egypt - iuj.ac.jp · country report egypt november 2006 the economist intelligence unit 26 red lion...

Country Report

Egypt

November 2006

The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

Egypt at a glance: 2007-08OVERVIEW There are some signs that modest advances in the political reform process could be made over the next two years, despite an increase in political control in recent months. The tightening of political control has been motivated in part by the strong performance of the outlawed Muslim Brotherhood in the parliamentary election in late 2005. The government will continue to press ahead with the programme of economic reform launched by the cabinet of the prime minister, Ahmed Nazif, based on an assessment that strong and sustainable economic growth to raise living standards is the best way to undercut the Islamists! appeal. More privatisations and significant investment in the country!s infrastructure can be expected in 2007-08. However, fear of social upheaval may prompt the president, Hosni Mubarak, to proceed more cautiously with some of the potentially painful reforms, such as a much-needed streamlining of the public administration. According to official data, economic growth accelerated to an estimated 6.8% in fiscal year 2005/06 (July 1st-June 30th). The Economist Intelligence Unit expects growth to slow gradually over the outlook period, to 6.2% in 2006/07 and to 5.7% in 2007/08.

Key changes from last month Political outlook • The president has announced that some changes may be made to the

constitution to allow for a fairer selection of presidential candidates. Other amendments may also be tabled in a referendum on the constitution, which is scheduled to take place in 2007.

Economic policy outlook • The Central Bank of Egypt increased its key intervention rates by 50 basis

points to 8.5% and 10.5% on November 3rd. Owing to strong domestic inflationary pressures, we expect interest rates to increase again in 2007.

Economic forecast • Official preliminary data indicate that real GDP growth rose to 6.8% in

2005/06, above our previous estimate. Higher interest rates and strong import expansion will contribute to a slowdown in growth, to 6.2% in 2006/07 and 5.7% in 2007/08.

The Economist Intelligence Unit

The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide.

The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

London The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom Tel: (44.20) 7576 8000 Fax: (44.20) 7576 8500 E-mail: [email protected]

New York The Economist Intelligence Unit The Economist Building 111 West 57th Street New York NY 10019, US Tel: (1.212) 554 0600 Fax: (1.212) 586 0248 E-mail: [email protected]

Hong Kong The Economist Intelligence Unit 60/F, Central Plaza 18 Harbour Road Wanchai Hong Kong Tel: (852) 2585 3888 Fax: (852) 2802 7638 E-mail: [email protected]

Website: www.eiu.com

Electronic delivery This publication can be viewed by subscribing online at www.store.eiu.com

Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office

Copyright © 2006 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited.

All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it.

ISSN 0269-526X

Symbols for tables "n/a" means not available; "�" means not applicable

Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK.

Egypt 1

Country Report November 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006

Contents

Egypt

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2007-08 7 Political outlook 8 Economic policy outlook 10 Economic forecast

13 The political scene

17 Economic policy

22 The domestic economy 22 Economic trends 25 Oil and gas 26 Manufacturing 28 Financial and other services 31 Tourism 33 Infrastructure

34 Foreign trade and payments

List of tables 10 International assumptions summary 12 Forecast summary 18 State finances 19 Financing 23 GDP by expenditure 24 Domestic credit 24 Inflation 25 Money supply 31 Suez Canal 32 Tourism 35 Current account 36 Capital and financial account 36 Foreign reserves

2 Egypt


List of figures 12 Gross domestic product 12 Consumer price inflation 31 Hermes Financial Index

Egypt 3


Egypt November 2006

Summary

There are some signs that modest advances in the political reform process could be made over the next two years, despite an increase in political control in recent months. The tightening of political control has been motivated in part by the strong performance of the outlawed Muslim Brotherhood in the parliamentary election in late 2005. The government will continue to press ahead with its programme of economic reform. More privatisations and significant investment in the country!s infrastructure can be expected in 2007-08. However, fear of social upheaval may prompt the president, Hosni Mubarak, to proceed more cautiously with some of the potentially painful reforms, such as a much-needed streamlining of the public administration. According to official data, economic growth accelerated to an estimated 6.8% in fiscal year 2005/06 (July 1st-June 30th). The Economist Intelligence Unit expects growth to slow gradually, to 6.2% in 2006/07 and to 5.7%, in 2007/08.

The annual conference of the ruling National Democratic Party appeared to provide a springboard for the political ambitions of Gamal Mubarak, the president!s son. The government has said that the constitution may be amended to allow a more equitable selection of election candidates. The authorities have continued to clamp down on dissenters. Proposals to limit the independence of the judiciary and its role in overseeing elections have been put forward.

The budget deficit narrowed in 2005/06 to an estimated 8.9% of GDP, despite strong growth in expenditure. The government has indicated that it will continue to borrow domestically to fund the deficit. The government has announced its intention to develop a civil nuclear programme. Omar Effendi, a department store, has finally been privatised. The Central Bank increased its intervention rates to 8.5% and 10.5%.

Real GDP growth reached 6.8% in 2005/06, buoyed by strong domestic demand. Inflation rose strongly in the first eight months of the year, as did money supply. Bank of Alexandria has been privatised. Banking reform has made progress. Revenue from the Suez Canal has reached new highs. Google has announced its intention to establish its regional headquarters in Egypt.

The trade deficit widened in 2005/06 and the current-account surplus consequently narrowed, despite a strengthening surplus on the services balance. Foreign-exchange reserves reached US$24bn at the end of September.

Editors: Ania Thiemann (editor); Hania Farhan (consulting editor) Editorial closing date: November 3rd 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Outlook for 2007-08

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 Egypt


Political structure

Arab Republic of Egypt

Based on the constitution of 1971

Formally bicameral: the Majlis al-Shaab (People!s Assembly) has 444 directly elected members and ten additional members nominated by the president. Deputies serve a five-year term. The president may dissolve the Assembly only if he gains the support of the people in a referendum. The Majlis al-Shura (the Consultative Council, or "upper house") was established in 1980 and has 264 members: 176 are directly elected and 88 are appointed. Currently, the ruling National Democratic Party controls 255 seats

September 2005 (presidential); November-December 2005 (legislative). Next elections due in 2011 (presidential) and November 2010 (legislative)

President, directly elected. Current president is Hosni Mubarak, who was elected for a fifth six-year term in Egypt!s first multi-candidate elections in September 2005

Council of Ministers headed by the prime minister. The president is responsible for appointing and dismissing ministers. The People!s Assembly can require a minister to resign if it passes a motion of no confidence. Should a motion of no confidence in the prime minister be passed against the president!s wishes, the matter may be put to a referendum. Last cabinet reshuffle: December 2005

National Democratic Party (NDP, the ruling party, 324 seats); New Wafd Party (six); National Progressive Unionist Party (Tagammu, two); al-Ghad (one); the Muslim Brotherhood (officially banned: standing as independents, its members won 88 seats in the 2005 election); Democratic Nasserist Party (no seats in 2005 election)

Prime minister Ahmed Nazif

Administrative development Ahmed Darwish Agriculture Amin Abaza Communication & information technology Tarek Kamel Defence Mohammed Hussein Tantawi Economic development Osman Mohammed Osman Education Youssry al-Gamal Electricity & energy Hassan Ahmed Younes Finance Youssef Boutros-Ghali Foreign affairs Ahmed Abul Gheit Foreign trade & industry Rashid Mohammed Rashid Health Hatem al-Gabaly Housing & new communities Ahmed al-Maghrabi Interior Habib al-Adli Information Anas al-Feki Investment Mahmoud Mohieddin Justice Mamdouh Marei Manpower & Immigration Aisha Abdel Hadi Abdel Ghani Parliamentary & legal affairs Mufid Shehab Petroleum Sameh Fahmy Public works & water resources Mahmoud Abdel-Halim Abu Zeid Social solidarity Ali al-Sayed al-Moselhi Tourism Zoheir Garana Transport Mohammed Mansour

Farouk al-Okdah

Official name

Legal system

National elections

Head of state

National legislature

Central Bank governor

National government

Main political parties

Key ministers

Egypt 5


Economic structure

Annual indicators

2002a 2003a 2004 a 2005 a 2006b

GDP at market prices (E£ bn) 378.9 417.5 485.3 536.6 608.5

GDP (US$ bn) 84.2 71.5 78.3 92.9 106.2

Real GDP growth (%) 3.0b 3.1 4.2 4.9 6.8

Consumer price inflation (av; %) 2.7 4.5 11.3 4.9 7.0

Population (m) 69.9 71.3 72.6 74.0 b 75.4

Exports of goods fob (US$ m) 7,250 8,987 12,274 16,073 23,226

Imports of goods fob (US$ m) -14,709 -15,156 -21,586 -27,200 -35,338

Current-account balance (US$ m) 849 3,723 3,237 2,207 2,425

Foreign-exchange reserves excl gold (US$ m) 13,242 13,589 14,273 20,609 25,405

Total external debt (US$ bn) 30.0 31.4 30.3 32.3 b 31.4

Debt-service ratio, paid (%) 10.3 11.7 7.8 6.0 b 6.1

Exchange rate (av) E£:US$ 4.50 5.84 6.20 5.78 5.73

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2004/05 % of total Components of gross domestic product 2004/05 % of total

Manufacturing 18.2 Private consumption 71.3

Mining (incl oil and gas) 14.8 Government consumption 12.2

Agriculture 13.9 Gross fixed investment 16.6

Trade 11.0 Exports of goods & services 30.5

General government 9.7 Imports of goods & services -30.6

Transportation & communication 6.0 Changes in stocks 0.1

Principal exports 2004/05 US$ m Principal imports cif 2004/05 US$ m

Petroleum & products 5,276 Intermediate (semi-processed) goods 6,803

Aluminium, iron & steel 915 Investment (capital) goods 4,895

Raw cotton, yarn, textiles & garments 858 Petroleum & products 3,975

Pharmaceuticals 215 Consumer goods 3,202

Agricultural products 209 Raw materials (excl petroleum) 2,688

Main destinations of exports 2005/06 % of total Main origins of imports 2005/06 % of total

US 30.6 US 18.9

Italy 11.3 UK 9.7

Spain 7.3 Germany 6.5

India 5.3 Switzerland 5.3

6 Egypt


Quarterly indicators 2004 2005 2006 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 QtrPrices Consumer prices (2000=100) 123.3 126.0 126.3 127.7 128.5 130.0 131.0 134.9Consumer prices (% change, year on year) 11.7 11.9 7.3 4.8 4.2 3.2 3.7 5.6Wholesale prices (2000=100) 142.9 148.8 148.0 151.9 151.7 154.4 149.9 159.9Financial indicators Exchange rate E£:US$ (end-period) 6.229 6.131 5.788 5.779 5.752 5.732 5.737 5.752Deposit rate (av; %) 7.7 7.7 7.6 7.6 7.2 6.5 6.2 6.0Discount rate (end-period; %) 10.0 10.0 10.0 10.0 10.0 10.0 9.0 9.0Lending rate (av; %) 13.5 13.3 13.4 13.4 13.1 12.6 12.6 12.6M1 (end-period; E£ m) 81,146 83,990 86,528 90,268 100,734 101,136 103,799 109,867M1 (% change, year on year) -11.1 -13.8 16.0 15.2 24.1 20.4 20.0 21.7M2 (end-period; E£ m) 451,550 468,959 479,766 494,633 515,788 522,858 535,302 561,160M2 (% change, year on year) 15.1 15.1 14.0 13.5 14.2 11.5 11.6 13.4HFI stockmarket index (end-period)a 19,828 23,893 34,077 41,772 48,169 55,360 57,774 43,046

Sectoral trends Crude oil production (m barrels/day) 0.71 0.70 0.70 0.69 0.69 0.69 0.69 0.68

Foreign trade (E£ bn) Exports fob 11.81 12.86 12.64 13.44 15.27 20.27 19.59 n/aImports cif -21.51 -23.05 -26.30 -29.60 -29.68 -29.11 -28.52 n/aTrade balance -9.71 -10.19 -13.66 -16.16 -14.41 -8.84 -8.93 n/aForeign reserves Reserves excl gold (end-period; US$ m) 13,526 14,273 16,876 18,043 19,792 20,609 21,280 21,349

a Hermes Financial Index.

