| Fiscal and regulatory reform is needed if Cairo is to succeed in creating sustainable and broadly based economic growth |
“When I rang our clients this time last year and said they should invest in Egypt, they laughed. I rang them up a few months later and told them they’d missed returns of 13%. I still didn’t get any calls. I rang them up a few months later and told them they’d missed returns of 38%. That started to wake them up. And when in the next call I said 45% we really started to get some interest.” Mohamed Younes, chairman of Concord International Investments, laughs as he recalls the uphill struggle to interest his clients – specialist foreign equity buyers and high-net-worth individuals – in a country that has suffered from its association with the Middle East conflict and the war against terrorism.
In particular, Younes is dismayed by what he sees as “the absolute dichotomy between perception and reality”. By this he means that investors assume that the Egyptian economy, given its dependence on tourism, must have nose-dived after September 11 and then the invasion of Iraq.
In fact a brief history of the balance of payments deficit tells a different story.
In 2000 the deficit was around $4.4 billion – $3.3 billion taking into account privatization proceeds. By June 2001 it had fallen more than 75% to around $800 million. Then came September 11 – an event that forced the government to revise predictions for the deficit to $2.2 billion. The predictions were wrong. Tourism held up, Suez Canal revenues held up, remittances from Egyptians abroad held up.
In June 2002 the deficit was $447 million – though after a $1 billion Eurobond – on GDP of $84 billion. As of December the balance of payments was in surplus. After the float and devaluation of the pound earlier this year, the currency black market is now just 5% of the trading market and black market rates are only about 3% off the official market rate. In Younes’s view: “The fundamentals are fabulous. We have companies here with an 18% to 20% dividend yield trading on five times earnings with the prospect of currency strengthening.” Of course Younes is paid to be an optimist. If no-one buys Egypt, no-one uses Concord. But there is other good news.
The budget deficit is down from 20% of GDP in 1991 to around 2.5% of GDP now. Foreign debt as a percentage of GDP has dropped from 77.9% of GDP in 1991 to 32.1% in 2002. And, perhaps most significant of all, Egypt is set to move up the ranks of oil and gas producers and exporters after a series of recent discoveries.
Oil output in Egypt, deemed a mature producer, had declined in recent years to about 630,000 barrels per day (bpd) at the end of 2002 from around 900,000 bpd in the mid-1990s. However, in May BP Egypt announced the largest oil discovery in the Gulf of Suez in 14 years. The Saqqara field will pump at 60,000 bpd.
In July the Apache Corporation announced its most significant discovery to date in the country’s Western Desert. According to Apache CEO and president G Steven Farris: “It is perhaps the most significant discovery in Apache’s 49-year history and establishes the Western Desert as an important hydrocarbon province well into the 21st century.”
Export liquidity The country is also gearing up to become a major player in the liquefied natural gas (LNG) market. The first exports of LNG from Egypt are set to start in December 2004 from a project in Damietta involving Spain’s Unión Fenosa.
The $1 billion project will produce the largest capacity and fastest developed LNG plant in the world and will generate substantial export earnings for Egypt. The UK’s BG Group is involved in two significant export projects, including an export complex at Idku involving Gaz de France and Malaysian company Petronas. And an underwater pipeline to carry Egyptian natural gas to energy-scarce Jordan was recently inaugurated by Jordanian King Abdullah II and Egyptian President Hosni Mubarak in the Red Sea resort of Aqaba. The 16km pipeline runs from the Egyptian port city of Taba to Jordan’s Aqaba, from where it is expected to be extended to northern Jordan, Lebanon, Syria, Cyprus, Turkey and Europe.
By 2006 Egypt expects to be exporting gas not just to its immediate neighbours and Europe but even the US.
Most encouraging of all is the government’s attitude to foreign participation. Egyptian minister of petroleum Sami Fahmi says: “We want the support of foreign companies and we want to cooperate with them. We let them select their own acreage and do not try to keep sites from them.”
