Egypt: strong recovery in 1Q10, though risks remain

Published July 25th, 2010 - 09:04 GMT

NBK's latest GCC Brief stated: Egypt has largely avoided the negative fallout from the global financial crisis and economic recession, with real GDP in 2009 and early 2010 continuing to show strength. Thanks in part to reforms implemented since 2004 and the fiscal and monetary policy response to the crisis, the latter's impact was cushioned. Limited financial integration in the global financial system has also helped protect the Egyptian economy from financial contagion.

Figures for 1Q10 indicate a recovery is gathering momentum as a number of key indicators picked up and real GDP growth jumped to 5.8% from 4.7% in 4Q09. Tourism revenues moved higher for the second consecutive quarter, while non-hydrocarbon exports and imports both saw double digit growth in the quarter compared to a year ago. Suez Canal receipts and net FDI inflows were also up.

Despite the positive picture, some risks remain. Inflation is high and reforms are still needed to reduce the structural deficit. Parliamentary elections later in 2010 and presidential elections in 2011 also present heightened political uncertainty. Nonetheless, these risks are limited and are unlikely to derail the economic recovery.

Economic recovery will be gradual

While the impact of the crisis on Egypt's economy was muted, the recovery is expected to be gradual and growth is unlikely to return to pre-crisis levels. Important drivers of activity have only just turned upwards and proof of a sustained recovery remains limited. While first quarter figures reveal some improvement, this remains dependent on continued recovery in the global economy.

Growth during the first nine months of this fiscal year[1], which ends in June 2010, held at 5.1%, from 4.9% a year ago, thanks to a stronger 1Q10. We expect a pick up to 5.2% in this fiscal year and 5.5% in FY10/11. As the recovery takes hold in FY11/12, we see growth rising to around 6%.

* Net private transfers consist largely of worker remittances. They are used here rather than remittances because 1Q10 data for the latter is not yet published.

Policy response cushions impact of the crisis

During the global economic slowdown, the Egyptian economy was mainly impacted through five key channels: lower exports (mostly oil), tourism revenues, remittances from Egyptians working abroad, Suez Canal receipts, and FDI flows. More specifically, lower oil prices, weaker demand in key export and tourist markets, and a more cautious investment mood all weighed on the economy.

The government responded to the slowdown with two stimulus packages in December 2008 and in March 2009, which included capital expenditures, export subsidies, and tariff exemptions for capital goods. The packages injected a total of USD 5.4 billion, equivalent to 2.9% of GDP, to prop up economic activity. The move undoubtedly helped reduce the impact of the global slowdown on the domestic economy. The government also postponed a number of fiscal reforms expected to have a contractionary affect on the economy including the introduction of a property tax, widening the scope of the value-added tax and the continued phasing out of energy subsidies.

Monetary policy was also eased in the wake of the crisis with the Central Bank of Egypt (CBE) cutting policy rates. As a result, the interbank overnight deposit rate eased from 10.1% in July 2008 to around 8.3% in May 2010. With interest rates below inflation (i.e. real rates slightly negative), the monetary environment remains accommodative. In its June meeting, the CBE decided to keep policy rates unchanged.

Rapid economic growth before the crisis helped reduce the level of unemployment, though the figure remains relatively high. The unemployment rate had fallen from a high of 11.3% in 2004 to 8.7% in 2008 before rising again recently to 9.4% at the end of 2009.

Inflation has come down, but remains high

Inflation has been on a downtrend following a spike in 2008 sparked by reductions in fuel subsidies and rising food prices. Inflation picked up again in late 2009 due to sharp rises in fruit and vegetable prices. The general inflation rate has since eased to 10.6% in May 2010. Core inflation, which excludes volatile fruits and vegetables as well as regulated items, stood at 6.7%, mostly unchanged from the start of this year. We expect inflation to ease slightly to 10% in FY10/11 and to 9% in FY11/12. However, additional reductions in fuel subsidies, which remain substantial, could push inflation higher again, albeit temporarily.

