funds, and (e) expanding financing in partnership with international and regional institutions. Other measures envisaged include: (a) developing public-private projects, (b) efficient use of state-owned assets, (c) restructuring public sector companies, including settling their debt, and (d) stimulating participation in publicly owned companies.

42. The program aims to improve industrial development through the following measures: (a) enhancing competitiveness of transformative industries and access to international markets; (b) stimulating industrial investment by offering 38 million m2 of land for industrial investment; (c) establishing integrated industrial complexes in different governorates; (d) simplifying licensing procedures and reducing the cost of doing business; and (e) saving distressed businesses, where EGP 4.2 billion (US$237 million) was allocated for priority projects.

43. The program highlights the importance of developing export capabilities of promising commodity and service sectors by increasing their international competitiveness. This part of the program focuses on: (a) increasing non-petroleum industrial exports; (b) increasing the amount of logistics centers and international exhibitions; (c) increasing production of internationally marketable agriculture produce through developing greenhouses and observing international quality and environmental standards; (d) improving air transport services for tourism by increasing the capacity of new airports; and (e) exporting contracting services, including IT, especially to Arab and African markets.

44. Finally, this pillar aims to improve public sector institutional performance and delivery of government services, including full utilization of data exchange platforms among 100 government agencies. This includes provision of 150 government services on mobile phone applications and development of all notary public services. It also includes establishment of a national database of judicial decisions, including automation of courts, police departments, prosecutors, and forensic offices. In addition, the program entails establishment of 11 new small claims courts and automation of technology centers in municipalities, and establishment of 60 new technological centers and increasing the number of portals in governorates up to 16 gates and at ministries up to 8 gates.

45. The Ministry of Investment and International Cooperation (MIIC) is exerting strong efforts to foster an attractive investment climate, focusing on establishing a conducive legislative environment, and building an institutional framework that promotes private investment. The Investment Law No.72 of 2017, supported by the previous DPF series, is a stepping stone to gear up domestic and foreign investments and aims to establish a conducive investment climate to promote private sector participation in the development process. The law also paves the way for major enhancements in the business climate through streamlining procedures, cutting red tape, providing investment guarantees and incentives to ensure fair and equitable treatment to investors, and fostering governance and accountability. Also, policies are being geared towards promoting financial inclusion and supporting access to finance. In an effort to introduce innovative non-banking financial tools, a financial leasing and factoring law has been enacted. This will contribute to supporting the micro enterprise sector and open new horizons for job opportunities.

46. To further promote confidence, and provide clear and predictable exit mechanisms to investors, a Restructuring, Pre-Insolvency Conciliation and Bankruptcy Law was enacted. The law governs the financial and administrative restructuring of struggling or defaulting enterprises and regulates their exit from the market in a manner that would protect the rights of all parties. The law attempts to simplify and


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streamline post-bankruptcy procedures and represents a key milestone in terms of improving investor confidence in Egypt’s investment climate, as it ensures the shielding of both foreign and domestic investors, and in particular smaller investors, from imprisonment in cases of liquidation and bankruptcy.

47. These efforts are being translated into major improvements of Egypt’s ranking in the latest Doing Business (DB) report. For example, starting a business was made easier by removing the requirement to obtain a bank certificate and by establishing a one-stop shop, thus reducing the time to start a business from 16 days to 11 days. In addition, access to credit was made easier by strengthening the rights of borrowers and lenders with regards to collateral, leading to an improvement in Egypt’s ranking for this indicator by 30 ranks. Furthermore, resolving insolvency was made easier by allowing debtors to initiate the reorganization procedure and granting creditors greater participation in the proceedings. On the whole, Egypt’s ranking improved from 128th in 2017 to 120th in 2018, marking a significant advancement.

48. Pillar 4: Job Creation. This pillar aims to create about 900,000 jobs annually for unemployed and underemployed, with a total of 3.6 million jobs throughout the four-year program, to help reduce the unemployment rate to 8.4 percent compared to 10.68 percent in Q1 of 2018 (implying a total of 3.2 million unemployed persons currently). It aims to do so through the following measures: (a) focusing on MSMEs; (b) introducing legislative and organizational reforms that encourage self-employment and entrepreneurship; (c) boosting integration of the informal sector with the formal system; (d) linking learning outputs to labor market needs through developing education methodologies and curricula; (e) establishing centers for entrepreneurship, technical education, and vocational training programs; and (f) intensifying developmental efforts for labor-intensive industries such as agriculture, industry, trade, and construction. This pillar also highlights inclusion and development of lagging regions by focusing on Upper Egypt governorates which have poorer economic and social indicators relative to other areas.