Much still to do However, in key respects, Egypt suffers many of the ills of other emerging markets. Foremost among these is the dominance of government in economic affairs. This is hardly surprising after 40 years of complete nationalization, but the price of government control, in terms of mismanagement and workforce conditioning, has been huge and will continue to depress growth and investment for years to come.
At the micro level, as elsewhere, an initial battle with inflation seemed to have been won only for fundamental imbalances to remain. Having brought inflation down to an average annual level of 2.3% in 2001 – it was almost 20% in the early 1990s – the government now has to face the consequences of this year’s liberalization of the Egyptian pound. The official inflation index, the CPI, is measured from a basket of subsidized goods and is therefore no indicator of true inflationary pressures. Even with the government absorbing price rises in core goods and services, foreign economists believe that CPI inflation will rise to 4.3% in 2003. The true rate is estimated to be closer to 10% to 15% for the middle classes – and rising.
Worse, economic growth is sluggish. The Economist Intelligence Unit estimates that real GDP growth in fiscal 2003 was just 1.8%, with the economy suffering from the high interest rates needed to support the currency and from a lack of hard currency to pay for imports and raw materials. For a country of 68 million people growing by about 2 million a year, this is not fast enough.
Of the population, 57% are under 24 and, officially, about 6.5 million are unemployed. A drive across Cairo suggests this figure is understated. There are too many people idling on street corners; too many young men ready to guard your parked car for a pound or two; and too many people in Cairo’s shops and banks clearly paid a pittance simply to move paper from one desk to another. This is not just a recipe for inefficiency. Without strong and sustained economic growth and increased employment it is a recipe for social instability. And the government knows it.
Again in common with many emerging economies, Egypt lacks the fiscal core of a modern nation state. Tax receipts are not enough for the government to fulfil its primary role as provider of core infrastructure, law and order and basic services.
Poor governments supplement their incomes by charging twice for their services, formally and informally. Their employees tend to do the same, which is why Egypt still has a reputation for corruption – it ranks 62nd in Transparency International’s corruption perception index where first on the list is least corrupt.
The population, believing that the government cannot be trusted with its money, tries not to pay.
Reform is the answer to these problems and here the government, for now, deserves the benefit of the doubt. The first phase of a comprehensive fiscal reform package was agreed last year. One of the most controversial measures is the separation of some 45 state-owned public authorities and entities from the state budget.
These entities, with a collective debt burden of E£42 billion ($6.8 billion), will no longer be funded by the finance ministry and will have to cover costs and debt service through their own operations.
Phase two of the reforms, planned for later this year, is even more ambitious. The main aim is to create what one MP calls “a sane and more balanced system” in which tax rates are cut across the board and tax exemptions for special interest groups are abolished.
The government hopes that in this way the country can move from a situation in which there is widespread tax evasion to one in which the tax base is significantly widened.
By definition a tax amnesty will have to operate to allow those who have previously been outside the tax net to come in without being penalized for a lifetime of evasion. In typically Egyptian fashion this amnesty is likely to be an unofficial, unwritten pardon. These tax reforms will be augmented with an overhaul of the customs service.
According to Ahmed Ezz, chairman of steel and ceramics manufacturer Ezz Group and a leading member of the modernizing faction of the ruling NDP party: “This law may be debated in the next session of parliament and in my view by the next session we will have a new tax law.” As for the effects, Ezz says: “There will not be much effect on government revenue in the first year and then over the medium term revenues will increase until in seven years revenues will have doubled.”
These reforms, though, are balanced by the government’s continued liking for price controls and subsidies on basic goods. Egypt – once the bread basket of the Roman empire – is today one of the world’s largest importers of wheat and a big importer of sugar and rice.
The devaluation of the pound has pushed up the prices of these goods and ministers have been quick to criticize what they see as profiteering merchants. The prices of 15 staple foodstuffs will continue to be subsidized at a net cost of about E£2,000 per capita.
