RaboResearch - Economic Research

Egypt: economy struggles with lower tourism but is helped by Pound devaluation

Country Report


Flag Egypt
Egypt’s economic growth will slow in 2016, as tourism is hurt by last year’s terrorist attacks. The industrial sector is helped by an EGP devaluation and the resulting greater access to FX. The lack of structural reforms will continue to weigh on growth and could strain relations with Saudi Arabia.

Strengths (+) and weaknesses (-)

(+) Geopolitical importance ensures financial support

Egypt’s strategic importance, derived from the Suez Canal and the country’s key role in regional diplomacy, helps the country attract financial support from the GCC countries and the US.

(-) 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 energy and food price fluctuations.

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

Still costly food and fuel subsidy programs, which support the poor, are difficult to reform as a large part of the population depends on them

(-) High level of unemployment

Chronically high unemployment coupled with a growing number of young people entering the labour market each year strongly adds to political and social tensions. 

Key developments

1. Lower growth for Egypt due to tourism woes

Growth in Egypt will subside in 2016 to around 2.8% and only modestly recover to around 3.1% in 2017 (figure 1). This reflects lower growth in the tourism sector (see below). The industrial sector should grow moderately, though, on gradually improving conditions in the energy and manufacturing industries. The devaluation of the Egyptian pound (EGP), which boosted capital inflows, has helped the Egyptian Central Bank acquire more FX reserves, part of which have been sold to private companies. Before the devaluation many companies were struggling to import components and equipment. Although this problem has not been fully solved, some of the acute bottlenecks have, which helps industrial performance. The energy sector is expected to grow as a result of a USD 21.5bn investment deal with Saudi Arabia. BP is also developing new gas fields in the West Nile Delta, which should boost gas production. Meanwhile, consumer prices are set to rise faster in 2016 at around 12.5% of GDP, which will weigh on political stability going forward. This will also make it extra difficult to pursue reforms (see below).

Figure 1: Growth subsides
Figure 1: Growth subsidesSource: EIU
Figure 2: FX reserves remain low
Figure 2: FX reserves remain lowSource: CBE, IMF, Rabobank

2. Edging towards more exchange rate flexibility

The Egyptian Central Bank has adopted a new currency management policy this year. To ease pressure in the foreign-exchange market, it devalued the EGP on the 14th of March and moved towards a more flexible exchange rate policy. The details of this policy have not been specified but companies have had easier access to foreign exchange, needed to maintain intermediate product and machinery imports, since the change. The impact of easier access to FX has offset the impact of higher capital inflows on FX reserves, and reserves have remained very low at 2.4 months (figure 2) as a result. Higher inflows in the wake of the devaluation and a successful bond issue show that moves towards greater EGP flexibility enhance investor confidence in Egypt. For the moment however, the black market rate signals that the EGP is still overvalued, implying that the FX framework needs to be strengthened further.

Figure 3: Deaths from terrorist attacks
Figure 3: Deaths from terrorist attacksSource: Global terrorism database
Figure 4: Tourism on a downward trend
Figure 4: Tourism on a downward trendSource: World Bank, Rabobank

3. Tourism and terrorism

Before 2015, Egypt had already been struggling with terrorism, especially relative to its tourism dependent neighbors in the Levant (figure 3). In 2015, this situation worsened with the downing of a Russian airliner in November, with 224 casualties, by insurgents in the Sinai desert. Later in the year, airport security in the country was shown to be feeble when an unarmed asylum seeker high-jacked a commercial flight and forced it to land in Cyprus. These developments have impacted tourism: by January 2016 the 3 month average tourist arrivals in Egypt were down by 42% compared to a year earlier. This weighs on Egypt’s growth and FX inflows. The outlook for the tourism sector will remain muted, which adds pressure on the economy and the government.

4. Reforms are necessary to raise growth and appease the GCC countries

The Egyptian government is still struggling to pursue the reforms that are necessary to enhance GDP growth. The country suffers from high levels of corruption, difficult and conflicting regulations and a lack of independence and sometimes competence in the judiciary. Enforcing contracts and resolving disputes is likely to be heavily influenced by the investors' prior relationship with the Egyptian military and is easier for well-connected large investors, especially from the Gulf. This does not encourage private sector growth that is necessary to raise overall growth. The government has made some steps in reigning in spending with a successful subsidy reform, but the deficit remains high at around 11.5% of GDP in 2016. Despite the recent support from Saudi Arabia, there are signals that Saudi Arabia is losing patience. Lower GCC support may eventually force Egypt to turn to the IMF, which would precipitate helpful yet painful economic reforms.

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 the river flows through 10 more countries, 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 international tensions. Egypt used to be a fairly closed economy, but the development of the oil and gas sector has 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 hinder 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 FX-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 a sizeable part of 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 could continue to intervene to protect its economic interests. 

Economic indicators of Egypt
Economic indicators of EgyptSource: EIU
Jurriaan Kalf
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO

naar boven