Figure 1. Selected Targets of Government Program

Source : Government program

8 Central Agency of Public Mobilization and Statistics (CAPMAS) figure.

- Allocation of 10 percent of lands allocated for SMEs- Enhance the role of Micro, Small, and Medium Enterprise Development Agency- Launching interactive platform to provide services to SMEs- Developing updated and modernized database for SMEs

Institutional Reform

- Establishing 200 incubators annually- Designing programs for training on entrepreneurship in universities and schools (entrepreneurs of 2030)

- Providing financial support to 225,000 SMEs- Implementing 2,400 programs to raise awareness of entrepreneurship-Increasing women economic empowerment through the program of (one village/one

product)

Encouraging Entrepreneurship Culture


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49. Pillar 5: Improvement of Standard of Living. This pillar aims to achieve the following: (i) preventing overpopulation in the existing population centers through incentives, increasing awareness, redistribution of population through developing new cities (including fourth generation cities), and improving connectivity to new population centers; (ii) developing areas prone to conflict or violence; (iii) providing housing units; (iv) narrowing developmental gaps among governorates by giving priority to the Upper Egypt region and frontier governorates (with the allocation of US$15.3 billion to projects of Sinai Peninsula development, completion of East Port Said City (Salam), inception of New Rafah and New Be'r El-Abd cities, in addition to implementing projects in the following sectors: roads, services, health, education, industrial development, agriculture and tourism); (v) developing 208 villages; (vi) improving the quality of potable water services; (vii) expanding transport services; (viii) enhancing social safety networks; (ix) eliminating gender-based discrimination; (x) enhancing protection of Egyptian expatriates; and (xi) increasing projects focused on environmental improvements.

4. PROPOSED OPERATION

4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION

50. The development objective of the operation is enabling financial inclusion, private sector development and strengthening fiscal management for inclusive growth in Egypt. The intervention logic of the DPF builds on the previous DPF series of fiscal consolidation by pushing for improved tax collection via online income tax filing, continuing fuel and electricity subsidy reforms, publishing a medium-term debt strategy and introducing efficiency in capital allocation for local governments. The DPF also helps improving access to finance and bolstering productivity. This means giving small firms better access to finance using digital technology so that they can pursue opportunities, improving financial intermediation and expanding the range of financial instruments. It also involves a stronger legal framework for small firms, more access for such firms to opportunities in public procurement and simplified administrative transactions through electronic tax filing.

51. The pillars of the proposed operation mainly align with two of the five pillars of the GoE program. These include Pillar 3: Economic Development and Improving Government Performance, and Pillar 4: Job Creation. As such, the operation contributes directly to the GoE’s overall vision to place inclusive growth and job creation at the center of the development agenda and contributes to improving governance and transparency. The GoE program provides the anchor for this DPF, supporting selected policy actions. The reforms supported by this operation will enable MIIC, through the General Authority for Investment and Free Zones (GAFI), to coordinate the enhancement of the business environment as needed for promoting private sector development. All measures supported by the DPF carry strong government ownership and are fully embedded within the Government program. The pillars of the proposed operation are thus complementary and interlinked with the GoE program. It is also addressing climate change as committed in the UNFCCC Nationally Determined Contributions (NDC, 2017) document.9

9 The proposed DPF prior actions address adaptation and mitigation goals articulated in Egypt’s First Nationally Determined

http://www4.unfccc.int/ndcregistry/PublishedDocuments/Egypt%20First/Egyptian%20INDC.pdf


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52. The proposed DPF is part of a larger World Bank Group multisectoral and programmatic engagement aimed at supporting inclusive private sector-led growth and strengthened fiscal management in Egypt, by addressing underlying social and economic imbalances. A series of operations are to be considered as part of this programmatic engagement in FY2019 and subsequent years and cover the various dimensions of this agenda in an integrated way. The proposed DPF will set the stage with critical policy reforms and will be complemented by support from other development partners for the government program.

