Egypt?S Economic Progress Essay, Research Paper
Thesis Statement:
A Detailed analysis of Egypt?s economic progress over the last decade whilst analyzing the effect of privatization on the Egyptian economy
Introduction:
Egypt is the third-largest economy in the Middle East and North Africa region (after Saudi Arabia and Israel), as well as one of the strongest, with significant potential for future economic growth and diversification. With a real commitment to economic reform, which encompasses a large privatization program and the encouragement of private investment and growth in the private sector, the attractions for both foreign direct investors and portfolio investors continue to increase. In my analysis I will first analyze the Egyptian economy in order to present a solid overview and background on which I will then base my own analysis on the effect of privatization on the Egyptian economy.
Economic Overview:
The Egyptian economy is the third largest in the MENA region (after Saudi Arabia and Israel) and is set to grow sharply as the effects of economic reform continue to kick in. Economic growth in the year to the end of June 1999 reached 5.7%, and should improve in the current year to reach 6%.
While budget deficit is set to fall to 1.1% of GDP, the fiscal situation remains very good. The budget deficit is expected to have been around 1.3% of GDP for the year to the end of June 1999. We forecast a slight fall to 1.1% for the current year. This is one of the key legacies of the IMF structural adjustment program that was introduced in the late 1980s and underpins government efforts to control spending.
Inflation is expected to remain below 3.5% The fall in inflation is one of the key economic success stories, with inflation well under control, currently running at a year-on-year rate of 2.9%. Although there may be slight price pressures going forward, we expect inflation to remain below 3.5% over the next few years.
The overall macro-economic environment remains strong, although several significant structural weaknesses continue to cloud the horizon, with the very low level of non-oil exports the major concern. The decision to cut taxes on exported production is a positive step to increase investment for exports, but the big trade deficit has to become a clear target of government policies.
The private sector is now growing very quickly, as highlighted by the earnings growth expected by listed companies: we forecast earnings growth of nearly 28% this year, nearly 17% in 2000 and 16.4% in 2001. As economic reform has altered consumer attitudes over the last few years, all areas of the economy have seen the development of private sector companies and have begun to reap the rewards through increased consumer spending.
The restructuring at the central bank under the control of the Ministry of Economy should bring about a number of welcome changes. At present, the management of foreign exchange reserves is under review, with all areas of the bank’s operations being scrutinized. One of the key issues to be addressed is the perception of the value of the Egyptian pound. We have already seen a de facto devaluation of the Egyptian pound this year of around 3-3.5% if currency is traded in the private sector?and the public sector banks may follow these rates in due course.
There is no need for a significant devaluation given the negative effects which would accrue?inflation and an increasing trade deficit?since Egypt is not yet in a position to export enough goods to benefit from a devaluation. We expect far greater clarity of operations at the central bank, particularly with regard to the exchange rate mechanism and increased flexibility in the handling of currency demands.
Trade:
Large trade deficit is a concern
Exports analysis, 1998A.
Egypt’s large trade deficit is an area of concern, particularly the fact that non-oil exports are so low. It is no great surprise that Egypt continues to maintain a large trade deficit since there is yet a large industrial base which is able to produce goods for either the domestic or export market, or goods which are cost-competitive with imports. Non-oil exports remain low and are centered around raw cotton and cotton yarn,
textiles, agricultural goods, chemicals and engineered goods.
Imports analysis, 1998A.
Toshka project should boost domestic food production
Food is responsible for the second-largest import bill and reflects Egypt?s under-developed agricultural sector, which has not kept pace with the growth of the population. With the Toshka project’s development of around 2m acres of land over 5-7 years, food production should increase significantly in the first few years after the infrastructure is completed. Chemical and petroleum product imports also reflect Egypt?s state of economic development, and its lack of an indigenous chemical and downstream petrochemical industry.
New oil and gas finds should boost future exports
On a positive note, there have been a number of oil and gas finds over the past few years off the Mediterranean coast, which should boost exports, and there are plans to build a refinery to add value to domestic production. The rise in the oil price this year should improve the current year’s current account. Added to this, the fast rise in tourism numbers and receipts, compounding the consistent remittance flows from Egyptian expatriates over the past year offers the prospect of an improved current account going forward.
