EGYPT: GOING FOR GROWTH

Egypt is on a roll. Strong macro-economic indicators include inflation at 5.4% for 1996 and a current account deficit of just 0.8% of GDP, which some analysts expect may even go into surplus this year, while the overall budget deficit stands at 1.1% of GDP. Foreign currency reserves of over $19 billion represent up to 18 months’ import cover. According to one analyst, per capita income has risen 25% in the past two years to E£1,100 ($320).

The agreement on the final $4 billion of the Paris Club rescheduling package, which is part of a continuing economic reform programme, brought IMF approval, which in turn paved the way for a rating. Since the Gulf War, Egypt has benefited from debt forgiveness, totalling $24 billion. Standard & Poor’s has now rated both Egyptian foreign and domestic debt at investment grade. The IFC is promoting Egypt to its composite investable index, while indirect foreign investment accounts for as much as a third of the Cairo stock exchange turnover. Foreign interest is expected to increase as the government finally embarks upon the sale of majority shares in state companies, after years of indecision and selling only minority stakes.

Largely discounted in the general euphoria was Moody’s speculative Ba2 rating last October, which annoyed government officials. But this did not hold back financings. While Egypt’s fifth global depository receipt (GDR) is being organized by Nomura and Merrill Lynch for MIBank, Commercial International Bank (CIB) has moved quickly to take advantage of the Standard & Poor’s rating by launching Egypt’s first Euroloan in more than a decade. Led by Chase, the $100 million three-year bullet for CIB (Egypt) SAE is priced at 4 basis points (bp) over Libor. Egypt itself is expected to launch a modest benchmark yankee bond issue.

According to Youssef Boutros Ghali, minister of state for the economy, the government is committed to the sale of one of the four big state-owned full service banks within the next 12 months. There is also much speculation about the sale of utilities. Premier Kamel Ganzouri’s administration has clearly accepted such privatization in principle. It is in the final stages of selecting the winning overseas consortium, possibly with local partners, for a $600 million build, own, operate and transfer project for a power generation plant west of Alexandria.

Drivers of $100-a-day limousines working around Cairo’s five-star hotels are becoming used to ferrying visiting investment bankers, fund managers and analysts around a circuit of the capital’s financial movers and shakers. Asked simply to go to 20 Emad Eldin Street, the driver mumbled “Capital Markets Authority” and took this writer straight to an apparently familiar parking space close to the authority’s rundown headquarters. As of this March, the authority has overseen a 700% growth in the Cairo stock market’s EFG index since it was established in January 1993. The first foreign broker, James Capel, will shortly be opening its offices in Cairo.

Making appointments is no longer a simple matter. Everyone in the markets is busy. Two years ago you would drink coffee while your host bemoaned the many failures of the government to push through market liberalization and privatization. Now, when you finally make it to someone’s office, you are likely to be assured, through a blizzard of telephone calls, that the long-laid economic plans are finally paying off, and hear considerable criticism of commentators who formerly gave negative reports on the lack of change.

There is quiet satisfaction that, despite long-standing IMF opposition, the Egyptian government’s policy of clinging tenaciously to a strong pound policy has paid off. Since the economic recovery has been domestically, rather than export, led the continuing strength of the Egyptian currency has not proved burdensome. In the short term, it will underpin the much needed import of capital goods to enhance the country’s manufacturing base.

“A strong Egyptian pound was the axis of our policy from the beginning,” explains Boutros Ghali. “From 1990 we chose to rely on the exchange rate as the nominal anchor for Egyptian reforms. We did this not just for technical reasons, but for socio-political reasons as well.”

Boutros Ghali explains that, after graduating from MIT, he spent six years in the IMF dealing closely with 22 out of the 60 countries that he visited, including China, Philippines, Argentina, Mexico, Dominican Republic, Haiti, Ethiopia, Cote d’Ivoire, Senegal and Thailand. Boutros Ghali joined the government in 1986 as an adviser to the prime minister. He was appointed a minister of state and member of the cabinet in 1993.

“I knew then that the period we were going through in Egypt was going to be painful and unpleasant. We had an economy in free fall, spending way beyond our means. The only way to stabilize was to cut spending. That meant lowering somebody’s standard of living, which also meant that of poor people,” he says.

Though the IMF had urged a policy of liquidity control, Boutros Ghali chose the exchange rate anchor instead, which was previously commended for its use in hyperinflationary environments. He maintains the Egyptian authorities were able to provide “a beacon” to the man in the street and so maintain popular support for the financial reforms.