53. The design incorporates lessons learned from previous operations in the following areas:

i. Matching the structure of the operation to the country context. An operation with multisector coverage paving the ground for and followed by subsequent engagements (PforR, technical assistance [TA] or subsequent DPF) focusing on implementation support is best suited to the current context of Egypt.

ii. Monitoring and follow-up of implementation of reforms at the highest level of the Government. The World Bank Group has established a strong dialogue at high levels of the Government, including at the Prime Ministerial level, allowing for strong follow-up of the reforms supported by the World Bank Group engagement.

iii. Fostering inter-ministerial coordination. Designing and implementing such an ambitious Government program requires different ministries and agencies to coordinate closely and develop medium-term coordination systems, overseen by a nodal ministry, to enable timely and successful implementation. Achieving the policy reform actions outlined in the Government’s program as well as this operation requires extensive inter-ministerial and cross-sectoral learning and coordination involving a large set of GoE agencies. This enables these agencies to gain experience in implementing shared visions, which has spillover benefits for all GoE programs and policies. This operation has included coordination with the following agencies: Ministries of Investment and International Cooperation; Finance; Planning and Administrative Reform; Trade and Industry; and the Financial Regulatory Authority.

iv. Focusing on concrete actions to achieve tangible results for the beneficiary population. While progress on legislative reforms has been achieved over the past years, implementation has been uneven, with little impact on private sector-led job creation. The proposed DPF strikes a balance between policy reforms and concrete implementation actions like the rollout of collateral registry, electronic and mobile payment for microfinance companies, and online tax filing that will have tangible results felt by the population in the short term.

Contribution as follows: PA 1 provides “protection to the poor” against climate impacts through access to resilience-generating capital, goods, and services; PA 5 encourages “switching from conventional energy sources to clean energy sources” by incubating cleantech entrepreneurs; PAs 6 and 8 reduce emissions from paper production via e-services and online tax filing thereby promoting “more efficient use of energy especially by end-users”; PA 9 increases the “use of renewable energy” and provides price signaling for energy efficiency to all consumers of electricity and fuels; PA 10 “improve the legislation and legal frameworks promoting the dynamics of sustainable and decentralized development”.

http://www4.unfccc.int/ndcregistry/PublishedDocuments/Egypt%20First/Egyptian%20INDC.pdf


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v. Supporting homegrown reform programs, buttressed by global best practices. This operation builds on a key lesson from previous operations and DPFs. Successful DPFs are based on homegrown reforms with strong political ownership of policy actions tackling difficult structural issues. The reforms undertaken in this operation are based on the GoE’s long-term objectives, as articulated in the Government program. Following transformational reforms focused on the economy, the energy sector, and competitiveness over the last three years (supported by the previous programmatic series of DPFs), this operation also builds on the World Bank Group’s extensive technical dialogue with counterparts on best practices in essential policy reforms related to private sector development, financial inclusion; and governance issues.

4.2. PRIOR ACTIONS, RESULTS, AND ANALYTICAL UNDERPINNINGS

Pillar 1: Financial Inclusion and Access to Finance

54. The overarching objective of Pillar 1 is to improve access to finance to firms, which is particularly important to avail more funding to private sector from financial markets. The Government is currently borrowing at rates close or below inflation, thereby improving sovereign debt sustainability but also crowding-out private sector lending by banks. With the reduction of public debt and the recovery of the economy, it is expected that public and private banks would change their lending policy and give more space to the private sector in their balance sheets.

55. Stiffer competition in the financial sector is not likely to come in the short term from the entry of new banks in the market, but rather by the emergence of non-bank financial institutions. In this respect, the proposed operation supports the development of non-bank financial institutions (NBFIs), improves financial sector competition and diversification, and broadens the range of financial institutions and products serving SMEs. The introduction of the collateral registry increases the attractiveness of SME finance (not only by banks but also by leasing and factoring companies) and the opening of payment instruments to microfinance companies strengthens NBFIs. Moreover, capital markets will provide alternative financing solutions in addition to the banking sector.

56. Reforms under Pillar 1 will help close gender gaps which have been well-identified by research in Egypt and at the global level. Barriers to access to bank/postal accounts are more acute for women and youth-led enterprises. The World Bank Findex 2017 survey reports that in Egypt only 27 percent of women of age 15 and above had an account at a financial institution, compared to 39 percent for men. The Findex data also point to some early signs that mobile money accounts (which seem gender-neutral as an action) might help narrowing the gender gap. Research in Sub-Saharan Africa shows that six economies managed to close the gender gap on mobile money account at a time when the gender gap with financial institutions’ account persists.10 Women mobile money agents play an important role in encouraging women to open an account, as women feel more comfortable sharing their mobile numbers with other women. Also, the literature on cultural barriers to women inheriting land in Middle East and North Africa shows that small firms owned by women are more likely to have movable collateral rather than immovable collateral. The establishment and the operationalization of the collateral registry is likely

10 In Kenya, for example, men are 18 percentage points more likely to have a financial institution account, but women are 11 percentage points more likely than men to have a mobile money account only.