Sources: International Energy Agency, Monthly Oil Market Report; IMF, International Financial Statistics; Oil Market Intelligence; Bloomberg.

Egypt 7


Outlook for 2007-08

Political outlook

There are some signs that modest advances in the political reform process could be made over the next two years, despite a tightening of political control in recent months. On the one hand, the authorities have very clearly increased political control, clamping down on anti-regime protesters and silencing dissenters who have spoken out in the press against the government. There have also been mass arrests of supporters of opposition groups, particularly of the banned Muslim Brotherhood, and a reining in of judiciary independence has been proposed. On the other hand, it now seems highly likely that several amendments to the constitution, including to Article 76, which relates to the rules for selecting presidential candidates, will be put to a referendum in 2007, possibly leading to a fairer process for selecting presidential candidates in future elections. Although it is too early to speculate whether the proposed amend-ments will lead to genuine political liberalisation, the Economist Intelligence Unit believes that the ruling establishment has started to realise that unless the next president is elected in a seemingly fair and open fashion, his lack of legitimacy will be a serious impediment to maintaining political control, particularly given the possible political ambitions of Gamal Mubarak, the son of the president, Hosni Mubarak.

However, the government will continue to worry about the possible threat to the regime posed by the strong performance of affiliates of the Muslim Brotherhood in the unusually liberal parliamentary election in November and December 2005. The Brotherhood has been noticeably more active in recent months, openly participating in public protests and street demonstrations. Affiliates of the group now hold 88 out of the 454 seats in the People!s Assembly, more than half of those they contested. The ruling National Democratic Party (NDP), a key institution through which the regime exercises power, has around 70% of the seats, well down on the 87% it held in the previous parliament. It is now difficult for the authorities to deny that the Brotherhood commands widespread support and, to dilute the appeal of the Islamists, the government may eventually ease restrictions on the operations of the legal opposition parties, whose credibility has been badly damaged by years of failure to weaken the state!s grip. However, as far as the Brotherhood is concerned, and given its visible opposition to the regime through street protest, it is highly likely that the establishment will continue to resist granting the Brotherhood party status. This strategy carries risks for the government. Over the past year the group has demonstrated its ability to mobilise supporters, and its leaders may be tempted to harness this backing to put further pressure on the government.

Over the outlook period, the government is also likely to attempt to encroach on one of the traditional strengths of the Brotherhood, namely the provision of social services. The government recently announced several policy initiatives to fight poverty and improve access to social and health services, but budgetary

Domestic politics

8 Egypt


constraints and the sheer scale of poverty in the country will continue to leave much room for the Brotherhood to maintain a strong presence in this area.

A key foreign policy concern for Egypt in the outlook period will be Israeli-Palestinian relations, with the aim of restarting peace talks. Egypt!s wider influence in the region"which in recent years has stemmed from its close ties to the US"is in turn based partly on its efforts to encourage progress in the Middle East peace process. Ties with the US have deteriorated in recent years, after the involvement of Egyptians in the September 11th 2001 attacks prompted unaccustomed scrutiny in the US of Mr Mubarak!s rule. Equally, the Egyptian government has been alarmed by the strongly ideological nature of policies espoused by members of the US administration under George W Bush. Until the outbreak of the conflict between Israel and Hizbullah, a Lebanese guerrilla group, in July, Egypt!s relations with Israel had been improving, with closer co-ordination over Israel!s withdrawal from the Gaza Strip and strengthening economic ties. However, strong popular support in Egypt for Hizbullah and growing anger at the dire situation in the Gaza Strip and the West Bank have weakened the government!s ability to play its traditional role of regional mediator. As a result, relations with Israel are becoming more strained, and Egypt!s regional influence is increasingly being undermined.

Economic policy outlook

The sharp deterioration in Egyptians! living standards in the early part of this decade, under the administration of the previous prime minister, Atef Obeid, was an important factor in generating opposition to the government, and undoubtedly contributed to the success of the Muslim Brotherhood in the parliamentary election in late 2005. Several younger, more dynamic, figures within the ruling establishment argue that an effective way to counter the Islamists would be to accelerate the programme of economic reform embarked on by the cabinet of the prime minister, Ahmed Nazif. This, they contend, would achieve more rapid, sustainable economic growth, which would raise living standards and, over the longer term, blunt the appeal of the Islamists. However, faster progress may imply a degree of social dislocation that the highly cautious president would be uncomfortable with, and that the Brotherhood could readily exploit. Therefore, we expect the pace of reform to remain measured.

Even so, reform will continue over the outlook period, with the aim of boosting economic growth and strengthening the capacity of the private sector to absorb the unemployed, and so reduce pressure on the public finances. Measures introduced so far have included sharp cuts in income tax rates and customs duties, and more moderate reductions in fuel subsidies. The cabinet has also reinvigorated the privatisation process, moved to consolidate the troubled banking sector, in part to improve access to finance for the private sector, and begun to overhaul commercial legislation. It is also attempting to tackle entrenched bureaucratic constraints. However, this approach carries risks. If commitment to reform flags, economic activity might not remain sufficiently

International relations

Policy trends

Egypt 9


strong"and privatisation might not accelerate enough"to generate enough jobs and tax revenue to ease the deficit on the fiscal account.

Preliminary data from the Ministry of Finance indicate that the central government deficit narrowed to 8.9% of GDP in fiscal year 2005/06 (July 1st-June 30th), from 9.3% in 2004/05. If extraordinary revenue from asset sales is incorporated, which is standard accounting practice in Egypt, the deficit was closer to 7.9% of deficit. However, we do not include this revenue in our own calculations. Spending growth is likely to remain strong in the outlook period, as still-high energy prices will continue to prevent the government from rationalising its payments on its social safety net (principally on subsidies), even though private-sector activity is picking up. Strong expansion in expenditure will also be underpinned by increases in public-sector wages"driven by pledges made in the 2005 presidential and parliamentary elections. Spending will also be pushed up by higher interest payments on domestic debt, which reached 104.7% of GDP at end-2004/05, and was an estimated 102% of GDP at end-June 2006. Partially offsetting expenditure growth will be the strong expansion in customs receipts as import volumes are expected to continue to rise robustly. Also, following the sharp reduction in the rates of corporate and personal income tax, the tax base has widened. The upturn in private-sector activity and overall economic growth is expected to help ease government spending pressure in 2006/07 and 2007/08, thanks to a projected acceleration of tax revenue growth as recent tax reforms bed down. As a result, we expect the budget deficit to narrow to 8% of GDP in 2006/07 and to 7.5% in 2007/08.

The government!s historical caution over contracting foreign debt makes it likely that it will largely finance the deficits through local borrowing. However, privatisation will pick up, and part of the proceeds will be used to pay down domestic debt. This means that the domestic debt stock, which has increased sharply in recent years, will start falling again as a percentage of GDP, and is expected to decline to 101.3% by end-June 2007 and to around 99.6% by end-June 2008.

After years of poorly focused monetary policy, the Central Bank of Egypt (CBE), under the governorship of Farouk al-Okdah"appointed in late 2003"has given more coherence to monetary management. The CBE under Mr Okdah has introduced a range of tools to influence monetary conditions and has begun to move towards targeting inflation. However, the measures are taking time to work appropriately. As well as properly developed instruments, this will also require significantly more sophisticated skills on the part of CBE personnel. After loosening its monetary stance in the first half of the year, an upsurge in inflation since May led the CBE to increase its key intervention rates, the overnight deposit and lending rates, to 8.5% and 10.5% respectively, on November 3rd. As inflationary pressures are likely to remain strong in the medium term, we forecast that the CBE will have to raise interest rates again in 2007.

Fiscal policy

Monetary policy

10 Egypt


Economic forecast

International assumptions summary (% unless otherwise indicated)

2005 2006 2007 2008

Real GDP growth World 5.0 5.3 4.6 4.8

EU25 1.7 2.7 2.2 2.2

US 3.2 3.3 2.0 2.7

Exchange rates ¥:US$ 110.1 116.2 105.0 97.5

US$:� 1.245 1.250 1.363 1.338

SDR:US$ 0.677 0.681 0.645 0.644

Financial indicators ¥ 2-month private bill rate 0.00 0.23 1.13 2.00

US$ 3-month commercial paper rate 3.38 5.05 4.83 5.09

Commodity prices Oil (Brent; US$/b) 54.7 65.8 65.0 63.3

Cotton (US cents/lb) 55.2 59.2 65.8 71.5

Food, feedstuffs & beverages (% change in US$ terms) -0.5 12.3 -0.4 0.8

Industrial raw materials (% change in US$ terms) 10.2 48.8 -3.4 -10.6

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

World economic growth is forecast to ease from 5.3% in 2006 (in terms of purchasing power parity exchange rates) to 4.6% in 2007, before picking up slightly to 4.8% in 2007. We project that US growth will slow more markedly from 3.3% in 2006 to 2% in 2007, but will then bounce back to 2.7% in 2008. However, there is a major downside risk to this forecast that stems from the large US current-account deficit. Our central forecast is that the US dollar will weaken against the euro (as well as against other major currencies), to an average of US$1.36:#1 in 2007, followed by a partial recovery to US$1.34:#1 in 2008"an important consideration given the prominent role that the Egyptian pound!s value against the US currency plays in Central Bank calculations. A much sharper and more prolonged fall in the dollar!s value is possible, as is a more drastic weakening of US demand.

The average annual price of the benchmark dated Brent Blend is expected to fall from US$65/barrel in 2007 to US$63.3/b in 2008, still above the 2005 average. Supply remains tight, and prices are likely to continue to be sensitive to developments that curb"or threaten to curb"output. The market should begin to loosen more substantially in 2008, as more capacity comes on stream.

Our outlook for Egypt!s growth prospects is positive. The tourism sector continues to perform well, notwithstanding several bomb attacks in popular resorts over the past two years. The robust performance of tourism has enhanced the prospects for private consumption and investment growth. Growth in domestic demand has also been boosted by the reduction of personal and corporate income tax rates in 2005/06. Bolstered by strong domestic demand, GDP growth was unexpectedly strong in the final quarter of 2005/06 (April-June 2006) at 7.6% year on year, according to preliminary data from the newly created Ministry of Economic Development. Real GDP growth

International assumptions

Economic growth

Egypt 11


was also revised upward to 6.9% for the third quarter (January-March 2006), resulting in real growth of 6.8% for full year 2005/06.

Over the next two years, we expect investment to be supported by rising business confidence, as the government presses on with legislative and administrative efforts to improve the business environment, and as privatisation gathers pace. A number of large-scale infrastructure projects will also sustain investment, helped by strong, oil-driven liquidity in the Gulf, as investors turn to Egypt. However, expansion will be substantially constrained by buoyant import growth, spurred on by consumer and investment demand. That said, the increase in purchases of capital goods bodes well for the future strength of the economy. However, the combination of a small dip in consumer demand growth, as interest rates increase, and still strong import demand means that real growth is likely to slow gradually over the outlook period, although growth rates will still be almost twice as high as in the early part of the decade. We forecast that economic growth will decelerate to 6.2% in 2006/07, and to 5.7% in 2007/08 as international trade growth slows.

