Egypt’s positioning as the most important Middle East nation with regard to its political weight is a well established given. Since appointment of the Nazif government, and its largely successful attempt to convert the Arab world’s most populous nation into a free market, Egypt’s economic significance within the region is what is increasingly grabbing headlines. The accompanying GDP growth trajectory which kicked off in 2003, continued unabated in latest FY07 numbers, (7.1% real growth) and what’s more appears set to continue, as officials have brought into play Egypt’s strongest assets in our opinion, a 75 million and growing population.
Consumer spending is powering domestic demand driven economic growth, compensating for well versed state budgetary constraints on the government pursuing an expansionary fiscal policy. As importantly, safety in (population) numbers is the key attraction for the wealth of FDI pouring into the country, from banking to real estate, to petrochemicals.
Net exports which essentially catalyzed the GDP growth take off post float have now, as expected, reversed into a drain on numbers, as the local currency strengthens and a wealthier middle class, a function of tax breaks and custom cuts, both new and old, buoy sentiments and fuel imports. While a ballooning trade deficit warrants keeping an eye on, Egypt continues to run healthy CA (FY07a US$2.7 bn) and BOP (FY07a US$5.3 bn) surpluses, net service and capital inflow attributable. An associated accumulation of FX reserves has allowed Egypt a build up of a US$29 billion cushion, equivalent to 10 months imports, (relative to a 5 to 6 month norm) and calls for a rating upgrade from some corners, as well as further flexibility of the currency from others.
Egypt really has reopened the “open door”…
The privatization process really has been a success this time round. To the surprise of many the government has managed to divest of close to 100 state owned entities since coming into power, securing steep price tags on a number of the high profile strategic sell offs, including 1 of the “Big 4” banking institutions, and the 3rd telecom license. Commitment to associated reform has also reduced concerns on budget financing and will aid further in reducing monetization pressure, as well as allowing for only limited reliance on the commercial banking sector to fund the deficit, in turn reducing crowding out repercussions for a government seemingly intent on bringing down interest rates and invigorating private sector consumption and investment.
Timing has proven equally inherent here, with a benign global environment and a petrodollar boom in the GCC fleshing out the pockets of large private investors and sovereign funds, which with oil at US$94/barrel as we prepare this note, have not only the cash but the confidence to aggressively implement a geographical expansion strategy. Moreover, we are further encouraged by the utilization of privatization receipts, with capital injections into state banks and restructuring of over ½ of private sector bank NPLs, in conjunction with an aggressive USD22 billion build up of NFAs in the commercial system, have all contributed toward solidifying the sector. Past experiences have made the viability of the financial sector in Egypt a priority with the state.
What we should be worried about…..
We do have a number of concerns however which do require attention, and have been covered in detail within this note. To sum up, inflation pressures top the list here. With monetary policy publicly defined as inflation targeting, and with associated numbers in, or close to double digits depending on base rates, we look at causes and consequences.
Continued bureaucratic red tape, we are also firm believers, continues to hold Egypt back from reaching true potential. Efforts have been concerted here as of late however, with the development of industrial investment zones awaiting cabinet approval and the most recent Doing Business 2008 Report, issued by the World Bank and IFC, labeling Egypt the worlds top reformer. The report also concluded that “equity returns are highest in countries that are reforming the most”. NB Our heavy weighted PAMI index is up 42.18 YTD.
Moving on, Egypt’s indebtedness also remains an issue for us; with government debt at ca. 64% of GDP, while we are skeptical on the states announced target pertaining to a 1% reduction in the deficit/GDP per annum in the medium term. FY07 numbers did show an aggressive improvement however (350 bps shrinking to 5.7%), although this is likely to be an exception rather than the rule, attributable to big ticket, and accordingly unsustainable, state divestitures, what we view as a peak in GDP growth rates over the associated 12 month period and most significantly various reclassifications of consolidated fiscal numbers which resulted large in extraordinarily elevating state expenditures, and accordingly the deficit in 2006, and similarly abnormally reducing outflows, and improving the cash deficit in 2007.
While government finance reform is talked about considerably, and subsidy reductions have occurred on fuel and utilities, the structural make up of Egypt’s economy, with very uneven income distribution and nominal GDP/capita at under US$1,800, reigning in spending is an extremely challenging and sensitive issue. How Egypt finances its inevitable deficits also require careful consideration, and although difficult to quantify, one should note with caution that the “economic boom” which many talk about with reference to Egypt as of late, is very localized within a middleclass minority, albeit growing, with the vast majority of Egyptians reaping only little of the fruit. That said, overall Egypt’s macro positives are far outweighing the negatives for the time being, with the numbers speaking for themselves.
Moreover benign fundamentals in our view are likely to continue over the foreseeable future. Our reasoning and forecasts are in the section to come. (Prepared by Prime Research)
