THAI TRADE CENTER, CAIRO ECONOMIC REVIEW OF 2011
A wave of protests of relatively loosely organized youth groups with support of Islamist and civil organizations forced an end to the 30+ years of Mubarak rule. In February the everpresent military took power by appointing an interim civil government, which made it very clear -right from the start- to be willing to honor all existing international financial and diplomatic obligations. Parliamentary and presidential elections plus a referendum on a potentially controversial new constitution are announced for the coming nine months.
Egypt’s economic outlook for 2012 is uncertain, but the worst fears of a total collapse are highly unlikely to materialize. GDP growth for 2012 will be lower (but remains positive), while inflation, fiscal and current account deficits will be higher than in previous years. Moderately optimistic consensus projections made just a few months ago, were all adjusted downward, but assume that the economy will in the end weather it through. Egypt’s financial system is in the favorable position of having built up large financial reserves in the past decade as a first line of defense.
Economic structure and growth
Egypt is for 97% barren territory, with most economic activity taking place in the highly fertile and irrigated Nile valley. Natural fresh water resources are non-existent apart from the Nile. Annually some 1,000 cubic m of fresh water per capita is extracted, three to six times as much as in similarly arid neighboring North Africa, Israel and Jordan. Most of the withdrawn water is used by agriculture (source of 13% of GDP, but using 86% of water available) on just 3% of total territory.
The energy sector (oil and gas) accounts for some 6% of GDP. Oil production more or less equals domestic consumption, but a third of the gas production is exported, enough to dominate Egypt’s merchandise exports with a 50% share. On a global scale Egypt is not an energy power of any importance, although the current —but temporary- regional geopolitical impact of its gas exports to Israel, Jordan, Syria and Lebanon since 2008 is substantial. Proven oil and gas reserves suffice for 16 and 35 years of current annual output respectively.
After a national revolution ousted the British-backed monarch in 1952, Egypt's economy for decades was highly centralized. Opening-up started in 1980, under former president Mubarak. The economic authorities pursued -with general international praise from 2004 to 2008- strong pro-market policies to attract foreign investment and spur GDP growth. But in recent years of global financial crisis, growth of the non-energy export-led sectors (some energy intensive manufacturing and tourism) fell, as did Suez Canal revenues (which account for 2% of GDP).
Despite the high level of average annual economic growth over the past decade (5%), living conditions for the average Egyptian have remained poor as high population growth (2% p.a.) eroded much of the progress. Currently, still a high proportion of Egyptians live in poverty(20% by national definition) and 2% even on less than USD 1,25 a day (internationally comparable).
Short-term GDP growth for 2011 has been estimated 1.2% much lower than in the previous years. Early 2011, political tensions rose and caused economic and logistic disruptions, which caused negative q-o-q GDP growth. In particular the process to and outcomes of the crucial presidential, parliamentary elections plus a referendum on a new constitution have been causes of uncertainty till the end of the year. As a result it is now projected that for 2012 as a whole, private consumption, investment and other exports were likely to remain subdued. But not all is bad or negative: tourism revenues (6% of GDP and 20% of export earnings in 2010) have gotten down, although -apparently- not as badly as initially feared. Also, energy-related and Suez Canal revenues are hardly or not affected, and real government consumption (food and energy subsidies and public sector wages) has increased by 7.5% in response to the recent food and energy prices and political unrest. These latter spending categories have partially compensated the slowdown of domestic private consumption and investment.
Overall GDP growth in 2011 made by respected sources differ widely (from 1.3% to 1.2 % for 2011), but a net economic contraction (i.e. a shrinking economy) is not one of the noted outcomes. In baseline scenario, growth has decelerated to 4% at most, with substantial downward risk as political uncertainty negatively impacted household and business spending for some time. But for 2012, a modest recovery to 5% growth, assuming at least some restoration of political stability, is projected. This growth rate is still below the level of 6-7% needed to absorb the influx of young entrants to the labor market and reduce the high unemployment levels to be estimated to climb to at least 10% (official data, excluding high hidden unemployment).
Over the past decade financial sector policies were aimed at (i) consolidating smaller banks into larger ones, privatization and restructuring of state-owned banks; (ii) reducing nonperforming loans (NPLs, which are successfully down from 22% of total loans in 2004 to 14% by mid-2010; over 95% of NPLs is now provisioned for) and (iii) improving supervision. All this has resulted in more solid banks (with on average and by national standards 15% capital adequacy) and much better provisioned banks. The number of banks dropped from 61 in 2004 to 39 currently, although they remain geared to service the government and large companies. Only 13% of small enterprises (that employ 75% of Egypt’s workforce) actually have access to bank finance. Also, there is now ample liquidity in the banking system: the private sector loans-to-deposit ratio is structurally at around 60 percent, the remainder largely invested in liquid government bonds. The decline in economic growth in 2011 as a result of lower exports and tourism revenue will impact banks’profitability and likely lead to higher NPLs.