The strengthening of domestic demand, which has in part been stimulated by large cuts in income tax rates, has led to an increase in consumer price inflation in 2006, which has also been pushed up by a reduction in government subsidies for energy products. In July average fuel costs rose by 30%, and consumer price inflation was 9.5% year on year in September. As a result, we estimate that inflation will have averaged 7% in 2006. In 2007-08 price growth should be constrained by the stability of the Egyptian pound against the US dollar (and other major currencies) as well as by a decline in average global non-oil commodity prices. In addition, the improvement of the monetary framework should enable more effective control of liquidity. These factors should allow the authorities to bring down the average rate of inflation to 5.8% in 2007 and 3.8% in 2008.

As a result of strengthening foreign-currency inflows and major improvements in the policy framework, the Egyptian pound has appreciated steadily in 2006, from an average of around E£5.78:US$1 in 2005, and we estimate that it will have averaged around E£5.73:US$1 in 2006. However, the competitiveness of Egyptian exports has not been significantly dented, owing to the extent of the overall fall in the pound since the start of 2000. In 2007, with confidence in the currency robust, and continued inflows of foreign capital, we forecast a small further appreciation, to an average of E£5.72:US$1. We expect the authorities to attempt to manage a slight depreciation in 2008 for the benefit of non-oil exports, which should result in an average exchange rate of E£5.75:US$1.

The trade deficit will continue to widen in 2007-08, to an annual average of around US$12.6bn, as an increase in import spending, bolstered by tariff cuts (introduced in late 2004), still-high oil prices, strengthening economic growth and a depreciation of the US dollar, more than offset a rise in hydrocarbons export earnings, especially from gas. The non-merchandise surplus will widen gradually, as growth in tourism and strengthening inflows of workers! remittances more than offset an increase in profit repatriation, much of which

Inflation

External sector

Exchange rates

12 Egypt


will be related to the gas sector. The expansion in the invisibles surplus will just outpace growth in the trade deficit, and the current-account surplus will thus widen modestly over the outlook period, helped by still-high energy prices, from an estimated US$2.4bn (2.2% of GDP) in 2006 to US$3.1bn (2.3% of GDP) in 2008.

Forecast summary (% unless otherwise indicated)

2005 a 2006 b 2007c 2008c

Real GDP growth 4.9 6.8 6.2 5.7

Industrial production growth 5.0 5.1 5.2 5.5

Gross agricultural production growth 3.5 3.0 3.2 3.2

Consumer price inflation (av) 4.9 7.0 5.8 3.8

Lending rate 13.1 12.6 12.8 13.0

Government balance (% of GDP) -9.3 -8.9 -8.0 -7.5

Exports of goods fob (US$ bn) 16.1 23.2 29.2 34.2

Imports of goods fob (US$ bn) 27.2 35.3 41.7 47.0

Current-account balance (US$ bn) 2.2 2.4 2.8 3.1

Current-account balance (% of GDP)d 2.2 2.2 2.2 2.3

External debt (year-end; US$ bn) 32.3 b 31.4 32.1 32.5

Exchange rate E£:US$ (av) 5.78 5.73 5.72 5.75

Exchange rate E£:¥100 (av) 5.25 4.93 5.45 5.90

Exchange rate E£:� (av) 7.19 7.16 7.79 7.69

Exchange rate E£:SDR (av) 8.54 8.42 8.87 8.93

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d Ratio based on calendar year GDP; national accounts use fiscal year.

Egypt (a) Middle East & North Africa

Gross domestic product(% change, year on year)

Egypt (a) Middle East & North Africa

Consumer price inflation(av; %)

(a) Fiscal years ending June 30th.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

20

02

03

04

05

06

07

08

2.0

4.0

6.0

8.0

10.0

12.0

20

02

03

04

05

06

07

08

Egypt 13


The political scene

Despite some signs that the regime recognises the need to acquire some political legitimacy, doubts remain over the government!s willingness to pursue political reform. Gamal Mubarak, the assistant secretary-general of the ruling National Democratic Party (NDP) and son of the president, Hosni Mubarak, appeared to use the annual conference of the NDP in September as a springboard for his political ambitions. He focused media attention on himself by announcing that Egypt will seek to develop a civil nuclear programme to meet future energy needs (see Economic policy), a move that was promptly endorsed by both his father and"to the surprise of many"the US ambassador to Egypt, Francis Ricciardone.

The NDP!s conference appears to have set the stage for Gamal Mubarak to become a sho0-in for the presidency, in spite of his repeated denials of any presidential ambitions, and assuming his father decides to step down at the end of his current mandate, which expires in 2009. In his opening speech, Gamal Mubarak focused on the "hardships" suffered by ordinary Egyptian citizens, emphasising that he believed the state should shift its role from participating in economic activity to "protecting the poor". This was echoed by the president, who stated in his own speech to the delegates that the time had come to focus more closely on social development, helping the poor and the middle classes. He reiterated his plans to expand the coverage of the social security network from 650,000 families to 3.3m families in six years. He also mentioned recent policies to allocate increased funding for bread subsidies, job creation, infrastructure improvement (especially of the transport and sewage systems) and health reforms. Although these aims have broad backing, they are also intended to drain support for the socially proactive Muslim Brotherhood (an opposition Islamist movement that is officially banned in Egypt, although it was allowed to campaign relatively openly in the 2005 elections and currently holds 88 seats in the 454-seat People!s Assembly).

The president announced at the conference that some constitutional changes will be made to the rules governing presidential elections, which will be put to a referendum in 2007. This may be a tacit recognition by the regime that if Gamal Mubarak were elected president under the present rules (amended in 2005 to allow for multi-candidate elections, but with very tight restrictions on who can stand), his legitimacy, and hence ability to control the country, would be compromised. The regime hopes that introducing a more democratic selection process could overcome this danger without jeopardising Gamal Mubarak!s chances of victory. The constitutional affairs minister, Moufid Shehab, simultaneously announced plans to enhance legislative oversight of the executive, which would allow the People!s Assembly to pass a vote of no confidence in the government and to amend the budget. He also stated that the president had asked for some of the prerogatives of his office to be transferred to the prime minister. Although these suggestions seemed to move in the direction of a more open and democratic political framework, Mr Shehab disappointed many observers by stating that the long-promised replacement of the emergency law by anti-terror legislation (May 2006, The political scene)

Limited constitutional reform may be forthcoming

Gamal Mubarak dominates the NDP's party conference

14 Egypt


would in fact only amount to a cosmetic change, formally ending the "state of emergency" that has been in place for 25 years, but not in fact repealing the emergency law.

Some government officials such as Mr Shehab and the secretary-general of the NDP, Safwat al-Sherif, have insisted that the constitution will not be completely rewritten, as some opposition figures have demanded. However, detailed constitutional reform proposals currently being drafted by the government-affiliated National Council for Human Rights (NCHR), which"though not yet officially published"are said to call for the amendment of Articles 76 and 77 to limit the presidency to two terms and reduce the restrictions on standing as a presidential candidate. The president, Mr Mubarak, has also indicated that article 76 will be amended.

Other changes are likely to limit rather than to increase political liberalisation. One such change is the proposed amendment to Article 88 of the constitution, which deals with judicial oversight of parliamentary elections. The speaker of the People!s Assembly and NDP loyalist, Fathi Sorour, argued in September that Article 88 should be redrafted to prevent judicial oversight of elections on the grounds that it is "unacceptable" that judges come into "direct contact" with voters and the police in polling stations, or that they should otherwise be involved in politics. In late August the Judges! Club (an independent, elected professional body) declared that it would resist these changes. This comes on the heels of the ongoing dispute between the"broadly independent"judiciary and the government over last year!s parliamentary election (May 2006, The political scene). In October the Court of Cassation (the highest national appeal court) announced that so far 1,050 appeals have been lodged for electoral irregularities, and the results of elections in 90 constituencies have been declared null by the court. That said, according to Article 93 of the constitution (which opposition groups and the NCHR also want to see amended), in order for the Court of Cassation!s findings to be enforced, they must be approved by a two-thirds majority of the People!s Assembly. Given that the contested seats include some held by senior NDP figures closely associated with the government, and that the NDP retains a substantial majority in the Assembly, such approval seems unlikely.

The regime!s hardening attitude towards dissident judges is reflected in the choice of a new minister of justice in the small cabinet reshuffle that took place on August 27th. The former justice minister, Mahmoud Abu Leil, had come under heavy criticism for his handling of the regime!s dispute with the Judges! Club, resulting in a spate of street protests when two judges who complained of vote-rigging in last year!s elections were committed to trial (May 2006, The political scene). The new justice minister is Mamdouh Marei, head of the constitutional court until July 2006 and a regime loyalist who chaired the Presidential Elections Commission in 2005. In this capacity, he was responsible for the controversial decision to prevent independent domestic and international election monitors from entering polling stations. His appointment appears to be the next step in the executive!s ongoing consolidation of control over the judiciary.

Cabinet reshuffle signals tighter rein on judges

Egypt 15


Although a reshuffle had been widely expected, its limited scope was a surprise to many observers. A local opposition newspaper, Al Masry Al Yawm, had even predicted the replacement of the prime minister, Ahmed Nazif. This prediction seems to have been largely based on an attack on Mr Nazif (who was described as a "failed man") in a weekly newspaper, Rose al-Youssef, which is seen as being close to the circle surrounding Gamal Mubarak. In the event, however, the only other major change in ministerial portfolios was the division of the former Ministry of Planning into two separate bodies"in a move to "achieve greater balance between central and regional planning", according to the official statement. The former minister, Osman Mohammed Osman, has been given the new and more specific post of minister for economic development, reflecting the high priority given to this goal by Mr Nazif!s government. At the same time, as part of the government!s efforts to achieve greater decentralisation, Mr Osman!s previous regional responsibilities have been passed on to a new minister for local development. This job was given to the former governor of Alexandria, Mohammed Abdel Salam Mahgoub. In his nine years as governor, Mr Mahgoub received a great deal of credit for his economic regeneration of the Mediterranean port town, and he is now expected to apply this successful model to the country at large.

Although political debate in Egypt has become more open since mid-2005, when public criticism of the president became permissible for the first time, recent developments have demonstrated the limits of this new freedom. The Annual Report of the Higher Press Council (an official body affiliated to the Shura Council), which was published in September, called upon the Press Syndicate, the journalists! elected representative body, to act to prevent journalists from "insulting the president". This resulted in an open exchange of insults between two newspaper editors as they were being interviewed on a privately-owned satellite television channel, followed by an extensive argument in the pages of state-owned and opposition publications, which appears to have been only partially patched up by a vague agreement between the rival camps to avoid "immoral" violations of the journalists! code of ethics.

This development came at a time when Ibrahim Issa, the editor of an opposition weekly newspaper, Al Dostour, was appealing against a 12-month prison sentence for publishing an accusation that the president had misused government funds. There is also an ongoing court case involving journalists from another local weekly, Sawt al-Umma, who published the initials of judges said to have helped to falsify the results of the 2005 parliamentary election (including one judge who has since been convicted for the same offence by the Court of Cassation).

Moreover, on October 31st, Talaat Sadat, the nephew of the former president, Anwar Sadat, who was assassinated in 1981, was sentenced to one year!s imprisonment for "insulting the armed forces". Mr Sadat, an MP and member of Al Ahrar, a liberal opposition party, had been stripped of his parliamentary immunity in early October following his claim, in a satellite television interview, that his uncle!s assassination had been the result of an "international conspiracy" involving collusion between the US, Israel, the former president!s own guards and some Egyptian army commanders. Like the presidency, the

The limits of freedom of expression are tested

16 Egypt


army has traditionally been immune from criticism in Egypt, given its "special status" as the founder and protector of modern Egypt. Although that position has been weakened to some extent, the army still plays an extremely important political and economic role in Egyptian society.