Inflation
Inflation, expected to remain under control
While inflation is currently under control.?and looks set to remain so? Egypt had a poor record on inflation until a few years ago, as the chart below shows. The success in bringing inflation down is due to the stabilization policies introduced by the IMF 1990 as part of its structural adjustment program. Under a tight monetary policy, inflation fell from over 25% in 1986/87 to present levels of around 3%. We expect inflation to remain under control, although there may be some price pressures as the economy gathers momentum.
Budget Deficit
Large fiscal deficits seem to be thing of the past
With the budget deficit remaining at low levels as a percentage of GDP, Egypt has been very successful in keeping its fiscal accounts in order. Until the implementation of the structural adjustment program, Egypt had run with very large fiscal deficits due to the high level of subsidies, sovereign indebtedness and poor tax collection. By contrast, the new Egypt is all about fiscal responsibility.
On the expenditure side, the government will be hard pressed to keep the tightest of lids on spending since the country has suffered from several decades of poor investment?one of the reasons for the low budget deficit statistics. There is a general requirement in a number of services, such as in health and education, where the government will have to increase spending. The government must also improve the infrastructure. A successful privatization program should help to fund this and, in the future, boost tax revenues.
The Egyptian Pound
Growth has trended upwards since mid-1990s
Economic growth has trended upwards since the mid-1990s, of the real reform program, and there are signs that a virtuous circle is developing which is helping to transform Egypt’s economic infrastructure. However, this process is still in its early stages and the first signs of strain earlier this year?the increased demands for capital into and out of the country?were handled poorly.
The issues surrounding the Egyptian pound are serious and remain a major factor in blocking possible investments by foreign institutions in particular.
The recent background
As the economy has developed rapidly over the past two years, there have been greater demands for capital equipment to be imported. Compounded by lower oil prices and lower tourism receipts, the level of foreign exchange reserves began to fall towards the end of 1998. The decline worsened throughout 1999, which has caused some concerns about the central bank’s management.
The central bank had previously used the high foreign exchange levels as an indicator of its prudent policies with the high reserves being used to show of the policies rather than being used as an asset.
General capital flows into and out of Egypt have increased significantly over the past 18 months, while state revenues from oil and tourism declined. The central bank mishandled the issue by placing restrictions on foreign currency coming into the market, which has resulted in shaken confidence in the Egyptian pound.
Although the central bank has released large flows of foreign currency in the last few months in an attempt to meet market demand, the market is still feeling the effects of the central bank’s handling of the reserves issue. There have been some requests in the market for the Egyptian pound to be allowed to have a limited devaluation or to float slightly to find a more realistic level.
However, a marked recovery in oil prices and tourist numbers has resulted in many believing that the crisis is a short-term one only. But with a number of local and foreign commentators criticizing government policy on the currency issue, the market is waiting for news on action at the central bank.
The Ministry of Economy has set to work on restructuring the central bank
The Ministry of Economy has been authorized by the Prime Minister to restructure the central bank and is already focusing on the management of foreign exchange reserves. We expect specific policy goals to be announced shortly.
We believe that new, additional staff might to be appointed at the central bank to deepen its management and that a positive mission statement from the Ministry of Economy on the currency should put the debate to rest. We expect to see statements on the transparency of the exchange rate mechanism and on the operations of the central bank in the short term.
Economic drivers
The opening of the banking sector has been significant
The drivers of the economy have altered somewhat over the last decade, as the economy has increasingly become free from limitations imposed by nationalization.
With the opening up of the banking sector in the early l990s, the banking, finance and investment sector has increasingly become one of the key drivers of change. The sector has become more competitive, with the banking industry in particular developing a number of new instruments to broaden the market and stimulate increased savings.
The sector has also expanded rapidly, with a number of foreign banks buying stakes in domestic banks as part of the privatization program. The four major state banks are expected to undergo significant restructuring over the next few years in preparation for privatization some time in the next decade.
General industry has also been undergoing major investment over the latter half of the l990s in particular, as the growth in the economy has improved confidence in the market and encouraged investment. This can be seen in the variety of privatization, ranging from the cement sector to the beverage and general manufacturing sectors. There is still an enormous way to go, with the textile sector in particular hardly started on the process of reform. Nevertheless, profit growth at the major industrial stocks has trended upwards for several years and looks set to improve further as more companies are established to satisfy local demands for goods and services.