Economic policy
Since the late 1990s, the government has shown a commitment to economic liberalization and speeding up the privatization of state assets, while at the same time improving the business climate to attract foreign investment. The last Mubarak cabinet pursued liberal economic policies, resulting in a period of strong, investment-led, economic growth and achieved real economic growth of up to 9%. But, with the ministers most closely identified with economic reforms no longer their positions, the interim government is likely to put reforms on hold,concentrating on the more urgent task of ensuring the delivery of essential goods and services to the population. The budget deficit may increase to 12% of GDP. Government revenues are expected to be lower than budgeted in 2012 given the expected lower economic activity and by another postponement of the introduction of the unpopular VAT. But revenues from the oil and gas sector, a major component of total tax income, will remain high, as this sector was hardly affected by the political unrest and prices are up. On the fiscal spending side, wage increases to placate the large number of public-sector workers, increased food and energy subsidies (in 2011: 25% of total expenditures) and higher interest costs (23% of expenditures)on public debt will lead to a much higher current spending by the government in 2012. In
addition, there will also be pressure on the government of whatever make-up to compensate for the unrest-related absence of private sector investment.
The ousted pro-market Minister of Finance was a strong advocate of fiscal restraint and gained respect for years of decreasing fiscal deficits and public debt/GDP ratios, contributing to better sovereign and country risk ratings. Just before the unrest broke out, a 3.5% deficit was targeted in 2014, down from almost 10% in 2004. With a deficit in 2011 of up to 12% of GDP, the public debt/GDP ratio -in our baseline scenario- increased to 86% in 2011. Thanks to high inflation (2011: 15%), this is a modest reversal of a speedy downward trend, which started in 2005, when the ratio amounted to 131% of GDP.
Almost all (90%) of government debt is held domestically and -given the ample liquidity of the banking system- financing has in the past not posed problems. Nevertheless, by mid-April the authorities were sounding the IMF and WB for soft loans to finance their expected 2011/2012 deficit, indicating that the authorities feel the need to diversify their creditor base and reduce upward pressure on the domestic interest rates.
Consumer price inflation has been high in recent years, reaching 18% in 2008, and is again increasing owing to higher global commodity prices and the political turbulences of early 2011. Not increased demand, but supply shortages and logistical distribution problems drove up food prices. As interest rate hikes or other monetary policy measures are irrelevant as a remedy in such circumstances, the policy interest rates are projected to remain stable. Consumer price inflation is set has increased in 2011 to 15% from its already high level of 11% in 2010.
Recent events also put the Egyptian pound (EGP) under strong downward pressure against the US dollar, as its value decreased by 5% in 2011. The central bank used some of its ample reserves to defend the currency, which proved partially successful in dampening EGP’s depreciation. However, with the prospect of falling foreign exchange reserves, costly interventions will remain modest and a further depreciation of around a 10% for 2012 as a whole is projected. This should also mitigate at least partly the effect of high domestic
inflation on the external prices of non-oil exportable goods (i.a. textiles) and services(tourism), which is helpful in keeping the large trade deficit somewhat in check.
Balance of Payments
Egypt has for long been a rather closed economy with merchandise exports at only 10% of GDP. With imports of goods structurally higher at 20% or more of GDP, this implies a trade deficit of 10% to 15% of GDP. Since 2008, the country has become a major exporter of natural gas via pipelines to only a narrow range of neighboring economies. Together with very modest income from oil sales, natural gas exports account for 50% of all merchandise exports. Some diversification of the export mix, to energy intensive products like cement,iron, fertilizers and other petrochemicals is underway, but structural quality problems hamper the export performance of these products, causing the export product diversification to remain narrow. On the import side, industry and development related goods (60%) dominate, with consumer goods accounting for only 20% of import value, which is all appropriate to a developing country.
Egypt is a member of the World Trade Organization and concluded an Association Agreement with the EU. This facilitates access to the EU markets, but also obliges the authorities to phase out tariffs on imports by 2015. A free-trade bilateral agreement with the US is in the making since the early 1990s, but the US still considers Egypt’s economy too much dominated by the state and Egypt’s “Military Inc.”, which is estimated to own as much as 40 % of the nation’s economy.
Existing bilateral US-Egypt tariff reductions can still unilaterally be withdrawn. Although a member of African and Middle Eastern trade bodies, these markets are not significant yet as bilateral trade is still low: the quality of Egypt’ s output cannot compete on the demanding Arab markets and black Africa’s markets too small to make an impact.
The large structural trade deficit is partly compensated by surpluses on services balance, where revenues are derived from tourism (expected to be down in 2012) and the Suez Canal transit fees (likely to remain unaffected by the turmoil). The services surplus in 2012 is projected to be substantially reduced to just 3% of GDP, against 10% in 2009. Of little help to restore balance of payment equilibrium are the transfers of Egyptians working abroad. These may lower to 3% of GDP in 2011, half the level of 2008 and 2009, when the Gulf state economies were still booming. Helped by low average interest paid on external debt (2% to
3% on principal), the county’s income balance is reported to be more or less in equilibrium, despite the negative net investment position of the economy (-16% of GDP).
The overall effect of these developments is a worsening of the current account from an -on average- near equilibrium in the past five years to a projected deficit of 6% in 2011. Provided political near-stability is maintained, tourist should return in higher numbers and the current account balance may improve in 2012, when the deficit may be reduced to 3% of GDP.
The current account deficits have until recently largely been financed by direct investments, with debt inflows and portfolio investments playing a minor role. For 2011 capital inflows most likely declined compared with recent years as investor confidence is down due to the political instability. Also, with domestic interest rates hardly changing, the value of the pound declined. The Central Bank resorted to modest selling of foreign reserves early in 2011 to support the Egyptian Pound.