It has been seven months since former president Hosni Mubarak stepped down from power. Yet Egypt is still being run by a Supreme Council of the Armed Forces (SCAF) that continues to crack down on civil liberties, and rein in the demands of the 25 January revolution.
On September 10, SCAF implemented a decision to reapply and expand the scope of emergency laws, which had been due to expire at the end of the month, much to the criticism of human rights groups – and the public.
Abolishing the laws, which were used in a draconian manner under Mubarak to silence political opponents, is a key demand of the revolution. SCAF’s decision came after a weekend of demonstrations against its policies, and an attack on the Israeli embassy in Cairo.
SCAF is under heavy criticism for the trial of an estimated 12,000 civilians in military courts, where the use of torture is claimed to be widespread. Many are also frustrated at the slow pace of reforming public institutions, still considered to be under the influence of former regime officials, such as the much-loathed interior ministry.
The mood in Egypt is one of mounting frustration at a drawn-out transition from military to civilian rule. A stagnant economy, in which unemployment is estimated at around 12% and rising, has also contributed to a sense that the demands of the revolution – which include a fairer distribution of wealth – have yet to be fulfilled.
Parliamentary elections, due in November, and presidential elections, due thereafter, are eagerly awaited by revolutionaries and Egypt-watchers alike.
A REVOLUTION IS COSTLY
But revolution comes at a price. Tourism has plummeted since January’s revolution, and much foreign direct investment (FDI) has left the country. Both are key sources of income for Egypt – and neither rebounded with the ousting of Mubarak.
Growth for the June 2010/11 financial year came in at a meagre 1.8%, most of which was achieved prior to January when Egypt was growing at an average rate of 6%. The domestic slowdown also comes amid a worsening global economic picture, particularly in Europe and the United States. For analysts and policymakers, this provides a worrying trend for the short-term outlook.
Central Bank of Egypt governor, Farouk El-Okdah, expresses his concern to Emerging Markets in a rare interview. “In 2008, we took a huge hit because a small sector – sub-prime mortgages – took a hit. Now, the US is not sure when its economy will pick up, while Europe is dealing with sovereign risks and banks that have still not finished their cleaning-up job.”
He adds: “I am worried, because this is going to be bigger, not short-lived. We might see a global recession for an extended period that will affect all emerging markets.”
The slowdown in Europe will affect Egypt’s Suez Canal receipts, tourism and FDI. According to the governor, 50% of Egypt’s trade is with Europe, and 50% of its tourism comes from Europe. “If the guys in Europe are losing their jobs, I don’t think they will come to Sharm El-Sheikh; they’ll say wait till 2013,” he says.
Tourism revenue fell by 47.5% between January and June to $3.6 billion, from $6.9 billion in June–December 2010, while FDI fell by 67.6% to $2.2 billion in the 2010/11 fiscal year, from $6.8 billion the previous year. Egypt’s 2010/11 balance-of-payments deficit is $9.2 billion.
The central bank has had to dip into its foreign reserves – which fell from $36 billion in December to $25 billion in August – to make up for funding the shortfall. But, remaining reserves are still equivalent to six month’s-worth of imports, which is considered to be reasonable.
For Egypt’s financial policymakers, the challenge has been how to fund the budget gap while meeting the social spending needs of the country.
FUNDING THE DEFICIT
The government has said it would rely on sales of local-currency debt to finance 90% of its budget deficit, with the rest sourced externally. It has also committed to a fiscal consolidation programme starting next June.
El-Okdah tells Emerging Markets: “The military council was adamant about trying to control the deficit this year, which has been revised down from 10.5% of GDP to 8.6% of GDP. Starting June 2012, we will have a fiscal consolidation programme by which we have to reduce the budget deficit by 1–1.5% every year until we reach a reasonable figure of 4% in the next three to four years.”
He adds that “social spending needs will come from the revenue side. If the country grows, we’ll see revenue growth and taxes grow.”
Egypt made headlines again in June when it put on hold the offer of a $3 billion, 12-month stand-by loan facility from the IMF. The decision was driven – at least on the surface – by a revised budget deficit forecast from E£170 billion to E£134 billion, and a desire to avoid the accumulation of foreign debt. The governor says that putting the IMF loan on hold was a matter of keeping it as a last-resort option.
The United Arab Emirates and Saudi Arabia have also offered Egypt financial support, pledging $7 billion. But Egypt’s current finance minister Hazem El-Beblawi said at a G7 meeting in Marseilles this month that only $500 million of this has come through, in the form of budget support from Saudi Arabia.