EU/Mediterranean agreements are encouraging greater efficiency
An added impetus for increasing efficiencies in industry is the EU/Mediterranean agreements to take forward a free trade zone over the next 10-12 years: domestic companies are being forced to increase efficiency in order to compete effectively. The increasing arrival of global businesses in Egypt through direct investment is also adding to growth and encouraging domestic companies to gear up both investment and overall strategy to fight increased competition.
Petroleum products sector is becoming more important
The petroleum and petroleum products sector has also seen sound growth over the last few years, although the fall in the oil price has held back the sector’s contribution to GDP. There has been significant investment from international companies searching for oil and gas on the north coast and off the Sinai over the past two years, resulting in an increasing number of finds. This should work its way through to growth over the next decade.
Privatization
Major privatization program scheduled for 2000
The privatization of the state’s assets, most of which were nationalized in the 1950s and 1960s, is one of the government’s central economic policies. A thorough programme of privatization is planned across several industrial and service sectors. However, the privatization process has been slower than originally expected. The high pricing of issues was a key problem until 1998, when the then Minister of Privatization, Atef Ebeid (now the Prime Minister) reduced the prices of privatization to meet market demand, showing an admirable flexibility.
This year the government has begun to realize the seriousness of delaying the programme and has begun to clear the decks in preparation for the larger privatization?Telecom Egypt and the electricity utilities?in 2000. The government has also made it clear that there will be a full privatization of all state holdings in the cement and gas distribution sectors.
Privatization ministry has been pragmatic in lowering price
Several ministers have made over-optimistic speeches and comments about the privatization plans over the past year. As the process has been not altogether transparent (the case of Arab African Bank), there has been some skepticism over whether the program is on track. We believe that it is. The privatization ministry has been pragmatic enough to cut the prices of the companies being privatized as the domestic stock market has fallen. While the domestic market might not have been ready for large-scale privatization in the past, we believe it is now well prepared.
The four main state banks are not being privatized in the short term
The state would be left with its four main banks?National Bank of Egypt, Banque Misr, Bank of Alexandria and Banque du Caire. The President recently stated that these banks would not be privatized in the short term, but is clear that they will undergo significant restructuring before privatization in the next decade.
All four banks are far less efficient than the private sector banks, and it is likely to take a number of years to turn the banks around. Nevertheless, the market share of these four banks should result in them being well received by investors domestically and overseas.
Economic Structure
The Egyptian economy is relatively well diversified, although the importance of sectors such as agriculture signal that Egypt is still a developing economy. The key features of the Egyptian economy are:
a) Growing trade, finance and insurance sector;
b) Large agricultural sector;
c) Government and social services are an important element; and
d) Growth of services, construction and industry set to remain strong.
Agriculture
Agricultural sector is responsible for 18% of GDP
The agricultural sector remains relatively large at 18% of GDP. This is a reflection of the damage done by nearly forty years of nationalization, which diminished Egyptian industry so that it is currently responsible for only 19% of GDP, just one percentage point more than agriculture. Agriculture is a cornerstone of life outside the Cairo and Alexandria conurbation and it is an area of production where there has been little investment as yet to improve productivity. Fields are still flooded to provide irrigation, wasting water, and the staple crop of upper Egypt is still sugar cane, rather than other more productive crops such as sugar beet or wheat.
Domestic food production should be boosted by Toshka Canal project
As one of the world’s biggest importers of wheat, and with food the second largest part of the import bill, an increase in local food production and the increased efficiency of that production must become a core part of government policy. A key development is the Toshka Canal project to the south west of Cairo, which is being constructed to take water from Lake Nasser (behind the Aswan Dam) to irrigate a large area of desert (around 2m acres over 5 – 7 years) for agricultural production in particular, although some industries will also be encouraged to set up there.
With 95% of the population living on just 5% of the land, much of Egypt is severely underdeveloped, and it is hoped that this project will change that. While the construction sector should benefit significantly from the Toshka project, the issue for some critics is that the project depends on water from Lake Nasser?water which flows through many other states and which in the future may not be so free flowing.
Trade, finance and insurance
Trade, finance and insurance sector is set to account for 25% of GDP by middle of next decade
Over the last few years, the trade, finance and insurance sector has grown steadily (an increase of around 1% of total GDP each year). We expect this sector to continue to grow steadily, as the financial services sector picks up activity and deepens operations over the next few years. By the middle of the next decade, trade, finance and insurance should account for around one quarter of total GDP. It would be useful, however, to have a specific breakdown between trade and financial services, to improve the understanding of the dynamics of Egypt?s growth.