The government continues to arrest and detain members of the Muslim Brotherhood. Despite the release in mid-October of Mahmoud Ezzat, the movement!s secretary-general, along with 14 others, a number of senior members remain imprisoned, including two leading members of the political bureau, Essam al-Erian and Mohammed Mursi. This is despite the fact that their release was ordered in August by a local misdemeanour court, under new legislation (passed by the People!s Assembly in June) that gives detainees a right of appeal.

The continued detention of Muslim Brotherhood activists reflects a broader concern within the regime about the activities of militant Islamists in Egypt. Since the most recent attack on the Red Sea resort of Dahab in April 2006 (May 2006, The political scene), the Egyptian security forces have conducted extensive operations in Sinai. In early September three members of al-Tawhid wa al-Jihad, a militant Islamist group said to be composed largely of Sinai Bedouins, some of whom have Palestinian connections, were sentenced to death for their role in the 2004 Taba bombings. In early September the security forces launched a major search in the Sinai region for five militants. Following an Israeli government warning in late August that Israeli tourists should leave the area immediately, an official from the Egyptian Ministry of the Interior, Colonel Wagdi Ramzi, stated that the ministry had received intelligence that members of al-Qaida, a militant Islamist network, were planning to carry out new attacks in Sharm el-Sheikh and Dahab. A planned visit by the president to North Sinai was cancelled because of security considerations, according to Al Fagr, a local daily newspaper. These developments reflect the government!s ongoing concerns over security in the Sinai region.

The Egyptian government is seeking to play a mediating role in the region against a backdrop of a series of regional crises, including the Israeli offensive in Lebanon in July-August, the conflict between Hamas and Fatah in the Palestinian territories, and the worsening situation in Darfur. This involves in particular striking a delicate balance between support for and criticism of US foreign policy towards the region. Egypt was slow to condemn the Israeli attack on Lebanon in July, because of the regime!s dislike of Hizbullah, leading to embarrassment as the Lebanese guerrilla group!s popularity with the Egyptian population grew rapidly, as did anger at the government for not distancing itself from the US. Despite an attack by Gamal Mubarak on the Middle East Initiative Project, a key US policy in the region, at the NDP conference in September, official relations were clearly cordial when the US secretary of state, Condoleezza Rice, visited Cairo in October. No doubt aware of the delicate situation of the government, in an unusual move, she refrained from criticising Egyptian domestic policy, including plans for a civil nuclear programme, and"in contrast to previous visits"did not lambast the government for the slow progress of political reform in Egypt.

"Islamist threat" continues to worry the government

Egypt's relations with the US diminish its regional clout

Egypt 17


Instead, Ms Rice indicated that her purpose was to meet US regional allies"the six member states of the Gulf Co-operation Council (GCC), together with Jordan and Egypt. The Egyptian foreign affairs minister, Ahmed Abul Gheit, explained that the Arab states felt that these meetings represented a positive way to influence, as much as possible, the US perception of and plans for the region. He emphasised the necessity of improving the US!s understanding of the Palestinian question in particular. However, without positive, identifiable results in terms of US policy changes, these meetings could backfire within Egypt, increasing public disapproval of the government.

Egypt!s close relationship with the US is also having a negative impact on its influence as a mediator in the region. Even though the Egyptian government is still able to talk to all the actors in the region (as illustrated by recent meetings with both Israel and Syria, as well as Hamas), its ability to play an important balancing role is much diminished. Egypt has been active in recent negotiations to secure the release of an Israeli soldier, Corporal Gilad Shalit, who was captured in the summer by Palestinian militants. So far, however, these efforts have borne no fruit, partly because one of the Hamas leaders, the Damascus-based Khaled Meshal, is more influenced by Iran and Syria than by Egypt, which has tended to support the rival Fatah movement, headed by the Palestinian president, Mahmoud Abbas. With Hamas snubbing Egypt, there are growing signs that Egypt, alone, will not be able to make the various actors in the region change their policy.

Economic policy

Preliminary data indicate that central government revenue for the fiscal year 2005/06 (July 1st-June 30th) rose by almost 35%, to E£149.5bn (US$26bn), compared with the outturn for 2004/05. This is 15% higher than the revenue projection in the budget, largely because of higher than expected tax receipts, which rose to E£98bn"a 29% increase on 2004/05 and 20% above budget. The improvement can be partly explained by the rapid growth of the Egyptian economy in 2005/06 (see The domestic economy: Economic trends). It is also attributable to the success of recent tax reforms, which, by lowering income tax rates and generally simplifying procedures, appear to have broadened the tax base and increased compliance. The change is most marked in the case of income tax, which at E£48.5bn is the largest single item on the revenue side. Income tax receipts from individuals and businesses increased by more than 50% year on year, exceeding budget projections by almost 40%. The rates of both corporation and personal income taxes were lowered to a maximum 20% from July 2005. Most of the increase in income tax revenue came from corporation taxes, which rose from E£22.3bn to E£38.9bn. Tax receipts from goods and services, the next largest item, rose by a more modest 10% year on year, exceeding the budget target by 6.5%. Most of the increase in this category came from a 12% rise in sales tax revenue, which makes up almost two-thirds of the whole. Income from custom duties climbed by 24%, despite a lowering of tariffs from September 2004, another indication of strong economic growth, which is sucking in imports. Property tax revenue, though a relatively insignificant item in the fiscal accounts, rose by 17%.

Full-year fiscal results indicate a 35% revenue rise

18 Egypt


Returns on financial assets also rose strongly compared with 2004/05, more than doubling from E£17.8bn to E£36.4bn, partly because of a rise in global interest rates. Even so, the returns fell slightly short of budget projections. Other sources of revenue, including proceeds from the sale of goods and services, as well as grants from foreign governments, were significantly lower than in 2004/05, but the losses were not sufficiently large to dent the overall increase in fiscal revenue.

State finances (E£ m unless otherwise indicated; fiscal years)

2002/03 2003/04 2004/05 2005/06 2005/06

Outturn Outturn Outturn Outturna % change b Budget % changec

Revenue

Taxes 55,707 67,147 75,759 98,030 29.4 81,607 20.1

Income tax 20,842 27,280 31,571 48,487 53.6 34,844 39.2

Property tax 785 785 1,034 1,214 17.4 1,004 20.9

Taxes on goods & services 23,102 26,552 31,430 34,450 9.6 32,359 6.5

Taxes on international trade 8,233 9,234 7,744 9,561 23.5 9,115 4.9

Other taxes 2,746 3,297 3,979 4,317 8.5 4,285 0.7

Grants 3,290 5,058 2,853 1,584 -44.5 2,861 -44.6

Other revenue 30,350 29,839 32,252 49,907 54.7 45,683 9.2

Returns on financial assets 13,353 14,547 17,758 36,389 104.9 37,903 -4.0

Proceeds on sales of goods & services 7,790 9,451 7,197 7,451 3.5 5,096 46.2

Other 9,207 5,842 7,297 6,067 -16.9 2,685 126.0

Total revenue 89,347 102,045 110,864 149,521 34.9 130,152 14.9

Expenditure

Wages & salaries 33,816 37,266 41,546 45,918 10.5 45,843 0.2

Purchases of goods & services 8,548 9,342 12,613 13,746 9.0 13,143 4.6

Interest payments 25,848 30,700 32,780 36,761 12.1 42,605 -13.7

Subsidies, grants & social benefits 20,567 24,787 29,706 68,751 131.4 50,546 36.0

Other expenditure 18,290 21,042 21,692 19,600 -9.6 18,285 7.2

Purchases of non-financial assets 20,251 22,851 23,275 19,687 -15.4 17,395 13.2

Total expenditure 127,320 145,988 161,611 204,464 26.5 187,817 8.9

Net acquisition of financial assets 5,671 2,036 896 -5,974 - 1,735 -

Budget balance -43,644 -45,979 -51,643 -48,969 -5.2 -59,400 -17.6

a Preliminary. b Year on year. c 2005/06 outturn on 2005/06 budget.

Source: Ministry of Finance.

Healthy growth in fiscal revenue was, however, largely offset by a strong rise in government spending, which increased by more than 26% compared with 2004/05. Expenditure on subsidies, grants and social benefits climbed by more than 130%, from E£29.7bn in 2004/05 to E£68.8bn in 2005/06, exceeding budget projections by more than one-third and overtaking public-sector wages and salaries as the government!s largest single spending category. The scale of this increase is largely attributable to the steep rise in oil prices that occurred during the year, which pushed up the cost of the government!s fuel subsidies. The public-sector wage bill also increased, by over 10% to E£45.8bn, although it came in just over budget. Interest payments rose by 12%. This was entirely due to a rise in borrowing from domestic financial and other institutions rather than to an increase in domestic interest rates, and foreign interest payments and domestic payments to government units actually fell. The government managed to reduce its purchases of non-financial assets (largely fixed assets) by

Egypt 19


15%"but by less than it had budgeted for. Purchases of goods and services rose by 9%, as a steep drop in the value of goods bought was more than offset by a rise in the cost of services and other items.

The final outturn for the central government was an overall cash deficit of E£54.9bn in 2005/06"up by more than 8% on the previous year and the equivalent of 8.9% of GDP, according to government figures. However, in the Ministry of Finance accounts, this deficit is offset against the net acquisition of financial assets (a net sale in assets, including privatisation receipts), valued at E£6bn. Consequently, the finance ministry puts the overall central government deficit at just E£49bn"the equivalent of 7.9% of GDP and 5% lower than in 2004/05, when the fiscal deficit stood at nearly 10% of GDP. The Economist Intelligence Unit does not include privatisation receipts as part of government revenue for budget purposes, and therefore considers the deficit figure of 8.9% of GDP to be more accurate. Following the pattern established in previous years, the deficit will be financed largely by domestic borrowing. This borrowing is increasingly from non-bank sources"borrowing from domestic banks halved in 2005/06 compared with 2004/05.

Financing (E£ bn unless otherwise indicated; fiscal years)

2001/02 2002/03 2003/04 2004/05 2005/06a % changeb

Overall budget balance -38,486 -43,644 -45,979 -51,643 -48,969 -5.2

Net privatisation proceeds 419 39 17 1,012 126 -87.5

Net borrowing requirements 38,067 43,605 45,962 50,631 48,843 -3.5

Borrowing 30,015 31,494 44,195 66,862 54,954 -17.8

Domestic sources 23,488 25,914 43,692 71,105 51,323 -27.8

Non-bank 16,308 16,650 24,331 32,174 35,929 11.7

Bank 14,391 19,293 21,002 31,395 15,970 -49.1

Net credit & debit liabilities -7,211 -10,029 -1,641 7,536 -576 -107.6

Foreign sources 6,527 5,580 503 -4,243 3,631 -185.6

Payments of outstanding arrears -5,863 -3,103 -2,734 -2,477 -1,326 -46.5

Other 4,110 3,660 2,209 1,876 -338 -118.0

Exchange rate revaluation 4,497 12,740 1,486 -3,935 -452 -88.5

Unidentified 5,308 -1,186 806 -11,695 -3,995 -65.8

a Preliminary. b On previous year.

Source: Ministry of Finance.

