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Country Report Egypt

Country Report

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Domestic stability in Egypt has improved markedly and the economy is showing timid signs of recovery. The government has engaged in bold reforms and generous aid from the GCC countries gives Egypt the financial space to gradually implement them.

Strengths (+) and weaknesses (-)

(+) Geopolitical importance ensures financial support

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

(-) Dependence on food and fuel imports

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 price fluctuations on these markets.

(-) A large welfare state that is difficult to reform

Costly food and fuel subsidy programs, that amounted to 9% of GDP and 20% of spending in 2013, were already in place during the Mubarak regime. The high reliance of the population and small business on this system makes it difficult to reform without causing a backlash.

(-) Fluid political preferences

The political preferences of most Egyptians are not based on ideology, but on other grounds, such as the perceived capability to improve living standards or voter’s familiarity with a party, and are therefore very volatile. A certain degree of widespread loyalty to the army provides some stability. 

Key developments

1. Stability improves, even though security threats intensify

Political stability in Egypt has improved in the past year, but the country remains vulnerable to another bout of widespread unrest if the living standards do not improve. Security threats have intensified, but that has also cemented Egypt’s regional geopolitical importance. The roadmap announced by the government shortly after the toppling of President Morsi in July 2013 has been implemented without major setbacks. A peaceful constitutional referendum and presidential elections had a positive effect on stability. The transition will be completed with parliamentary elections, which are planned for the beginning of 2015 and are not expected to lead to any major disruptions. However, Egypt has been diverging from the democratic path towards being a de facto security state again, under the firm rule of president al-Sisi. The harsh crackdown on critics, including Muslim Brotherhood (MB) supporters, is expected to continue or even pick up. That is set to lead to clashes with security forces. But, that is also not expected to cause major disruptions in the medium term. Nevertheless, the Egyptian society remains highly polarised and that makes the future volatile. Egyptians yearn for stability and president al-Sisi has increased his political capital by astute expectations management. That should contain unrest for now. But, if he fails to improve living standards in the medium term, a new bout of social turmoil could follow.

Domestic Islamic insurgency persists, and could intensify as recent attacks indicate that the militants possess increasingly sophisticated weapons and as the heavy handed crackdown on MB supporters continues. That might hinder the recovery of tourism and FDI, but it is not expected to threaten state security. Egypt is also dealing with increasing external security threats due to the conflict in Libya turning violent and ISIS expanding into Iraq and Syria. However, these developments have also stressed the importance of a stable and strong Egypt in a region tormented by violent conflicts. Consequently, support from and ties with the GCC countries and the US have strengthened and bode well for domestic stability in Egypt.

Figure 1: Market sentiment improves
Figure 1: Market sentiment improvesSource: Egyptian Exchange, GFI Group
Figure 2: FX reserves have stabilized
Figure 2: FX reserves have stabilizedSource: CBE, EIU, Rabobank

2. Economy shows timid signs of recovery and perspectives have improved

After four years of muddling through, the economy seems to be picking up steam. Improved market sentiment and a sizeable stimulus programme bode well for the future, but it remains to be seen whether it will bear fruits. Economic growth floated around 2% in the 4 years after the Arab Spring, which pushed unemployment from 9% in 2010 to 15.5% in 2014. In the first two quarters of 2014 the economy seemed to be finally accelerating. Indeed economic growth in 14Q2 was 3.7%yoy, the highest growth rate since 12Q1, on the back of increasing private consumption. In September, the PMI reached a near-record high of 52.4. Perspectives have also improved. Growth should find support in a USD 6.68bn stimulus programme, including an ambitious plan to expand the Suez canal. Government payments of arrears to International Oil Companies bode well for higher output in the gas sector, as low investments had led to declining output in recent years. Besides, markets have reacted positively on improvements in domestic stability. The 5 year CDS has fallen below 300bps for the first time since the end of 2011 and the benchmark stock index, the EGX30, has stayed above its 2010 levels during most of 2014. These developments bode well for the future and economic growth is forecast to pick up to 3.5% in 2015.   

3. Egypt remains dependent on external assistance

Against the backdrop of weak economic activity and low FX receipts, Egypt’s structural twin deficits render the country reliant on external financial assistance. Fortunately, support has been generous and is expected to remain so. Egypt’s current account deficit was 1.3% of GDP in 2013 and is estimated at 2.6% of GDP in 2014. The budget deficit was 13.7% of GDP in 2013, and is estimated at 12.2% of GDP in 2014. The shortfalls would have been even higher without generous financial aid from the GCC countries (USD 16.5bn in FY 2013/2014), which has also stabilised FX reserves, thereby preventing a balance of payments crisis. FX reserves have been hovering just below the critical level of 3 month import cover since July 2013. Bold reforms of the subsidy programme that cost 9% of GDP in 2013 will lead to improvement, but that will be gradual, in order to prevent any backlash. The economy seems to be gaining steam, but recovery will also be gradual. Recent reforms have placed the country on better footing for an IMF deal, a structural solution to Egypt’s dependency, and the Fund is reported to be planning a visit in November. Still, until a deal is reached, Egypt will continue to rely on financial support from its neighbours. The fact that Egypt has gained geopolitical weight in recent months on the back of regional security threats increases the chances that support will remain strong. In fact, additional commitments of USD 14bn in petroleum and deposits with the central bank have already been made in recent months. As a result, the current account deficit is forecast at 2.8% of GDP and the budget deficit at 10.5% of GDP in 2015.

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

Background information

97% of Egypt’s territory is a vast desert plateau. The remainder is made up by the Nile valley and delta, where most economic activity takes place. The Nile is very important for the Egyptian economy, as it provides the necessary water for agriculture, 98% of fresh water needs and 10% of energy supply. Though 10 other countries are located on the river, colonial agreements granted water rights to Egypt and Sudan only, of which the lion’s share to Egypt. However, the situation might change as these rights have been challenged in recent years, leading to increased tensions. Egypt used to be a fairly closed economy, but the development of the oil and gas sector boosted the value of exports. Mining, mainly oil and gas exploitation, is the largest sector (roughly 15% of GDP in 2012). However, its share has been declining as public arrears to exploring companies hindered investment. Wholesale and retail trade account for the largest share of output in services, but tourism and the Suez Canal transit fees are the main foreign exchange earners. The current account is also structurally supported by remittances inflows (7% of GDP in 2013). Ever since independence from the UK in 1952, the Egyptian army has played a prominent role in politics, albeit mostly behind the curtains. The military facilitated both the ousting of Hosni Mubarak and of Mohammed Morsi - both events representing de facto coups backed by the Egyptian people. The ouster of Mubarak in 2011 was also backed by the international community, while Morsi’s ouster was more controversial. The military’s influence is also visible in the national economy, in which it has an estimated stake of 40% (2009). It is therefore expected that the army will intervene to protect its economic interests, and thus play a stabilising role.

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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