LOCAL BANKS TO THE RESCUE
Egypt’s 39 private and public banks have stepped in to increase their investments in Egyptian government Treasury bills. Foreign investors reduced their holdings of T-bills by E£34.9 billion in the first six months of the year to E£24.5 billion, according to central bank data.
Bank of Alexandria (BoA), whose major shareholder is Italy’s Intesa Sanpaolo SpA, has meanwhile increased its holdings by 70% to E£8.16 billion.
BoA chairman Bruno Gamba tells Emerging Markets: “Alexbank is extremely liquid, with a loan-to-deposit ratio of 63%. Our deposit base both in local and foreign current has increased this year ... on the other hand, following the January revolution, the growth of the local economy has been negatively affected, particularly in real estate and tourism. Consequently, we have seen a slowdown in the demand for new loans. We find ourselves with an excess liquidity, which we are using to sustain the government demand for funding.”
The bank’s other shareholders are the Egyptian government with a 20% stake, and the International Finance Corporation, the private-sector arm of the World Bank Group.
But some analysts are concerned that a strategy of relying on local banks to fund the deficit will crowd out lending to the private sector. Magda Kandil, executive director and director of research at the Egyptian Centre for Economic Studies, says the decision to rely on domestic borrowing was made before the January 25 uprisings began in an effort to curb the reliance on foreign loans. But, “it is an expensive strategy and has a big toll on private-sector activity,” she says.
Kandil does not think the government should borrow externally in the private market, such as by issuing bonds, because most of the country’s sources of foreign receipts, such as tourism and FDI, have not fully recovered. “To borrow externally would put pressure on the exchange rate,” she says.
Going forward, she would like to see the government looking more closely at concessional lending from international and regional donors to ease budget constraints. But, she says, “[whilst] the international community has pledged support; most of it is in project lending and won’t address the fiscal shortfall.” She adds that many donors have complained about the lack of an action or business plan from the Egyptian government to target specific projects.
THE FUNDAMENTALS REMAIN STRONG
Egypt’s ability to withstand the financial burden of the revolution, for now at least, was helped by the remarkable growth it posted up until December. A financial reform programme that began in 2003 had also helped create a well-capitalized and well-managed banking system, for which El-Okdah has received much praise.
The reform programme focused on three pillars: creating a foreign exchange market; creating a transparent monetary policy committee at the central bank; and reforming the banking system. The latter involved increasing the capitalization of banks, which went up by 250% between 2003 and 2008, reducing a large amount of non-performing loans, equivalent to 40% of the total loan portfolio in 2003, and consolidating the number of banks from 59 in 2003 to 39 in 2008.
When the 2008 financial crisis hit, Egypt was in some respects ready for it, and it appeared to handle the shock well. Although $16 billion worth of foreign investment left the country in the form of Treasury bills and bonds as the financial crisis hit, El-Okdah says these returned to the country in June the following year.
Meanwhile, in 2011, while short-term investors have liquidated their positions, about $3.5 billion-worth of T-bills are still held by foreign investors, which the governor sees as a vote of confidence.
The banking sector has also witnessed a growth in deposits in both US dollars and Egyptian pounds, increasing by a combined value of E£30 billion between January and September.
The governor is satisfied by the fact that dollar deposits have only gone up by around 1% since January. As a percentage of total deposits in the banking system, dollar deposits amounted to 18% in December, and this now stands at 19–20%, he says; a figure that has been constant since April. This is down from 33% of dollar deposits in 2003.
Furthermore, currency depreciation has remained relatively moderate given the circumstances. Since December, at the onset of the Tunisian revolution, the Egyptian pound’s value has depreciated by 6–7%.
El-Okdah says he intervened only once in the market, in February, when he suspected speculation in the currency. “Our intervention was just a message. I don’t mind if the pound depreciates, but it should be based on supply and demand, not speculation.”
STILL, INVESTORS WAIT AND SEE
But for Egypt’s economy to pick up, much now depends on how the political process evolves over the coming months. Private-sector investment, which is important for meeting the job creation needs of the country, is on hold for the moment.
Simon Kitchen, strategist at Egyptian investment bank EFG Hermes, says: “Local and foreign investors will want to see what the political picture is going to look like before making major investment decisions. They will want to know what the rules of the game are going to be in terms of taxation, labour, regulations etc. They will also want to see stability in interest rates, fiscal balances, and the currency.”
Kandil adds that the current government has not done enough to address the concerns of investors. She says: “Small and medium enterprises also need to come back on track, because they have a lot of potential to absorb unemployment.”
Added to this is the issue of corruption, and reforming the system of crony capitalism that was present under the former regime.
A key trigger of the revolution was poor wealth redistribution. But it remains to be seen what policies a new, civilian government will come up with to create a more fair, and democratic Egypt.