Current account sees first deficit in years

As a consequence of the global economic slowdown, the current account registered a deficit for the first time in eight years in FY08/09. Lower export, tourism and Suez Canal receipts pushed the current account into a deficit of 2.4% of GDP. Figures for the first nine months of FY09/10 indicate some improvement thanks to growth in oil exports. Still, the balance remains off its pre-crisis level when there was a current account surplus of 1.8% of GDP in FY06/07.

Despite the current account deficit, central bank reserves have remained high, standing at roughly nine times monthly imports. Large FDI inflows and a positive current account balance have helped Egypt build up a strong reserve position over the last five years. During the crisis, the impact on reserves was limited and they were rising again by 3Q09.

The fiscal deficit remains high

One of the key concerns is Egypt's budget deficit, which despite strong economic growth has remained relatively high. Since the crisis erupted, the deficit has deteriorated slightly rising to 6.6% of GDP in FY08/09. Additional measures to bolster tax revenues through modernized collection and more efficient structures are planned. However, the crisis has delayed many of these measures that are now expected to be in place by FY14/15.

Despite a large deficit, Egypt's external public debt has actually fallen as a percent of GDP, standing at 15%. Instead, the deficit is being financed with domestic debt. In particular, there is a heavy reliance on short-term treasury bills, which poses a risk in the event of a change in investor sentiment. The government's total debt to GDP ratio is relatively high, at around 75%, and is expected to rise further in the medium term. Nonetheless, the IMF views as feasible the government's plan to reduce the deficit to around 3.3% by FY14/15.

Reforms laid foundations for future growth

Before the financial crisis, real GDP had been growing at around 7% for three consecutive years thanks to a successfully implemented reform program. Reforms, which were launched in 2004, included the liberalization of trade, investment and foreign exchange. The government also privatized a number of state entities and bolstered the banking sector with new policies and regulations.

One of the chief gains of the reform program was an increase in foreign direct investment (FDI) which, at its peak in FY07/08, reached USD 13.2 billion, or 9% of GDP. As a result of the financial crisis, FDI declined significantly and has yet to show an uptrend. While undoubtedly impacted by global FDI trends, the decline has also been a result of the completion of a number of large projects with foreign investor participation, particularly in the oil and gas sector. Foreign direct investment in Egypt remains robust considering the global context.

Foreign investors have been drawn to a number of sectors including oil and gas, petrochemicals, banking, and power. In order to support investment, the government established an independent investment authority, the General Authority for Investment (GAFI), and launched an ambitious program in a number of sectors including petrochemicals, and oil and gas development.

Export growth has been a key strength

Notwithstanding the recent slowdown, exports have grown strongly since the implementation of reforms in 2004. While hydrocarbon exports have grown in recent years on the back of large investments in the sector, non-petroleum exports have also been impressive and they form an important part of the government's growth strategy. Exports other than oil and gas grew at an annualized rate of 16% in the ten years prior to the global economic slowdown. Today non-hydrocarbon exports account for 7.6% of GDP.

Cleaning up the banking sector

The banking system in Egypt was shielded from contagion in the wake of the global financial crisis thanks in part to significant reforms undertaken since 2004. The government was pushing reforms aggressively in an effort to reduce high levels of nonperforming loans (NPLs) and to improve poor governance at domestic banks. These reforms also included enforcing minimum capital requirements, which induced mergers and improved the sector's capitalization. The government also restructured and privatized one of the large state owned banks, the Bank of Alexandria. Efforts have also focused on improving the governance of state owned banks.

The central bank is expected to remain committed to reforms in the sector, improving supervision, standards and implementing Basel II. Efforts will also likely continue to improve the efficiency of state banks. Another key goal is to reduce banking sector concentration and spur competition.

Positive outlook, gradual pickup expected

The NBK report concluded: The outlook for the Egyptian economy is positive with a robust reform program likely to bolster growth in the years ahead. The economy has emerged from the global financial crisis relatively unscathed. High inflation is expected to ease slightly, though we expect it to remain high by international standards. An area of concern is the fiscal deficit, which remains large. Additional reforms are expected in the coming years in order to reduce it to a more sustainable level. ÿ

[1] Annual economic data, including national accounts and balance of payments data, are published on a fiscal year basis running from July to June. The notation FY09/10 indicates the fiscal year ending in June 2010. All references to quarters in this report indicate calendar quarters. 

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