Egypt has decided to diversify its energy sector by launching a civil nuclear programme. The decision was announced by Gamal Mubarak, the son of the president, Hosni Mubarak, at the annual conference of the ruling National Democratic Party (NDP) on September 19th (see The political scene). The president subsequently confirmed the plan, emphasising in an article published in the Armed Forces Journal on November 9th that the Non-Proliferation Treaty, to which Egypt is a signatory, guarantees the country!s right to use nuclear energy for "peaceful means". In late October the electricity and energy minister, Hassan Ahmed Younes, told Al Akhbar, a state-owned daily newspaper, that Egypt would have a "permanent and vast nuclear programme", approved by the International Atomic Energy Agency. Egypt!s first nuclear power plant will be built at Al Dabaa, on the Mediterranean coast. Work seems likely to begin

Egypt embraces nuclear energy

The deficit is financed largely by domestic borrowing

20 Egypt


within months, as Mr Younes has set a target for Egypt to have an operational nuclear facility within ten years. The estimated cost will be around US$1.5bn, which the government expects to be financed by foreign investment.

The Egyptian regime has been careful to emphasise that the primary justification for the decision to move ahead with nuclear energy is economic rather than political. Egypt considered adopting nuclear energy in the 1980s, but the plans were abandoned as several large oil and gas discoveries were made, and energy prices world wide were falling. The return to an active nuclear energy policy no doubt reflects some geopolitical developments, such as a desire to balance Iran!s ongoing nuclear programme. It has also received the approval of the US. However, a key underlying concern is the possibility that current gas reserves will not be sufficient to generate all of Egypt!s energy needs, especially when it also needs to continue to attract foreign direct investment (FDI) into some of its energy-intensive industries. The government has been increasingly concerned over the past year about the problem of securing sustainable energy supplies. Mr Younes stated in late September that annual power generation had risen to 150bn kwh from 18bn kwh in 1998, and that the number of users stood at 22m (up from 4.5m in 1981). On October 10th the Higher Council for Energy"a ministerial-level body that was convened for the first time in 18 years to discuss the nuclear question"reviewed a report on the uses of petroleum and natural gas in industry. This showed that the total local consumption of natural gas and petroleum had risen from 21.6m tonnes/year (t/y) in 1985 to 51.7m t/y in 2005, with natural gas usage climbing especially steeply, as Egypt has increased the usage of gas-fired power stations in recent years. However, with Egypt!s demand for gas for industry growing and its liquefied natural gas exports rising, and fewer new discoveries than expected, there is now a strong incentive for further diversification of the energy sector. Although the initial costs will be high, it is expected that lower fuel costs and cheaper energy will make the nuclear programme economically viable in the longer term. There are also ongoing efforts to develop alternative energy sources. In early October the Ministry of Electricity and Energy reviewed technical offers for the establishment of a 150-mw solar power plant in Kuraymat.

The government is continuing with its efforts to implement economic reforms in order to attract additional FDI, which rose strongly in 2005/06, reaching US$6.1bn compared with US$1bn in 2003/04, according to Central Bank of Egypt data. Following the approval in July of the new stamp duty law, which in particular lowered taxes on advertising, life insurance policies, loans and credit facilities, but also substantially reduced the number and level of duties, as well as streamlining payment procedures, the government has moved to focus on the public administration and insurance sectors.

On October 17th the prime minister, Ahmed Nazif, met with officials for a final discussion of the new draft civil service law, which the government hopes will be ratified in the forthcoming parliamentary session that runs for nine months from November. According to an official statement, the law aims at "combating slackness, negligence and corruption in the bureaucratic system" by improving and speeding up disciplinary procedures, as well as defining penalties,

The government steps up economic reform

Egypt 21


including mechanisms for the dismissal of employees. The Egyptian civil service is vastly over-staffed and heavily bureaucratic. However, the govern-ment!s concern to keep unemployment under control is likely to deter it from any radical restructuring.

In early September the finance minister, Youssef Boutros-Ghali, announced that comprehensive new insurance and pensions legislation would be passed in early 2007. The laws will establish mandatory and voluntary social security funds governed by a single monitoring apparatus. Also in September, a new holding company was created to oversee the financial restructuring of the ownership and management of the three state-owned insurance companies (Misr Insurance, Al Sharq Insurance and Al Ahlia Insurance, which together control about three-quarters of the relatively small Egyptian insurance market), as well as the Egyptian Reinsurance Company, in preparation for the privatisation of some or all of them. According to a statement from the Ministry of Investment, the aim will be to achieve capital and management efficiency and improve co-ordination with firms involved in related activities. The three state-owned insurance companies together control about three-quarters of the Egyptian insurance market"which remains relatively small. However, it is likely that a more competitive market will improve coverage in the future.

As with the Bank of Alexandria privatisation, which finally went through in October (see The domestic economy: Financial and other services, other high-profile deals have also experienced delays. In September the Alexandria Mineral Oils Company (AMOC) sold 50% of its capital to a strategic investor, following the completion of due-diligence procedures on five potential buyers. The state-owned Indian Hindustan Petroleum Corporation Limited had been named as a potential purchaser, together with some Kuwaiti and Saudi oil firms. However, by mid-October no bids had been received. This was in contrast to AMOC!s previous flotation, of a 20% stake in October 2005, which was heavily over-subscribed (November 2005, Economic policy). Some analysts attributed this slow response to "privatisation fatigue", or to the heavy reliance of AMOC on the Egyptian government, which both supplies it with raw materials and is the main purchaser of its product. However, some analysts have suggested that the current market price, which has risen in expectation of a deal, is simply too high for any investor seeking a 50% stake.

On September 25th the sale of 90% of Egypt!s well-known chain of state-owned department stores, Omar Effendi, to Anwal of Saudi Arabia was finally approved by its parent company, the Holding Company for Trade (HCT), and the deal was signed on November 2nd, after many last-minute delays. Anwal will pay E£589.5m (US$103m), in addition to investing E£180m in the firm, assuming E£155m of its liabilities and funding the early retirement of 1,230 employees at a total cost of E£50m. The HCT will temporarily retain a 10% stake (which will eventually be transferred to employees) in order to protect workers! rights. Anwal is also committed to continue to operate the department store chain, without selling any of the six branches that are identified as being of particular historical or architectural value.

Further hitches for AMOC

Omar Effendi is finally sold off

22 Egypt


Further disputes may cause problems for Anwal. There may be difficulties over relations with Omar Effendi!s long-established suppliers. The Endowments Agency, a semi-autonomous public body, which holds the lease on several of the chain!s most important premises, has also expressed dissatisfaction with the deal, arguing that it should have received more money, given the high valuations placed on the properties during the sale process.

At its meeting on November 2nd, the Monetary Policy Committee of the Central Bank raised its overnight deposit and lending rates to 8.5% and 10.5% respectively, having left them unchanged over the past quarter, at 8% and 10%. This decision was unsurprising in view of the strong rise in the rate of inflation in recent months (see The domestic economy: Economic trends) and buoyant economic growth. The accompanying press release from the Central Bank hints that more increases could follow if inflation continues to increase. The Central Bank attributes rising inflation to second round effects of the price "adjustment" in July, when the government reduced fuel subsidies, and to rapid economic expansion. We have previously highlighted the underlying inflationary pressures, also evident in strong money growth (see The domestic economy: Economic trends).

The domestic economy

Economic trends

The economic development minister, Osman Mohammed Osman, announced in mid-September a provisional figure of 6.9% for real GDP growth (at factor cost) in fiscal year 2005/06 (July 1st-June 30th). This compares with a rate of 4.6% in 2004/05. (In terms of market prices, the figures translate into 6.8% in 2005/06 and 4.5% in 2004/05.) The quarterly breakdown indicates that growth picked up markedly in the fourth quarter (April-June), reaching 7.6% year on year, compared with a third quarter rate of 6.9% year on year. As the figures are not seasonally adjusted, an analysis of the quarter-on-quarter changes would be misleading; however, the year-on-year figures suggest buoyant growth. Indeed, the 2005/06 growth rate exceeds the government!s official 6% target, a figure that it deems necessary to achieve in order to deliver sufficient job creation for the roughly 600,000 people who enter the Egyptian labour market each year. A recent report by the Merrill Lynch Foundation, a US grouping of several financial institutions, hails the government!s "sound economic policies" and, in part, attributes the upturn in growth in 2005/06 to rising inflows of foreign direct investment, especially from the oil-rich Gulf states. In the latest ratings report by Moody!s Investors Service"in which it assigns Egyptian government bonds a Baa3 rating with a negative outlook and local- and foreign-currency bonds Ba1 with a stable outlook. The Economist Intelligence Unit expects GDP growth to ease to just over 6% in 2006/07, but this would still meet the government!s target.

According to the data provided by the Ministry of Economic Development, aggregate domestic demand has been the main engine of growth for most of

The Central Bank increases its intervention rates

Full-year figures indicate strong growth in 2005/06

Egypt 23


the past 18 months. The acceleration of domestic demand in the fourth quarter was mainly due to strong household consumption, which grew by 10.2% year on year in the final quarter, double the third-quarter growth rate. Overall, household consumption growth averaged 6.4% in 2005/06, up from 4.8% in 2004/05. Total investment growth (including inventory building) decelerated to a still respectable 8.6% year on year in the fourth quarter. Despite the slowdown in the fourth quarter, full-year investment growth nonetheless rose to 13.3% year on year in 2005/06 from 10.3% in 2004/05. With no disaggregation of the investment total it is difficult to precisely determine the influence of inventory growth. However, judging by the amount of construction work and business capital spending under way, we can assume that gross fixed capital formation played a substantial role in overall inventory growth.

GDP by expenditure (% change, year on year; constant prices, fiscal year 2001/02)

2004/05 2005/06 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year

Household consumption 6.2 3.8 4.1 5.1 4.8 4.3 6.9 5.0 10.2 6.4

Public consumption 3.0 3.6 3.2 1.5 2.8 5.1 6.1 0.8 0.7 3.1Investmenta 11.5 -3.9 17.3 14.1 10.3 17.9 18.2 12.6 8.6 13.3Domestic demandb 6.8 2.9 6.6 7.3 5.9 6.6 9.0 6.5 9.5 7.9

Exports 13.5 29.5 9.3 28.8 20.2 43.1 26.0 14.6 7.5 21.3Imports 27.7 19.8 14.4 33.4 23.8 42.2 32.0 10.7 10.1 21.8

Foreign Balanceb -2.6 1.9 -1.7 -2.0 -1.1 0.0 -1.7 0.8 -1.3 -0.6Total GDP (factor cost) 4.4 4.5 4.6 4.9 4.6 6.3 7.0 6.9 7.6 6.9

a Including inventory building. b Contribution to GDP growth.

Source: Ministry of Economic Development.

The foreign balance (net exports) subtracted 1.3 percentage points from the year on year growth rate in the fourth quarter. Although this was partly due to vibrant import expansion, in turn reflecting the pace of domestic demand, it was also a function of slowing export growth. In comparison with the first half of 2005/06, when goods and services exports increased by an average of 35% year on year, the pace slackened to 11% in the second half of the year (7.5% in the fourth quarter).

According to the latest available data from the IMF, the long-term downward trend in total domestic credit growth continued during the first five months of 2006. The slowdown was due to two separate developments: decelerating growth in credit both to the private sector and to non-financial public enterprises, following substantial expansion in the latter in 2005. By contrast, central government borrowing resumed its former pattern of growth, after a drop in 2005. Central government borrowing also increased its share of the total to almost 44% in May 2006. The rise in government borrowing reflects the wide budget deficit, with the government preferring to borrow domestically rather than on the international capital market.