These began on January 2 1991 with the liberalization of the money markets and the institution of a weekly auction to create an interest rate reference. Boutros Ghali recalls: “At the end of that February we liberalized the exchange markets. But most importantly, we started to liberalize the capital account of the balance of payments, and not the current account. Most programmes reduce tariffs on exports and imports, but keep capital controls. The key to success was confidence. It was created, but of course we took no chances. In the three months that followed this decision, we engineered a [radically different] domestic monetary situation. Where people used to say that they cannot find dollars, after 1991 they complained that they could not find Egyptian pounds. ‘Where have you hidden the pounds?’ “

By contracting the money supply by around 20% on an annualized basis, the government drove up interest rates to between 24% and 25%. After having taken advantage of the removal of exchange controls, the initial foreign currency flight began to slow, as people could not find the local currency to buy hard currency. At rates of 25%, T-bills began to look attractive, and the outward flow of foreign currency, which between February and August 1991 was valued at about $500 million, began to slow and then reverse.

“By January 1992, the returning funds had become a healthy stream, which has since continued and is the origin of our current $19 billion of foreign reserves. And we have created low inflation and sound growth on the basis of that early confidence,” says Boutros Ghali.

The next stage in Egypt’s recovery, says Boutros Ghali, is the promotion of savings formation and exports. “We can rely on domestic market expansion for continued growth generation only up to a certain point. Our market has 60 million people but it can absorb only so much. To attain annual growth of between 7% and 8% by 2002, we must expand abroad.”

Boutros Ghali does not envisage a reversal of the exchange rate anchor policy to improve the country’s export position: “The most important consideration is to get our inflation rate right down to the level of our main trading partners. On a weighted basis at the moment our inflation is 5.4%, compared with 3% for our partners, so we are not that far off and our international competitiveness is already similar.” The minister is also looking to productivity increases, which will be strong in part because of the low starting base, but also because of increasing market deregulation.

Privatization receipts, says Boutros Ghali, are being treated as a capital item and are being used to restructure Egyptian debt to lower the interest burden. They are also being used to rebuild state companies, among other things, by providing funds for redundancy or early retirement. These are enterprises which “are technically viable, but have not flourished because they have been burdened by debt, and the authorities have interfered in their business by fixing prices and undermining their commercial viability”, he says.

Despite being enthusiastic about Egypt’s progress, particularly over the last 12 months, Boutros Ghali concedes there is still much to be done. Though now on the move, the privatization programme has still not produced any big deals, such as the sale of a utility. Egyptian financial regulation is a mess, with over 52,000 separate pieces of legislation still on the statute books. Much of it is out-dated, inconsistent and contradictory. Furthermore, commercial courts are still woefully incapable of handling complex cases. One senior official says: “Send a judge a highly involved financial dispute and he will shoot himself. We need a lot of training coupled with clarification of the legislation with which judges have to operate. We need to streamline and speed up the commercial courts. It is starting, but the whole task is considerable.”

But overall the mood in Cairo is one of optimism, causing one banker to boast that on its current economic performance, Egypt would qualify more easily for Emu under the Maastricht criteria than Germany. Other bankers are concerned at the hectic rate of growth of the stock exchange compared with the underlying strength of the economy.

Adel A El-Labban, managing director of CIB, is one of the few players prepared to inject a sense of proportion. He says: “What we have is the financial sector – the securities side – outstripping the real economy because we have a stock market that is effectively doubling in size annually, while the economy is growing at around 4%.”

El-Labban welcomes indirect investment, but says direct investment has greater long-term importance. “My question is, if we are an emerging market, why are we not getting direct industrial investors looking at the market?” he asks. “No emerging market can really emerge unless there is a productive economy providing growing value for investors to work in. If you look at southeast Asia, which is the example that people like to draw here, they have all had major inflows of direct investment long before their markets started to attract any degree of investment. And indeed it is arguable that they still do not have big enough capital markets. In Egypt we have exactly the reverse. We have a stock market that has boomed in size in a way that is disproportionate to the growth in the economy.”

Egypt needs to move its manufacturing base from assembly to production. As tariff barriers are lowered, the value added in assembly will disappear and Egyptian companies will be forced to invest to become competitive on an international level. Analysts assert that, in many industries, this will require the presence of international companies wishing to take advantage of both the local and regional markets. A senior executive of MIBank, Mohamed Ozalp, points out: “Egypt has always suffered from a negative presentation. In the case of foreign investment, there are real success stories, like the Egyptian operations of General Motors, Xerox and Ever Ready, which have never been properly highlighted.” While accepting that there were bureaucratic problems, Ozalp wondered if Egyptian bureaucrats were actually any worse than in many other countries that are attracting direct investment flows.