A perfect system to boost NPLs Reform has also taken root in the banking sector, starting with the big four publicly owned banks. These are National Bank of Egypt, Banque Misr, Banque du Caire and Bank of Alexandria. Between them they account for around 58% of the deposits of the banking system, between 50% and 60% of the assets, and 75% of all transactions.
For years these institutions had suffered not simply from mismanagement (in the year to June 2002, for example, they lost $133.53 million in foreign exchange transactions) and lack of investment in modern information systems and training, but also from being conduits of government largesse as each was tasked with supporting a particular sector of the economy.
Directed lending to state-owned enterprises is one of the easiest ways to ensure that a bank’s credit culture is tainted by cronyism and corruption. It is also one of the easiest ways for bankers to generate bad loans. According to official statistics, these now stand at E£45 billion or around 13% of the total deposit base of the banking system.
However, banks do not publish these figures with their annual reports and the definition of a bad loan is neither clear nor stringent.
Take ratings agency Capital Intelligence’s assessment of the non-performing loans problem at Banque Misr: “As is the practice among banks in Egypt, Banque Misr does not disclose the amount of its NPLs in the financial statements. However, according to management, NPLs stood at 9.63% of gross loans. The treatment of rescheduled debt is not disclosed, neither is the amount of rescheduled debt.”
Banks have also converted debts to equity and to government paper – again the amounts and terms of these transactions go unreported. It is therefore safe to assume that the true level of impaired assets as they would be defined internationally is higher than the published figures.
The government has responded to the problem. It has jailed corrupt executives and creditors, it has installed new management at the public sector banks, and it has drafted a more modern banking law.
At the beginning of this year more than 30 senior figures in government, finance and business were indicted on charges of having carried out illegal financial transactions. Among those prosecuted are Muhammad Abu Al-Fath, the former managing director of Banque du Caire; Abdullah Tayel, the former head of Misr Exterior Bank; Abdul-Wahab Qota, member of parliament and chairman of the board of directors of Misr Exterior Bank; and millionaire industrialist Tayseer Al-Hawari.
| Mubarak: the Egyptian president recently inaugurated, alongside Jordan’s king Abdullah II, an underwater gas pipeline to Aqaba. |
Bardai, the former Citibank Egypt head, was appointed chairman of Banque du Caire in March 2000. Abdel Latif moved to Banque du Caire in 2001 before his appointment to the chair of Bank of Alexandria last year. The Bank of New York’s former Middle East regional manager, Farouq el Okdah, was appointed chairman of National Bank of Egypt in 2002, while former Egyptian American Bank chairman and Egyptian Gulf Bank vice-chairman Mohamed Barakat accepted a position on the board of Banque Misr, later moving up to chairman, also in 2002.
One small indication of the task these men face in disentangling their banks from government control is that the banking laws themselves had to be ignored to allow the new appointees to be paid a market rate. While the private sector paid its chairmen up to E£2 million a year, the banking
law capped public sector salaries at a tiny fraction of that amount – another incentive to indulge in dubious lending.
Bank of Alexandria’s Abdel Latif explains the government’s plan: “About three years ago the government decided to replace the senior management of the big four banks with people from the private sector. Banque du Caire was first and I went there as vice-chairman and stayed for 11 months. It was a great experience because as number two I could focus completely on internal matters.
“The aim now is to deliver our short-term goals, things like renovating 15 major offices, re-engineering the branch network, putting in modern technology and, most important, training the staff. I give half the credit seminar myself.”
But the first task was to negotiate with the biggest creditors – state-owned enterprises (SOEs) – and reschedule their debts. This is no easy task and the banks are reluctant to talk about it. “We need government support for the rescheduling,” says Banque Misr’s Barakat. “Because ultimately they will be paying the bill, whether by enabling the SOEs to pay us or by paying us directly. We have been discussing this for around six months and I am hopeful that we will have reached agreement in another three months – certainly by the end of the year.”
