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Country Report Egypt

Country Report

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Egyptian flag

The political turmoil in Egypt has pushed the economy into a dismal state. Extensive government spending has aggravated the fiscal and external imbalances and rendered Egypt reliant on elusive assistance. Egypt will probably muddle through until the elections, but the downside risks are high.

Strengths and weaknesses

Strengths

Geopolitical importance ensures financial support during crisis

Egypt’s strategic importance is derived from the economic significance of the Suez Canal and the country’s key role in regional diplomacy, and facilitates financial support in times of crisis.

Revenues from transit in the Suez Canal resilient to political turmoil

Services revenues consist mainly of receipts from tourism and from transit through the Suez Canal. Unlike tourism, Suez Canal receipts were not affected by the political turmoil.

Weaknesses

Import dependency for food and fuel

Egypt imports more than half of the 19m tons of wheat it consumes every year and the majority of the fuel it needs, rendering the country highly susceptible to the volatile prices on these markets.

The legacy of a large welfare state that is difficult to reform

Food and fuel subsidy programs were already extensive during the Mubarak regime (9% of GDP in 2010 or 27% of the budget) and were expanded to contain social unrest afterwards. The high reliance of the population on this system makes it difficult to reform without causing backlash.

Key developments

1. Political stalemate

The increased efforts of the Muslim Brotherhood (MB) to consolidate power have increased the tensions with the seculars and brought the country to a political stalemate. The MB’s attempts include actions that undermined the independence of the judiciary, a controversial adoption of the constitution after a referendum with a mere 32% turnout, retaliation on critics and a recent cabinet reshuffle increasing MB representation. Consequently the opposition joined forces in the National Salvation Front and refuses any collaboration, which impairs the implementation of much needed reforms. MB’s attempts to tighten its grip on the power also  aggravated the conflict between the executive and the judiciary, causing serious delays of the parliamentary elections. Though the polls are expected in October 2013, the necessary legislation is still in limbo.

2. Social turmoil intensifies

The popularity of the MB has decreased amid unmet expectations and the deteriorating economic situation. Economic growth is sluggish (2% forecast for 2013) and far too low to create jobs for the many unemployed (unemployment is forecasted to break records in 2013 at 14.8% and more than 30% among the young). Social unrest and security issues linger, while sectarian violence between Copts and Muslims has re-emerged. Against this backdrop, certain developments could trigger a level of social upheaval that might threaten government stability, in which case the army is expected to step in. For the upcoming months, possible electricity shortages during the hot Ramadan summer days and the erosion of the purchasing power as a result of soaring inflation are such worrisome developments. The deal with Qatar for gas supply this summer provides some risk mitigation against the electricity shortages, but the recent disagreements on delivery terms indicate the shortage issue is not off the table yet. Inflation skyrocketed from 4.7% yoy in December 2012 to 8.1% yoy in April 2013, mainly driven by a 10% depreciation of the currency (EGP) in 2013, as policy stagnation reinforced the negative market sentiment. Moving forward, the situation is expected to deteriorate as the current political deadlock aggravates the imbalances in an already downtrodden economy and deters market sentiment.

3. An external crisis looming on Egypt...

In the aftermath of the Arab Spring, the Egyptian government picked up spending to contain unrest. In 2012, the budget deficit soared to 10.9% of GDP, driven by a 20% increase of the wage bill. Fuel and food subsidies remained high, accounting for around 8% of GDP altogether. Public debt increased to 88% of GDP, mainly financed domestically (87% of public debt is domestic and 60% comes from banks). The readily available domestic financing provides comfort. But the upsurge in borrowing has pushed rents and – thereby – debt service costs up, raising concerns about Egypt’s financing needs. However, the highest matter of concern with respect to Egypt is its plummeting FX reserves. These are down to critical levels of around USD 11bn (support from Libya caused a slight improvement from the USD 10.1bn in March) or roughly 2 months of imports, from USD 33bn at the end of 2010. Defending the currency, external debt servicing and the high import bill for subsidies have dried out the reserves, affecting the government’s capability to finance the imports required for providing food and energy to the people. Consequently, Egypt has become highly reliant on elusive external assistance for staving off a balance of payments crisis (S&P reported in May 2013 a build- up of arrears on trade credits and to energy companies of 2% of GDP). The low FX reserves have also evaporated the possibility of defending the EGP, which is now plummeting freely, feeding through into higher inflation and increasing the pressures on the fiscal burden and the current account. Though Egypt is likely to muddle through until elections, a balance of payments crisis is looming on the country until the subsidy system is drastically reformed.

Figure 1: Fiscal deficit soaring
Figure 1: Fiscal deficit soaringSource: EIU
Figure 2: FX reserves dwindling to critical levels
Figure 2: FX reserves dwindling to critical levelsSource: EIU

4. ...as IMF loan unlikely before elections

A deal with the IMF for a USD 4.8 loan is regarded as a crucial milestone. Though the loan falls short of covering Egypt’s financing requirement estimated at USD 12.9bn for 2013, it will release another USD 9bn of external assistance from the international community and restore investor confidence, since reforms for bringing spending to sustainable levels would be part of the deal. Despite an agreement in November 2012, the government backed down, because the Muslim Brotherhood is reluctant to implement subsidy reforms and lose popularity amid upcoming parliamentary elections. Despite resuming talks earlier this year, no progress has been made so far and the recent replacement of key ministers involved in the talks does not bode well for an agreement being reached soon. Recent bilateral assistance from Libya and Qatar gives the current government the room to stave off reforms and a deal with the IMF until after elections, which they seem inclined to do.  

Factsheet of Egypt
Economic indicators of EgyptSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank, World Economic Forum.

Background information

Egypt is for 97% of its territory a vast desert plateau. The remainder is made up by the Nile valley and delta, where most of the economic and human activity takes place. Though the Nile waters are shared with Sudan and Ethiopia, historically Egypt has the right to use most of the water stream, the majority being used in agriculture which makes up for 15% of economic activity. The largest sector however is industry which accounts for 38% of GDP, though the services sector, at 37% of GDP, is not much smaller. The services sector derives its revenues from tourism and transit on the Suez Canal, significant income and FX generators. While in the past Egypt used to be a fairly closed economy exporting some merchandise for around 10% of GDP, the development of the oil and gas sector changed that, doubling the value of exports. In 2012, it accounted for 49% of exports (roughly 10% of GDP). The remainder of exports still consists of (semi)finished goods, though some diversification towards iron and steel is visible.

Ever since the independence from the UK in 1952, the Egyptian army has played a prominent role in politics, albeit behind the curtains. Actually, the smooth change of power following the outset of Hosni Mubarak was de facto a military coup backed by the international community, as the military temporarily took over the country rule and handed it over to the newly elected government. However, the military’s influence is also visible in the economy where their stake was estimated at 40% of the national economy in 2009. It is estimated that the army will intervene to protect its economic interest (including traffic over the Suez Canal) in case any government endangers the functioning of the economy, which makes the army play a stabilizing role and provide some mitigation against an eventual state collapse.  

Economic indicators of Egypt
Economic indicators of EgyptSource: EIU
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Author(s)
Alexandra Dumitru
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 60441

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