President Hosni Mubarak is predicting that foreign investment will increase by between $1.5 billion and $2 billion a year. However, a few in the markets warn that, while this will contribute to capital formation, Egypt could nevertheless remain a short-term play for fund managers anxious merely to have a diversified portfolio of emerging market risk. To avoid this, a significant proportion of funding has to take the form of direct investment from strategic players who are also prepared to transfer management and technological expertise to Egypt, the dominant economy in the Arab world.

“Managing success is much harder than managing failure,” admits Boutros Ghali. “It is 10 times as hard as handling a crisis. A crisis imposes itself on you. You don’t sleep at night. If you run out of money, it is simple; you stop spending. However, if you succeed, you relax, you start spending and you dabble in useless projects. People forget that you are still at a delicate stage.”

The IMF and World Bank are believed to have expressed concern at just such a proposal to spend in excess of E£200 billion on the development of a new industrial conurbation in Upper Egypt. One banker said that this “would represent a serious case of mission slip and therefore will never be allowed to happen”.

Anxiety over deteriorating relations between the Israeli and Arab governments, and the dangers to regional stability, has largely replaced concern over fundamentalist terror gangs. A security clampdown appears to have confined the terrorists’ operations to parts of Upper Egypt. The tourism industry, which was once the soft target favoured by the terrorists, has made a remarkable recovery.

After years in the economic wilderness, Egyptians can perhaps be forgiven for their enthusiasm, which is typified by Boutros Ghali: “Sure we still have to bring some of our institutions into the 20th century – and I do mean 20th – but we have done a huge amount. Egyptians have never seen the Egypt that you see today, not even in the days of Mohammed Ali. This is an economy that has a budget deficit of less than 1%, and foreign reserves representing almost a third of total GDP. Show me a country that can say the same.”

More market momentum

Enthused by strongth growth, brokers are eager to release the Egyptian stock exchange from the clutches of the authorities. But the bureaucrats are cautious about letting go

The gold merchants along Cairo’s Al Sagha Street are not happy. Despite the slashing of import duty from 50% to just 1%, and the removal of sales tax, demand for gold has slumped and prices with it. It is not simply down to over-importing of supplies. Gold as a value hedge is out of fashion. The problem lies not far away at the revived Cairo stock exchange. According to one merchant, even rich ladies are pawning their jewellery and investing the proceeds in the stock market.

With no dividends or capital gains taxes for private investors, the exchange has grown rapidly. It began in 1991 with 627 listed companies – the majority registered for fiscal reasons only – and with a market capitalization of $2.7 billion. By the end of January 1997 this had grown to 746 companies, with a market capitalization of $15 billion. Earnings growth stands at around 15%, with inflation at 5.4% and interest rates falling.

Since the first large-scale privatization – of Nasr City Housing and Development in the summer of 1996 – the market has climbed strongly. The sharp 20% downward correction earlier this year was described by brokers as a mix of both technical factors and profit taking. “The market demonstrated its maturity by the fact that the retreat was not across the board. Indeed, some blue chips rose against the trend,” says one broker.

The EFG index, a capitalization-weighted monitor of the 40 most actively traded stocks, had a 12-month rise of 133% to February 1997. This means that, since the index began in 1993, the market has recorded a 700% growth with an average monthly increase of 19%.

Says Ashraf Shams Eldin, deputy chairman of the Capital Markets Authority (CMA): “There are a million small investors today. After 30 years, the Egyptian investor has a real market again. Having that market grow until it constitutes almost 31% of GDP as it stands today, compared to less than 2% in 1993, that is a remarkable achievement.”

In December 1993, open outcry was replaced by screen trading, on a 500-terminal system linking Cairo and the older Alexandria exchanges. A new price discovery system has been installed. A French-style central depository system (CDS) with locally written software not fully tested at start-up already has 22 issues dematerialized on it, including the first corporate bond. The remaining stocks are due to follow in the next two years. A new settlement system is overcoming early teething troubles. New regulations at the beginning of April brought about the creation of a stock exchange committee, on which brokers are to be joined by other market players.

All of these developments, including the CDS owned by the banks and brokers, have been prompted by the CMA. This is not entirely popular. One broker says: “We are still being run by diktat. They have done a good, if rather slow, job of laying the foundations, but they should now be letting the market have its head.” Shams Eldin asserts that the CMA’s conservatism has been necessary and may remain so for a while because of the need to foster trust among investors.

The market is dominated by a handful of broking houses which between them share 80% of the business. Some of the more go-ahead brokers are critical of the low entry thresholds established for new brokers back in 1991. There are now some 135, many with negligible capitalization and even less expertise.