Total credit growth slows in first five months of 2006

24 Egypt


Domestic credit (E£ m unless otherwise indicated)

2001 2002 2003 2004 2005 2006 Dec Dec Dec Dec Dec MayTotal domestic credit 334,522 378,621 436,655 480,258 500,629 518,726 % change, year on year - 13.2 15.3 10.0 4.2 3.6

To private sector 197,038 207,089 225,023 259,833 273,272 279,917 % change, year on year - 5.1 8.7 15.5 5.2 2.4 % of total 58.9 54.7 51.5 54.1 54.6 54.0To central government 94,092 127,216 158,174 206,260 185,456 227,539 % change, year on year - 35.2 24.3 30.4 -10.1 17.6 % of total 28.1 33.6 36.2 42.9 37.0 43.9To non-financial public enterprises 43,393 44,316 47,999 38,266 67,820 41,775 % change, year on year - 2.1 8.3 -20.3 77.2 -38.4 % of total 13.0 11.7 11.0 8.0 13.5 8.1

Source: IMF, International Financial Statistics.

After averaging 3.7% year on year in January to March, inflation has accelerated in recent months. According to the Central Agency for Public Mobilisation and Statistics, the consumer price index increased in year-on-year terms by 8.4% in July and 8.9% in August, the fifth consecutive month of acceleration. The upward trend reflects buoyant economic growth (strong domestic demand fuelled in part by income tax cuts) and high energy costs. A reduction in state fuel subsidies in July boosted fuel prices by 30% and contributed to a 10.4% surge in transport costs in August. Food prices have also continued to rise rapidly, as a severe case of avian influenza ("bird flu") earlier in the year has led to a general increase in the prices of non-poultry protein. Other factors boosting inflation include tobacco prices, which are controlled by the government and rose, by 7.4% in August, for the third consecutive month, following a year of no growth at all, and communications costs"a small component in the consumer price index, but one that continued to rise rapidly for a fifth consecutive month. There have also been sharp increases in the costs of housing, utilities such as water and electricity, and transport.

Inflation (fiscal year 2001/02=100)

2005 2006 Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug

Consumer price index 136.4 137.3 137.5 137.6 138.3 138.5 138.8 140.7 142.6 143.7 146.9 147.9 % change, year on year 3.8 3.0 3.2 3.1 3.4 4.0 3.7 4.4 5.4 6.5 8.4 8.9 % change, month on month 0.4 0.7 0.1 0.1 0.5 0.1 0.2 1.4 1.4 0.8 2.2 0.7

Source: Central Agency for Public Mobilisation and Statistics.

Such sharp increases in inflation jeopardise the government!s inflation target of no more than 4% in 2006/07, although the authorities argue that inflation will stabilise. We agree that inflation should start to ease, constrained by the stability of the Egyptian pound against the US dollar (and other major currencies) as well as by a decline in average world non-oil commodity prices. In addition, the overhaul of the monetary framework should enable more effective control of liquidity. These factors should allow the authorities to bring down the

Inflation picks up strongly

Egypt 25


average rate of inflation to around 5.8% in 2007, although this will still be above the government!s target.

The recent rise in inflation also reflects the strength of "base" money supply growth earlier this year. According to figures published in the IMF!s International Financial Statistics, the narrow measure of Egypt!s money supply (M1) expanded by just over 20% year on year at the end of May, similar to the rate recorded for the end of the first quarter of 2006. Meanwhile, the growth in Egyptian pound liquidity, although still fairly strong, has steadily declined in comparison with last year. This suggests that the prevalence towards switching out of hard currencies by Egyptian residents, which caused foreign-currency deposits (a proxy for dollarisation) to decline, has eased slightly. Nevertheless, growth in Egyptian pound liquidity is still robust, which is likely to continue to underpin high levels of domestic consumption and investment.

Money supply (E£ m unless otherwise indicated; end-period)

2004 2005 2006 Mar Jun Sep Dec Mar Jun Sep Dec Mar May

M1 74,610 78,331 81,146 83,990 86,528 90,268 100,734 101,136 103,799 106,755 % change, year on year -8.0 -8.9 -11.1 -13.8 16.0 15.2 24.1 20.4 20.0 20.3M2 420,777 435,823 451,550 468,959 479,766 494,633 515,787 522,857 535,303 551,889 % change, year on year 17.6 15.9 15.1 15.1 14.0 13.5 14.2 11.5 11.6 12.5Foreign-currency deposits 152,973 157,469 161,453 163,841 151,523 146,194 141,893 142,258 136,727 142,824 % of total 18.6 14.1 11.3 10.2 -0.9 -7.2 -12.1 -13.2 -9.8 -3.8

Egyptian pound liquidity 267,804 278,354 290,097 305,118 328,243 348,439 373,894 380,599 398,576 409,065 % change, year on year 17.1 17.0 17.3 17.8 22.6 25.2 28.9 24.7 21.4 19.5


Oil and gas

The under-secretary for gas affairs at the Ministry of Petroleum, Hany Soliman, told Zawya, a Middle Eastern online news agency, in mid-September 2006 that gas production could reach 100trn cu ft by around 2011. His proclamation underlines the extent to which the Egyptian gas sector will continue to expand in the coming years as production rises sharply from its current rate of around 68trn cu ft. Gas is currently the country!s fastest growing sector and, as a result, Egypt is now the sixth-largest exporter of liquefied natural gas in the world.

Mr Soliman revealed that the petroleum ministry currently has around 80 agreements with international energy companies, which are expected to translate into drilling operations worth US$10bn. These include deals struck with BP, Royal Dutch Shell and Eni. The expansion of the gas industry goes hand in hand with plans to increase the use of gas domestically and thus make the economy less reliant on oil subsidies. The government also intends to maintain oil production at around current levels for the foreseeable future, and, as more gas is used for domestic energy needs, more oil could perhaps be released for export. According to the Oil and Gas Journal, a specialist industry publication, Egypt!s proven oil reserves are currently about 3.7bn barrels

Government still upbeat on gas outlook despite constraints

Money supply growth remains strong

26 Egypt


(equivalent to 0.3% of global reserves) and crude oil production was 579,000 barrels/day in 2005 (less than 1% of total world production).

However, there is concern that Egypt is not offering sufficient incentives to gas companies to entice them to continue to search for new gas reserves. Rising prices for offshore petroleum rigs and long delivery lags owing to booming international demand are putting a damper on exploration activity in Egypt. In late August, for instance, Shell announced that it was postponing its drilling works at the North East Mediterranean field for one year, and others are likely to follow suit. To prevent a drying up of exploration activity, more incentives to gas companies are likely to be needed, such as the government paying more for the gas it purchases; reducing the share of profits the government takes from gas exports (currently it takes 60% of the profits from Idku and 40% of the profits from Damietta); and reducing the quotas gas companies are forced to allocate to the domestic market. This would free up more gas for export, and make the Egyptian gas market more attractive to foreign investors.

In late September an independent British oil and gas company, Dana Petroleum, announced an asset exchange transaction between its subsidiary, Dana Petroleum (E&P) Ltd, and Gaz de France. Among other interests, the exchange involves Dana gaining a 30% interest in the production-sharing contract for the West El Burullus concession in the Nile Delta operated by Gaz de France. In return for Gaz de France paying all of Dana!s costs associated with its exploration activities in Mauritania, Dana has agreed to stump up a 30% share of the costs associated with the first exploration well in the West El Burullus concession, up to a limit of US$3m. In addition to the exchange agreement, Dana is set to acquire more assets from Gaz de France, including an additional 20% interest in West El Burullus, which will give Dana a total 50% interest in exploration at the Egyptian site. The agreement is subject to approval from the national authorities.

The fallout from a 600-tonne oil spillage in the Suez Canal in February 2006 rumbles on following the announcement in early October that Trade Maestro, the owner of P.C. Anna, the Liberian tanker responsible for the disaster, faces a series of compensation claims. The tanker crashed into the canal bank when attempting to moor after a supertanker ran aground ahead of it. In addition to demands for E£10m (US$1.8m) in compensation from the Egyptian environmental agency and E£15m from local fishermen and tourist resort owners, the Suez Canal Authority has announced a separate claim of E£30m to cover damages and clean-up costs"a total of some E£55m. The boat has been impounded by the authorities. (Another tanker, the Grigoroussa 1, was impounded in February and released in September after its owners paid out US$3.4m in compensation for a separate oil spillage.)

Manufacturing

Egypt!s Industrial Development Agency announced in late September that a new pharmaceuticals laboratory, which is to be sited in the industrial zone at Arab al-Awamer in the south of the country, had been approved. Construction

Gaz de France and Dana make asset exchange

Suez spillage dispute continues

New pharmaceuticals laboratory to be built

Egypt 27


of the laboratory will take place early in 2007. It will be partly owned by investors from the UAE, who will hold a 45% share in the company, with the remainder held by Egyptian partners. The laboratory will produce 120m packs of antibiotics and other medicines a year for the treatment of illnesses such as coronary heart disease. Around 60% of the medicines will be exported, with the balance being supplied to the domestic market. This forms part of the government!s wider plans to expand the domestic pharmaceuticals manufacturing sector, with a total export value target of US$221m for 2008. In 2005 export earnings from medicines totalled US$141m.

The government has also announced that it will start to manufacture oil rigs in the country from next year. This marks the first time that offshore drilling rigs have ever been manufactured in the Middle East and North Africa region and underlines the needs of the country!s rapidly expanding petroleum industry. Following a visit to China by the Egyptian oil minister, Sameh Fahmy, the government has established a joint Egyptian-Chinese partnership that plans to construct three oil rigs in 2007 and a further seven in 2008, rising to 20 a year by 2010. Although details of the Egyptian and Chinese partners have not been revealed, the rigs have been bought by Sino-Tharwa, another Egyptian-Chinese joint venture established in 2005 between the Egyptian authorities and the China Petroleum and Chemical Corporation (Sinopec). According to the American Chamber of Commerce in Egypt, there are currently 95 offshore rigs in operation in Egypt, most of which were manufactured in the US. The cost of a shallow-water offshore rig is currently around US$120m-160m, and that of a deep-water rig around US$400m-450m.

The government has announced that it plans to sell the state!s 82% stake in Suez Steel, valued at E£1.1bn (US$190m), to Attaka, an Egyptian steel company. Suez Steel was set up in the Suez industrial zone in 1997 and began producing steel in 2000. The company currently has a production capacity of 600,000 tonnes/year of steel billets, which are made from scrap metal and pellets of reduced iron. Around three-quarters of the sale price will be used to pay off the company!s debts, with the remainder going to Banque du Caire, a state-owned bank, which is the majority shareholder.

Efforts by the authorities to curb the rise in cement prices bore fruit in October when seven domestic cement producers complied with the government!s demands to lower prices. The move contributed to a 15% drop in market prices to around E£340 (US$60) per tonne, compared with E£380/tonne before the government decided to try to regulate the market in August 2006 by announcing price caps of E£330/tonne for consumers and E£290/tonne at the factory gate. However, four cement firms, with a total market share of nearly one-third, failed to comply. Regional cement prices have been rising strongly since the beginning of the year against a backdrop of a construction boom across the region, especially in the UAE, fuelled by high international oil prices.

Egypt!s Industry Modernisation Centre (IMC), which is financed by the EU, has revealed that it has offered E£890m (US$156m) in loans to manufacturers in the 15-month period running from July 2005 to September 2006. The IMC

Oil rigs to be manufactured in Egypt

Suez Steel to be sold to Attaka

Government attempts to stem rising cement prices

IMC criticised for neglecting Upper Egypt

28 Egypt


principally focuses on assisting over 4,000 Egyptian manufacturing companies of all sizes, around one-quarter of which are located in Cairo and a further one-quarter in the Nile Delta. One of the official goals of the IMC is to boost the value of manufacturing exports to E£3bn by the end of 2006. However, the IMC has been criticised by small manufacturers, which complain of the difficulty in obtaining financial services because of the relative dearth of IMC development agencies in Upper Egypt. There is only one such agency, in Sohag, serving the nine governorates of the region.