One recent rescheduling has surfaced publicly: Sinai Cement (SCEM) has settled its debts with Banque du Caire. Total debts owed by SCEM to the bank had been valued at E£282 million ($46.43 million). The structure of the deal has, typically, not been revealed.
The government has also drafted a new Central Bank and Banking Sector Law that increases the independence of the central bank, sets a framework for the privatization of Egypt’s joint-venture banks (the joint venture is between the public and private sector) and imposes minimum capital adequacy levels and a minimum paid-in capital requirement.
These moves will force mergers and closures upon Egypt’s 57 domestic institutions, though the deadline for the most important of the increased capital requirements is 2006. Around $696 billion of new capital has already been injected into the big four. And a series of other modernization measures, including regulations concerning related party transactions, are being put in place.
However, external analysts, including Fitch Ratings, still argue that the banking sector is poorly capitalized by international standards and that the understatement of non-performing loans means that many banks, especially in the public sector, would already be below the new minimum requirements if the true level of problem assets was known.
The public failure of four banks to increase their capital adequacy by the central bank’s March 31 deadline (in addition to the rumoured private failure of many more) has highlighted the sector’s continuing weakness
It is also worrying that, despite the replacement of senior bank officials with private sector candidates which started in 2000, a quarter of the bad loans at the large banks were incurred in 2002 through loans to large corporations, both public and private.
The most publicized of these was the E£1.5 billion lent to Hossam Abul-Fotouh, who is, among other things, owner of the local BMW car assembly plant. He is now at least as famous for the bootleg video CDs of his romps with Egypt’s leading belly dancer – discovered by police when they raided his house for evidence of financial wrongdoing and then mysteriously distributed across Cairo’s dinner party set – as he is for representing the rot in the Egyptian banking system.
Who’s central bank governor? Elsewhere in the financial sector it is also clear that old habits die hard. The floating of the pound at the beginning of the year has been dirtied by continued government influence on the exchange rate (through the public sector banks and the central bank) and continued compulsory purchases of hard currency from the private sector.
Of more concern, the central bank still sets a poor example to the institutions it supervises, particularly in terms of transparency. Earlier this year depositors at the nation’s banks started to find it hard to withdraw their dollars from local foreign-currency accounts. They were told by staff that the edict had come from the central bank. The central bank denied that there were limits and the chiefs of the big four duly toed their regulator’s line. However, dollar withdrawals continued to be capped.
And then, as Euromoney went to press, there was the seemingly simple question of who actually was the governor of the central bank.
It was reported on July 23 in the local Egyptian press that Mahmoud Abul-Oyoun had resigned just 18 months after his appointment. Unusually, the central bank itself would neither confirm nor deny this, except to say, rather oddly, that a new governor and board of directors would be appointed within a week if it were true that the governor had actually resigned.
On August 7 political sources confirmed to Euromoney that the governor really had resigned. The central bank again refused to confirm or deny this while a contact at the Egyptian embassy in London at first confirmed the resignation then backed off, saying: “I can’t understand why you would want to know that. Egypt is a very different country [to the UK] and you will not be able to find out this kind of information easily.”
It is perhaps because Egypt is so very different that net FDI inflows fell from $1.66 billion in fiscal 1999 to just $428 million in 2001. Those differences may also be one of the reasons exports are just 7% of GDP.
Power and the patronage and perks it brings are hard drugs to kick. The big test for Egypt will be making the transition from failed, repressive command economy to some form of more open and democratic society.
The younger generation is cautiously optimistic. Ahmed Ezz says: “We have been through a period in which people questioned the value of the private sector. We are beyond that now.
“More generally, I am quite positive on the Egyptian economy and I am optimistic that we have left behind the period of difficulty that we experienced over the last three years. I would like to see the country regain its investment grade rating and I think that this is possible within two years as long as we continue the present sound policies.”
The jury is still out.
GDP growth and unemployment
*estimates
Source: Ministry of Foreign Trade