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to have disproportionate effects for women since land usually gets inherited by male members of the family due to cultural issues, leaving female members of the family unable to use land as collateral, hence the increasingly important for movable assets. For the relevant prior actions, the proposed operation, therefore, includes gender-disaggregated targets.

• Improving access to finance for subsistence entrepreneurs

Prior Action 1: The Borrower, through its Designated Authorized Entity, has issued: (a) Decisions No. 8/2018 and No. 9/2018 to allow the use of mobile payment in microfinance activities; and (b) Decisions No.156/2018 (amending Decision No. 3/2018) and No. 4/2018 to allow the use of electronic payment by microfinance institutions, leading to improvement in access to finance for subsistence entrepreneurs.

57. Rationale: Subsistence entrepreneurs play an important role by forming small businesses that represent a way of life, providing employment at the base of the pyramid and contributing to the alleviation of poverty. Subsistence entrepreneurs face multiple challenges related to limited access to finance, low financial intermediation, and limited financial products. Access to microfinance credit is growing quickly but has not reached its full potential. The microfinance active portfolio increased from EGP 4.5 billion and 1.8 million active borrowers as of December 2016 to EGP 9.7 billion and 2.7 million active borrowers as of June 2018 (215 percent and 150 percent increase, respectively). Despite recent strong growth from a low base, the microfinance institution (MFI) portfolio quality and nonperforming loan levels remain in line with international norms. Recent market assessments suggest the potential market for microcredit to be 10 million microentrepreneurs; thus, the market is only reaching 27 percent of its potential. In Egypt, men are 12 percentage points more likely than women to have an account, so the gender gap is significant. Moreover, while there are many MFIs in Egypt, there are many geographical areas where demand is unmet. Most of the distribution channels of the large NGOs are in Delta governorates and a few are in Upper Egypt while frontier governorates (Red Sea, Sinai, and the New Valley) are lagging with active borrowers less than 3 percent of the total microfinance customers and low penetration rates.

58. At the same time, mobile penetration in Egypt is relatively high (accounting for 66 percent of the population by January 2018), offering an opportunity for diversified payment services. Mobile payment activity has increased significantly in recent years, as evidenced by the increase in the number of mobile phone accounts, which reached 11 million accounts with an annual growth rate of 36 percent by the end of July 201811 and the number of monthly transactions reached 2 million with a total value of EGP 955 million. Moreover, there are 100,000 agents for m-wallets (such as Fawry, Massary, Bee, Aman, and mobile network operators). Thus, the engagement of microfinance NGOs and companies in mobile money services and loan disbursement/repayment is one powerful and quick solution to overcome limited outreach to rural and remote areas in Egypt, especially for women who suffer more from limited mobility.

59. Policy reform: The Financial Regulatory Authority (FRA), the designated authorized entity responsible for supervising and regulating non-banking financial markets and instruments, has issued several decisions that describe the eligibility criteria and necessary documentation to provide mobile payment licenses and e-payment to microfinance companies and NGO-MFIs. The decisions aim at diversifying the services provided to beneficiaries and simplifying loan disbursement and repayment and

11 Financial Stability report, 2017.


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allowing new entrants to provide such services. The decisions allow microfinance NGOs and companies to deal with e-payment networks through commercial banks authorized from the CBE either through prepaid cards or point of sales recommended by e-payment companies. The decisions also ensure that the commitment to adequate compliance/reporting is provided to the FRA to ensure consumer protection.

60. Expected results: The FRA decisions represent a real breakthrough for MFIs, as they will increase the outreach of intermediaries to cover underdeveloped regions, particularly lagging regions with low urbanization rates and limited number of microfinance outlets. The decisions help existing microfinance beneficiaries save time and money, experience greater security, and manage their cash flows with more flexibility through facilitating disbursement and collection operations with services that are available 24 hours/7 days a week. The average micro loan size for 80 percent of end borrowers range from EGP 5,000-8,000 which matches with mobile payment daily transfer ceiling. The decisions are also expected to reduce operational costs for MFIs and provide data on the financial behavior of borrowe