Financial and other services

In October Egypt!s monopoly landline telecommunications operator, Telecom Egypt (TE, which was partially privatised in 2005 in a landmark initial public offering), announced that it had purchased an additional stake in the UK-owned mobile-phone company, Vodaphone Egypt, for E£5.5bn (US$965m). This will increase TE!s share in Vodaphone Egypt from 25.5% to almost 49%. Vodaphone Egypt initially balked at TE!s strategy, and has carefully resisted relinquishing control of the company by retaining a 50.1% share. The purchase is a result of several minority shareholders such as Alkan Group, Banque du Caire and Egypt Post deciding to offload their equity interests in Vodaphone Egypt, giving TE the opportunity to boost its stake in the company. TE believes that its acquisition will place it in a more favourable position to compete effectively next year, when the third mobile-phone operator, Etisalat of the UAE, launches its operations with third-generation mobile telephony from March 2007 (August 2006, Financial and other services). The domestic telecoms market will be further liberalised in 2007 when two international dialling operating licences will be granted to the private sector. Vodaphone Egypt has made clear its intention to bid for one of those licences, but must first seek authority from Egypt!s National Telecommunications Regulatory Authority. To enhance its position, Vodaphone Egypt has moved swiftly to put itself in the running by acquiring a majority 51% stake in Egypt!s Raya Telecom, the largest national player in the communications and information technology industry, for E£104m (US$18m), which many analysts believe will improve its technical expertise.

Mohammed Barakat, the chairman of one of the remaining state-owned banks, Banque Misr, announced in early October that a delayed merger with Banque du Caire is finally due to take place before the end of 2006 (although a firm date has yet to be agreed). The new bank will continue with the name of Banque Misr and will have combined assets of E£160bn, making it Egypt!s largest. This merger of Egypt!s second- and third-largest banks (both state-owned) is integral to the government!s financial sector reform programme, which began two years ago. The reform is leading to fewer, but larger, banks, which are finally getting to grips with the problem of bad debts that afflict much of the sector. The government!s aim is to have just 34 banks by the end of 2007, and ultimately only 26, although the latter figure seems overambitious. Banque Misr has restructured debts of around E£15bn, but by merging with Banque du Caire it will be able to resolve the latter!s bad debt problem. The

TE increases its stake in Vodaphone Egypt to 49%

Merger of Banque Misr and Banque du Caire delayed again

Egypt 29


new merged entity, which will be responsible for 27,500 staff, has also promised not to force employees into early retirement.

Bank of Alexandria (BoA), the smallest of the "big four" state-owned banks, was finally privatised at the end of October. An 80% share of BoA was sold to Sanpaolo IMI in mid-October for a higher than expected US$1.6bn. The Italian banking group beat rival bids from several suitors, including the Commercial International Bank (Egypt), BNP Paribas (France), a consortium of Mashreqbank (Dubai) and Dubai Investment Group, and a consortium of Jordanian and Saudi banks. Eurobank (Greece) decided at the very last minute to pull out of the bidding process. The proceeds from the sale of BoA"the only state-owned bank to be privatised so far"will be used to finance the restructuring of the banking system and to mop up some of the bad debts in the remaining state-owned banks: the National Bank of Egypt (Egypt!s largest bank), Banque Misr and Banque du Caire.

In its Banking System Outlook for Egypt, released in late September, Moody!s Investors Service, a credit ratings agency, argues that the government!s banking sector reform programme is delivering tangible results, but that additional measures are still needed. Moody!s maintains a stable Ba2 rating for Egyptian banks, but says that the Egyptian authorities have identified long-standing weaknesses in the banking system (including heavy-handed bureaucracy among the leading banks and a fragmented system) that, along with a weak economy and low income per head, have historically led to poor asset quality, under-capitalisation and weak profitability. One of the more positive develop-ments has been the sale of joint-venture banks, which has led to better loan-loss provisioning. Other notable improvements include better banking supervision by the Central Bank of Egypt, and attempts to achieve consolidation within the sector and deal with the high level of non-performing loans (NPLs). Some of the privatisation proceeds have been redirected to deal with public enterprise-related NPLs, while private-sector NPLs are resolved through a special unit set up within the Central Bank to assist banks in resolving their NPL problems. According to the Central Bank, more than 50% of the NPLs in the private banking sector have been rescheduled to date and a further 20% settled by these new initiatives. Moody!s estimates that the ratio of NPLs is around 35-50%.

In the three years preceding the privatisation, the BoA had been restructured at a cost of E£11bn, of which almost E£7bn was paid by the government to offload NPLs (then amounting to 44% of total loans). The three remaining publicly-owned banks are also in the midst of a restructuring programme, which will be partially funded from some of the proceeds of the BoA sale, as well as from E£6bn in loans from the African Development Bank and the World Bank. At the end of August the investment minister, Mahmoud Mohieddin, predicted that all of the debts owed to local banks by state-owned Egyptian companies (worth around E£20.5bn) would be settled by the end of 2006/07.

The Paris-based Planet Finance, a non-governmental organisation specialising in microfinance (supplying small loans to the poorest members of society to

Microcredit financing continues to expand

Bank of Alexandria is privatised

Banking sector reform makes progress

30 Egypt


establish a business), argues that the Egyptian microfinance sector is continuing to experience rapid growth. Planet Finance estimates that there are more than 500,000 Egyptian citizens who have been able to set up businesses with the aid of microfinance, having been unable to obtain finance from the traditional banking system because of a lack of collateral and the small amounts involved. Planet Finance also estimates that there is a market of around 4m microfinance clients within Egypt!s borders. Microfinance is more stable than traditional banking; whereas banks typically have a default rate of around 15-20% of their loan base, the rate for microfinance institutions is just 1-2%. Moreover, the development of microfinance goes hand in hand with the government!s attempts to foster economic liberalisation.

Google, the ubiquitous online search engine, has announced that it will site its Middle East and North Africa regional operations in Egypt. The announcement is surprising given the attractiveness of other places in the region, such as Dubai, where business costs are lower and where companies have larger advertising budgets (Google!s revenue depends mainly on corporate online advertising). However, Google argues that Egypt boasts the largest number of advertisers of any country in the region. It has also decided to locate closer to its user base, citing Egypt as the country with the largest number of Internet subscribers in the region, with over 5m users. Google also estimates that Egypt has substantial growth potential. Currently, the information technology penetration rate of small and medium-sized enterprises in Egypt is less than 5%, which Google views as an opportunity rather than a restrictive factor. The advertising potential of the underdeveloped financial sector and the booming Egyptian tourism market are also viewed positively. Taking advantage of falling broadband Internet access tariffs"recently lowered from E£150 (US$26) to E£95 a month for businesses for a 256k connection"and taking into account the potential for growth, Google!s decision to use Egypt is less surprising.

The Suez Canal Authority (SCA), which controls the flow of traffic through the waterway, posted another record in August when it announced its highest-ever monthly revenue, of US$334m. This arose from a total of 1,581 ships loaded and 63m tonnes of transit freight, and was also boosted by the 3% rise in fees introduced in March 2006. The increase in revenue has led the Authority to forecast that total revenue in 2006 will reach US$3.7bn on the back of total cargo shipments of 680m tonnes. This would be another record high, following a previous peak of US$3.5bn and 672m tonnes in 2005. The government has recently ruled out the privatisation of the Suez Canal (which was nationalised in 1956), no doubt in part because of the canal!s revenue-raising potential. An ambitious US$208m project to deepen the canal from 62ft to 66ft is currently under way and should be completed by the end of this year. This will allow oil tankers weighing up to 240,000 tonnes to use the canal, thereby boosting revenue even further. In a separate development, the signing of a trade-boosting agreement between the US and the Association of South-East Asian Nations (ASEAN) is also expected to contribute to higher transit volumes through the Suez Canal.

Google arrives in Egypt

Monthly revenue from Suez Canal reaches new high

Egypt 31


Suez Canal 2001 2002 2003 2004 2005 2006 2006 2006

Yeara Yeara Yeara Yeara Year a Jan-Mar Apr-Jun Jul-Aug

Vessels (no.) 13,986 13,447 15,667 16,850 18,193 4,422 4,563 3,156

Tonnage (m) 458 445 567 621 671 173 180 126

Receipts (US$ m)b 1,911 1,964 2,606 3,085 3,458 853 937 665

a Calendar years. b Includes navigation services.

Source: Suez Canal Authority.

The Cairo & Alexandria Stock Exchange has recovered quickly from its falls earlier in the year, buoyed by an end to the conflict between Israel and Hizbullah in Lebanon and by positive sentiment towards Egypt because of several significant inward foreign investments and positive growth indicators. The Hermes Financial Index had reached 56,850 by mid-October, compared with an annual low of 41,900 on June 27th. Several positive announcements have boosted share prices, including the offer in August by Abraaj Capital, a UAE private equity firm, to purchase 25% of EFG Hermes, Egypt!s largest investment bank. Banking shares also rose on the news in October that 80% of BoA had been sold to Sanpaolo IMI for US$1.6bn.

20,000

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

65,000

70,000

Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov

Hermes Financial Index

Source: Bloomberg.

2005 06

Tourism

Official figures indicate that tourism has been affected by the bomb attacks in the resort town of Dahab in April 2006 that killed 23 people and wounded 62. These followed the bombings in Sharm el-Sheikh in 2005 that killed 88 people. According to monthly figures from the Central Agency for Public Mobilisation and Statistics there were a total of 794,000 visitors in July 2006, down from 840,000 in July 2005, the third consecutive monthly decline. With confidence shaken, many tour operators are attempting to entice people to visit Egypt with very competitive holiday packages. In the UK, the Red Sea resort of Sharm el-Sheikh was the best-selling package holiday destination for lastminute.com during this year!s summer season. The online travel agent also reports that four of its ten most popular resort destinations in 2006 have been in Egypt. The

Tourist numbers decline in July for third month in row

Stockmarket recovers in the third quarter

32 Egypt


government has set a target of attracting 14m tourists a year by 2011, which will require an annual increase of 1m arrivals.

Tourism 2004 2005 2006

2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr JulNo. of visitors ('000) 1,911 2,390 1,912 2,101 2,160 2,125 2,265 2,154 2,193 794

Receipts (US$ m)a 1,321 2,111 1,401 1,450 1,468 2,322 1,611 1,442 1,472 565Receipts/tourist (US$) 691 883 733 690 680 1,093 711 670 671 712

a From January 2006, tourism receipts are calculated using a multiplier of US$75 per tourist night.

Sources: Ministry of Tourism; Central Agency for Public Mobilisation and Statistics; Central Bank of Egypt.

In light of the slowdown in the second and third quarters of 2006, the tourism sector!s rapid capacity expansion is raising concern over the mounting oversupply of rooms relative to tourist numbers. Official figures indicate that around 131,000 rooms are currently being built, although occupancy rates are running at only roughly 80% of the current stock of 148,000 rooms.

More luxury accommodation will also be added: a new project unveiled in October by the Shaheen Group of Jordan plans to develop a new upmarket tourism resort in Sahl Hasheesh near Hurghada on the Red Sea. This immense development, valued at around E£11.5bn (US$2bn), will comprise a new seven-star hotel, an 18-hole golf course, a 300-yacht marina, shopping centres, health facilities, 700 housing units and luxury apartments. Construction will begin in 2007 and the entire resort is scheduled to open in 2010. The Shaheen Group is aiming to attract the wealthier segment of the tourism market, with a particular focus on European customers seeking a holiday home, replicating the successful strategy employed by Egypt!s Orascom Construction Industries, which has brought scores of Europeans to its El Gouna resort near Hurghada.

