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FOR THE FIRST time in four years there is room for optimism about the Egyptian economy. The economy is growing, the stock exchange is beginning to show real gains and there is hope that the government will begin structural reform. Now the appointment of a new central bank governor, Farouk El Okdah, has boosted confidence. He has earned the respect of bankers in the two months since he took office and has started to bring order to the country’s currency policy.
However, few bankers are under any illusions about the scale of the task ahead if the third-largest and most diversified economy in the Middle East is to fulfil its potential. Growth is still low by emerging-market standards and not substantial enough to create the jobs needed to support the country’s rapidly growing population. The private sector has yet to feel the benefits of the better macroeconomic performance and the government has until now failed to deliver the privatization needed to create a dynamic economy.
“The economy is looking a little better, with growth of 3.3% compared with 2.5% last year,” says Allan Conway, head of global emerging markets at WestAM. “But it is not impressive compared with other emerging markets and, with such a young population, it needs to grow by at least 5% to 6%.”
Conway argues that the real problem remains the lack of liberalization in the economy. “There has been some privatization but the government is still involved in too many aspects of the economy,” he says.
One of the most positive developments, say bankers, has been the appointment in January of Okdah as governor of the Egyptian Central Bank. Okdah, a former chairman of the National Bank of Egypt, who had previously worked at the Bank of New York, is regarded as the most professional and experienced person to hold the position for some years.
“Okdah knows and understands the problems facing Egypt extremely well,” says Michel Accad, the Cairo-based division head for the Middle East and North Africa at Citigroup. “The central bank now says very little and acts decisively when it is necessary.”
That positive reaction is shared by Egyptian bankers. “While it is still too early to make a judgement about his performance, from what we have seen so far his appointment is a step in the right direction,” says Mustafa Abdel-Wadood, head of investment banking at Cairo-based brokers EFG-Hermes.
Okdah’s biggest impact has been in the management of Egypt’s exchange rate policy, which is now much more coherent. As a result, the official rate for the Egyptian pound is once again much closer to the parallel unofficial rate. There is now, say bankers, a chance that this position can be sustained for the long term.
However, there is always the risk that the government will lose its nerve again. The frequently wide gaps between the official and parallel rates for the currency, which are caused by the government’s reluctance to devalue or raise interest rates sufficiently, have bedevilled Egypt’s economic policy management for years, proved a major deterrent to investors and done little to bolster exporters’ competitive position.
It looked for a while at the start of 2003 that the government was finally addressing the problem when it changed its policy from maintaining a fixed level to that of a managed float. By the middle of the year, the parallel and official rates were virtually the same.
But the government, alarmed at the speed of the devaluation, lost its nerve at this stage and reverted to the policy of applying a de facto peg. As a result, the gap between the two rates widened to more than 12%, which made it tempting for even large established companies to obtain their foreign currency on the parallel market.
Avoiding panic Since the appointment of Okdah, the difference between the rates has started to narrow and by the middle of March it was as little as 2% to 3%. “This is due both to confidence in the new governor and his decision to give foreign exchange to public-sector banks when they needed it, which has reduced demand for Egyptian pounds in the parallel market,” says one banker.
And bankers say that at last the central bank is starting to understand that it should not be panicked by what appears to be an over-rapid devaluation as this will almost certainly be followed by a correction.
The devaluation in the first half of 2003 prompted an improvement in Egypt’s current account, as well as an end to the drain on official reserves. The country has also benefited from the continued high price of oil. A surge in Suez Canal dues – a major foreign exchange earner – sprang from non-price factors such as an increase in military traffic and a rise in the value of SDRs, the IMF unit in which the canal fees are levied. This progress has been enough to encourage international companies such as Hero Jam, Nabisco and Nestlé to consider investment.
However, there is still concern about the overall direction of the economy. The devaluations of the past two years have fuelled inflation, which in 2002 was running at a manageable 5% but climbed to 20% last year and is once again pushing up towards 18%.
This leaves the authorities with a dilemma that bankers say they have yet to resolve. Either they push for more growth, risking even higher inflation, or increase interest rates to squeeze inflation and, in doing so, threaten economic growth.
Another concern is the failure of the government to address the need for structural reform. Despite promises of privatization, large parts of the economy including the banks, the fixed-line telecommunications company and the aluminium industry remain in state hands. One banker notes sardonically that the government regards even tobacco as a strategic industry.
Non-performing loans and defaulting businessmen have damaged banks over the past year, and banking reform is expected. The sector is still dominated by the four large state-owned institutions – National Bank of Egypt, Banque Misr, Banque du Caire and Bank of Alexandria – which between them take 60% of the market. But, these banks, which in three cases had changes in senior management, are gradually losing market share to the five more dynamic private-sector banks.
Under pressure The banking industry as a whole is expected to become stronger as the full impact of tougher capital adequacy laws is felt – one effect is that some undercapitalized financial institutions might come under pressure to merge. Stricter rules are also being introduced under a new banking law that imposes a minimum capital requirement of E£500 million ($80 million) as well as limits on exposure to individual customers.
According to Ahmed Marwan, chairman and chief executive of Cairo-based brokers Sigma Capital: “Just as important as the change of governor at the central bank is the change in the law which gives the authorities much more autonomy.”
However, there is little confidence that tougher financial requirements will lead to privatization of the financial sector. Nor are extensive sales of other state industries expected. “It is a real problem that privatization is so limited,” says one banker.
Some observers, though, perversely see the pessimism as a reason for optimism. As EFG-Hermes notes in its annual economic assessment: “Market expectations regarding possible structural reforms and privatization are at an all-time low; therefore any moves on these fronts will have a positive impact on stock market valuations.”
Sentiment on the Cairo and Alexandria Stock Exchanges has already started to anticipate broader economic progress. Although Egyptian equities have not risen as dramatically as those in some other markets in the region – Arab markets rose by an average 70% in 2003 – the Egyptian exchange climbed 63% in dollar terms last year and by 50% in the year to the end of March.
This marks a significant change in sentiment. Foreign investors, who had been irrationally over-enthusiastic about Egypt in the late 1990s, refused to touch the market in the early part of this century as its capitalization plunged to as low as $7 billion in early 2003. They had lost faith in the country when the promised reform programme failed to get under way.
The main difficulty for foreign equity investors is that, without privatization, there are simply not enough liquid stocks in the market – the last IPO was in July 2000. The focus now is on such companies as Orascom Construction Industries, Orascom Telecommunications and the manufacturing firm Oriental Weavers, which have benefited from devaluation.
The country’s prospects depend on the political leadership, which bankers believe is still too conservative and reluctant to take decisions that will create a dynamic market economy. Until that attitude changes, the verdict of investors is likely to be that Egypt is at last moving in the right direction but not as fast as it should be.