At that time, the equivalent of $15,000 bought a seat. Shams Eldin explains: “These new brokers have now had two years to learn their business. But while we have now raised the capital requirement for new entrants, what we have done is require all existing brokers to qualify for, and buy, book-keeping licences.” This move effectively raises the ante to around E£3 million and is likely to force mergers and departures among the weaker brokers.

With a leaner and more experienced broker base, the CMA could reconsider own account trading, though Shams Eldin suspects that it could still be three years away, in part because of the necessity to establish clear procedures and to train compliance officers. His concern is shared by Mohamed Taha, general manager of Egyptian American Bank: “We will welcome the opportunity to trade on our own account, but there should be controls before this window is opened.”

While it accounts for 30% of the market turnover, officials estimate that foreign ownership is not much more than 2%. “Foreigners trade much more than the locals, and by the time an Egyptian gets onto a share, the foreign investors have had their value,” says one broker. Besides the chances of profit, overseas investors are being attracted to Egypt by the stability of the Egyptian pound against the dollar, together with the possibility of making a foreign exchange gain.

There is little doubt that the market has the capacity to take up a new product as it appears, whether from privatization or corporate issues, for which a number of mandates have been given this year. There are now 16 mutual funds, the latest of which – an E£300 million open-ended fund launched by American Express this April – attracted 57,000 applications worth in excess of E£1 billion. The funds currently have E£3 billion under management.

Keeping the ball rolling

The Egyptian government is no stranger to privatization, but things have taken a long time to get moving. Now that they are, the government must keep public opinion on its side

Glancing across the hotel lounge at two separate tables of huddled foreign and Egyptian deal makers, a senior Egyptian stockbroker confesses that a little over a year ago he was beginning to think of giving up. The government’s much heralded privatization programme was beginning to look like a joke. Maybe he had chosen the wrong business.

In the three years up to 1996 the government had undertaken 18 privatizations, the largest a 37.5% stake in Commercial International Bank, but the average amount of state equity sold was less than 20%. Then in May 1996 the government began another minority sale in real-estate company Nasr City Housing and Construction. The original plan had been to allot 10% to employees and 10% to outside investors. However, investor demand was such that, for the first time, the authorities decided to go for a majority sale. They put 70% of the company’s equity – some 2.8 million shares – out to the public, while offering a further 5% to employees. Price was fixed at E£65 each. The offer was heavily oversubscribed and raised almost $54 million. Overnight market sentiment changed and any thoughts the broker had of quitting the business were forgotten.

For the rest of 1996, the government sold stakes in 21 more companies, 11 of them involving more than 50% of the equity. As of the first quarter of this year, a further six blocks of shares had been sold, three of them in already partially privatized companies – Helwan Cement, Ameriyah Cement and Al-Ahram Beverages. Only the last deal, for a 75% stake worth E£231 million, proved at all difficult to place, and the problems here were blamed on market conditions.

This February, the government issued two further lists of planned offerings. The first listed 18 companies with a total value of $650 million, which was followed by 14 share blocks in 14 further companies. Analysts at EFG-Hermes are predicting that stakes in an additional 22 state enterprises will be coming to market. Privatization receipts in 1996 were E£3.65 billion and this year’s announced disposals are expected to yield a further E£2.2 billion.

On top of this the government has committed itself to privatization plans for one of the four big commercial banks. There is general agreement that the National Bank of Egypt will be the last bank to come to market and Misr Bank is considered to be in need of further restructuring. This leaves Banque du Caire and Bank of Alexandria to choose between.

Minister of state Youssef Boutros Ghali says the government wants a deal that “will cause the markets to sit up and take notice”, and is looking for a strategic international investor who will take over the management of the bank. This April officials were still analyzing the banks’ figures, but Boutros Ghali said he expected that a mandate would be awarded by June and the privatization completed within 12 months.

One respected Egyptian broker warns, however, that the government may be failing to explain the benefits of privatization, seen in some quarters as “selling the family silver”. It could still shy away from a major trade sale to a foreign bank. He points out that the official responsible for pricing the Nasr City issue has been widely criticized for the fact that the shares have appreciated over six and a half times since the issue: “People simply do not understand that this rise in share price was largely a consequence of market conditions and that the issue price was not necessarily too low,” he says.

Public opinion may yet throw the privatization programme off course. It is therefore being suggested that some form of voucher programme, possibly even the distribution of shares to individual households, might short-circuit any rising suspicion and resentment, by giving the ordinary Egyptian a vested interest in the process. The trade sale of a bank could still go ahead, it is argued, with the foreign purchaser being guaranteed control via a minority stake. This could be increased over time through normal purchases.