Reflecting expansion in the country!s tourism sector, and the onset of competition on domestic routes (February 2006, The domestic economy: Tourism), the state-owned national carrier, EgyptAir, has said that it will exercise an option to purchase six new Boeing 737-800 aircraft for a total of US$450m. The announcement comes in the wake of a ceremony in early October 2006 marking the delivery of a first batch of six aircraft ordered in 2005. The increase underlines the company!s aggressive expansion strategy as well as government-led efforts to transform Cairo International Airport into a regional hub. The Boeing 737-800 is a short-to-medium range aircraft carrying up to 160 passengers. In addition to the Boeing order, EgyptAir has also ordered six new E-170 aircraft from Embraer, a Brazilian manufacturer, valued at US$100m each. These jets will operate a new low-cost service to be launched in April 2007 when Egypt is expected to implement a new Open Skies policy, although no details have been forthcoming from the Ministry of Civil Aviation. Embraer has previously supplied the Egyptian Air Force with Tucano trainer aircraft, but this is the first civilian deal. A number of financing options are also being assessed to enable EgyptAir to purchase an additional 12 aircraft that would increase its fleet size to 64 by 2010. This includes floating a 20% stake in EgyptAir on the Cairo & Alexandria Stock Exchange to raise between E£4bn-

EgyptAir buys more aircraft

Rapid construction may lead to overcapacity

Egypt 33


5bn, although a precise date for the initial public offering has not yet been announced.

Infrastructure

The government!s aim to employ the public-private partnership (PPP) model in various construction and infrastructure projects will be assisted by the International Finance Corporation (IFC), the private-sector offshoot of the World Bank. The IFC signed a Memorandum of Understanding with the Egyptian government in mid-October, which will result in much-needed technical assistance, such as transaction and regulatory advice, to support the authorities! efforts to secure private finance for five pilot projects in the water, transport, health and education sectors. The government hopes the pilot projects will be successful test cases for the PPP model.

Work began on a 220-km road linking Sohag and the Red Sea in October. According to the government, the road will cost E£650m (US$115m), and will be entirely financed by the state. The project is part of an ambitious road-building programme that includes a proposal to build a new highway linking the north and south of the country. Work began in September on a feasibility study for the construction of a 1,200-km north-south highway. If approved, it would be the first road to link the north coast with the southern edge of Lake Nasser and would run west of the Nile linking cities along the river with 12 smaller highways. The north-south highway, dubbed the "development corridor", would provide a major boost to the local economy. The feasibility study is expected to take around nine months. Although precise estimates have not yet been forthcoming, current proposals are believed to be based on the PPP model rather than on government funding alone. However, many opponents are sceptical of the project!s claims that desert land between the highway and the river will be reclaimed and used for agriculture, that investment (including foreign capital) will be drawn in for the construction of residential housing and that industrial zones will be established alongside the highway.

The government also began a programme to upgrade the country!s railway network in October. Along with the road-building, this forms part of a wider infrastructure upgrade programme, which also includes the deep-sea ports at Said and Alexandria. The two-year railway programme will cost an estimated E£8.5bn. However, many parts of Egypt!s railways are more than 100 years old and there are concerns that the upgrading will involve significant disruptions to services. The government is keen not to link the train crash at Qalyoub in September, which killed 59 people, to its upgrade, even if a technical failure with the signalling system was blamed for the disaster. The train driver has not been held responsible, but the government has admitted that the wages of railway workers must be raised to improve the service. So far, however, privatisation of the loss-making railway has been ruled out. The government has amended the railway law, but only to permit the use of PPP schemes in new projects. The first such project, signed in August, established the Egyptian Transport Holding Company, a partnership between the government and

IFC signs a Memorandum of Understanding with Egypt

Ambitious road-building programme gets under way

Railway upgrade is on track

34 Egypt


overseas investors: the Abu Dhabi Investment House and the Gulf Finance House of Bahrain. The company plans to invest around US$30bn over five years in various transport projects concerning the railways, highways and ports.

Foreign trade and payments

The Central Bank of Egypt has released provisional balance-of-payment data for fiscal year 2005/06 (July 1st-June 30th). The merchandise trade deficit widened to US$12bn from US$10.4bn in 2004/05. Despite a 33.4% year-on-year rise in merchandise export earnings, to US$18.5bn, the trade balance moved further into the red owing to a 25.8% year-on-year increase in the merchandise import bill to US$30.4bn. The breakdown reveals a huge 92.9% increase in the value of petroleum exports, but "other exports", which are non-petroleum-related, slipped by 3.5% year on year to US$8.2bn. The Central Bank refers to the former category as "oil" exports, but qualified this by stating that the strong increase was mainly due to the start-up of liquefied natural gas (LNG) exports since 2005. Although the first LNG was shipped in January 2005, the real impact on the balance of payments has been felt in 2005/06. High international oil and gas prices are additional factors, boosting not only exports earnings, but also the import bill, as Egypt imports large amounts of oil products and gas, especially butane for domestic household usage. The Central Bank also points out that the sharp rise in imports must be assessed in light of the significant share of capital and intermediate goods in the total (53.6% in 2005/06), which it argues, with some justification, is a positive development, as it represents domestic capital investment in future growth potential.

The surplus on net services trade widened to US$8.2bn in 2005/06 from US$7.8bn in 2004/05 (a 4.4% rise). A broad-based improvement in services export receipts was behind the increase, especially investment income, which shot up by 119.8% year on year to US$2bn. Tourism receipts were also buoyant, indicating that Egypt!s allure continues to be relatively unaffected by the sporadic attacks in the Sinai. Such outbreaks tend to inhibit tourism inflows only for a short period. However, the most recent bomb attacks in the southern Sinai resort town of Dahab occurred in April 2006 and would only have a small impact on the full year total. Hence, travel receipts increased by 12.5% year on year to US$7.2bn. Suez Canal earnings were similarly buoyant, rising by 7.6% to US$3.6bn, owing to a rise in net tonnage and the number of transiting ships, which boosted transit toll revenue.

In addition to the improving services trade balance in 2005/06, the surplus on net transfers also increased by 2.2% year on year to US$5.5bn. Net official transfers halved in value to around US$570m so the rise was entirely a result of increased net private transfers, which totalled US$5bn. However, the increased surpluses on the services and transfers accounts were insufficient to avoid a narrowing of the total current-account surplus to US$1.8bn in 2005/06 from US$2.9bn in 2004/05.

The merchandise trade deficit widens to US$12bn in 2005/06

The surplus on the services account widens

The current-account surplus narrows in 2005/06

Egypt 35


Current account (US$ m)

2004/05 2005/06Merchandise trade balance -10,359.4 -11,985.9Exports 13,833.4 18,455.1 Petroleum 5,299.0 10,222.4 Other exports 8,534.4 8,232.7Imports -24,192.8 -30,441.0 Petroleum -3,975.3 -5,359.2 Other imports -20,217.5 -25,081.8Services balance (net) 7,842.2 8,190.7Receipts 15,029.6 17,437.9 Transportation 4,259.6 4,947.1 Suez Canal 3,306.8 3,558.8 Travel 6,429.8 7,234.6 Investment income 910.6 2,001.8 Government receipts 157.2 358.2 Other 3,272.4 2,896.2Payments 7,187.4 9,247.2 Transportation 902.4 1,214.9 Travel 1,438.3 1,619.6 Investment income 1,164.4 1,471.1 Of which: interest paid 583.7 586.5 Government expenditures 656.6 1,319.9 Other 3,025.7 3,621.7Goods & services balance -2,517.2 -3,795.2Current transfers balance 5,427.8 5,547.1 Private transfers (net) 4,371.7 4,975.4 Official transfers (net) 1,056.1 571.7Current-account balance 2,910.6 1,751.9

Source: Central Bank of Egypt.

A rise in net inflows on the financial account to US$3.5bn in 2005/06 from US$3.4bn in the previous fiscal year, supported the overall balance-of-payments surplus, which nevertheless narrowed to US$3.3bn from US$4.5bn. The financial account surplus was boosted by a strong increase in net inward foreign direct investment (FDI), which rose by 56.6% year on year to US$6.1bn. Even this figure is likely to be an underestimate owing in part to an under-reporting of real estate transactions. The government aims to attract higher levels of FDI and is hoping to raise this figure to around US$7.5bn-8bn in 2006/07. This would seem feasible given some large investment deals mainly in connection with the liberalisation agenda, including the sale of a third mobile-phone licence to Etisalat of the UAE for US$2.9bn and the divestment of 80% of the Bank of Alexandria to Sanpaolo IMI, an Italian banking group (see Financial and other services).

There was an even larger percentage rise in net inward portfolio investment to US$2.8bn (233% higher than in 2004/05), the majority of which (97%) was in the form of government bonds (November 2005, Foreign trade and payments). Meanwhile, the balance on "other investment" moved further into deficit, from US$1.9bn in 2004/05 to US$4.5bn in 2005/06, reflecting a virtual doubling of the deficit on the Egyptian banking sector net asset position.

Balance-of-payments surplus also narrows

36 Egypt


Capital and financial account (US$ m)

2004/05 2005/06Capital & financial account 3,377.7 3,511.3Capital account 0.0 -37.6Financial account 3,377.7 3,548.9 Direct investment outflows (net) -39.0 -145.3 Direct investment inflows (net) 3,901.8 6,111.4 Portfolio investment outflows (net) 540.6 -729.1 Portfolio investment inflows (net) 831.1 2,764.0 Bonds 25.9 2,690.2 Other investment (net) -1,856.8 -4,452.1 Net borrowing 1,000.6 1,425.8 Medium & long term loans (net) -783.8 -927.5 Drawings 727.9 795.6 Repayments -1,511.7 -1,723.1 Medium term suppliers credit (net) -525.8 -101.2 Drawings 86.2 625.4 Repayments -612.0 -726.6 Short term suppliers credit (net) 2,310.2 2,454.5 Other assets -3,180.0 -5,102.8 Central bank 23.0 3.3 Banks -2,171.6 -4,197.7 Other -1,031.4 -908.4 Other liabilities 322.6 -775.1 Central bank 0.0 2.2 Banks 322.6 -777.3

Net errors & omissions -1,810.6 -2,009.8Overall balance of payments 4,477.7 3,253.4Change in reserve assets (- = increase) -4,477.7 -3,253.4

Source: Central Bank of Egypt.

The strength of FDI and portfolio financial account inflows prompted a significant rise in foreign-exchange reserves in 2005/06, although mostly during the early part of the year as the reserves position subsequently stabilised between February and June 2006. According to the IMF!s International Financial Statistics, by the end of June 2006, Egypt!s foreign-exchange reserves (excluding gold) had reached US$21.2bn. This was sufficient to provide import cover for 6.5 months, easily exceeding the IMF!s recommended 3-month minimum target level. Foreign-exchange reserves totalled around US$12bn-13bn in the early years of this decade, and only really began to rise strongly in 2004/05 as the country attracted significant levels of inward investment. According to the Central Bank, net international reserves stood at US$24.4bn at the end of October 2006.

Foreign reserves (US$ m)

2003 2004 2005 2006 Dec Dec 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 QtrForeign exchange 13,400 14,108 17,950 19,692 20,508 21,172 21,236


Foreign-exchange reserves reach US$21.2bn in June

egypt - iuj.ac.jp · country report egypt november 2006 the economist intelligence unit 26 red lion...

Documents