Uncertainty in Egypt

The economy has been affected by the revolution and the ongoing political instability, with the unrest having a knock-on effect on the commercial trading environment.
Analisis Credito y Caución
Madrid - 07-mar-2012

President Mubarak resigned in February 2011, following more than two weeks of mass protests, and ceded power to the SCAF, which dissolved parliament and suspended the old constitution, promising in turn to cede power to a democratically elected government.

The election for the Peoples Assembly, the lower house, with 498 members, has taken place in three rounds of voting, beginning on November 2011 and ending in early January 2012. Two thirds of the members of parliament are elected from party lists and one third are individuals. In the lower house elections the Muslim Brotherhoods Freedom and Justice Party won 47% of the seats and will be the largest faction in parliament, followed by the more conservative Al Nur party backed by the Salafi movement. It is evident that liberal and secular parties have been marginalised.

Elections for the Shura Council, the upper house, with 270 members, have begun end of January. The two houses will jointly select a 100-member committee which will start immediately to draft a new constitution. Finally, the governing military council has repeatedly assured that presidential elections will be held by the end of June.

The resurgence of violent protests and clashes between protesters and the security forces in mid-November 2011 reflected a combination of a poor reform process and grown dissatisfaction with the ruling military leaders and the interim government.  The armys reaction to the mass protests that again flared up was harsh, with many victims and more than 10,000 civilians tried in military courts.

In order to show its willingness to compromise, the military council said that it will cede power when a new president is elected. Ahead of the anniversary of the start of the uprising the SCAF pledged to release prisoners and finally lifted on January 25 the state of emergency in place since 1981, giving the authorities extensive powers to suspend basic rights, albeit only partly.

Relations with the US are close and important: especially financially in terms of aid. However, relations with Israel have deteriorated. While the military establishment is still intent on maintaining a workable relationship with Israel, based on the 1979 peace treaty, there is rising public pressure for the government to take a tougher stance on the Palestinian-Israeli conflict: especially on the issue of the Gaza strip.

Economic growth deteriorated in 2011

After a 5.1% increase in 2010, growth is expected to have decreased to 1.8% in 2011. The economy has been affected by the revolution and the ongoing political instability, with the unrest having a knock-on effect on the commercial trading environment. Until recently, strikes and protests have continued to affect the economy and the industry is operating, at best, far below capacity, while tourism has suffered from a large drop in visitors. In Q3 of 2011, tourism revenues continued to decrease sharply [by 26.0% year-on-year] after declines of 35.4% and 34.0% in the previous two quarters. Egypts benchmark stock index declined 40% in 2011. Foreign direct investment [FDI] has dropped sharply, but at least the Suez Canal traffic, with its associated receipts, has been less badly affected.

Economic activity will continue to depend on political developments. Many investment decisions will be on hold until the outcome of the presidential elections is known. Inflation will decrease to 8.5% in 2012 after 10% last year.

The banking sector has so far proved to be relatively stable. In September 2011, the non-performing loans [NPL] ratio was 11%, while the capital adequacy ratio stood at 16%. Increased lending to the government has resulted in higher exposure to sovereign risks.

The budget deficit amounted to 10.3% GDP in 2011 and is forecast to increase to 10.8% of GDP this year, due mainly to government subsidies for energy and food products [about 27% of government spending]. While those deficits are being financed by domestic borrowing, costs have risen, adding to the already high public domestic debt [84.1% of GDP in 2011]. Interest payments have increased because of the higher cost of funding and the higher debt. Reducing the deficit will be a challenge for the government as cutting the subsidies for food and energy would result in public discontent.

Under popular pressure, the interim government is currently making ad hoc economic policy decisions - for instance, keeping food and energy subsidies in place - which, while popular, are making it difficult to address the high fiscal deficits. The interim government has also decided not to extend the privatisation programme, as large parts of the population associate the liberalisation agenda with the previous economic policies. In the long term, structural reforms to reduce the budget deficit and to contain red tape and corruption are needed.

Outlook: Political uncertainty continues for the time being

While the transitional government is still in place, Egypts future remains uncertain. The relationship between secular and religious political parties and movements will be key to political stability. In this respect, a big question mark still hangs over the future political role of the army: will it fully support a transition to democracy or try to secure special political rights and influence? The liberal and secular parties currently fear that the Muslim Brotherhood and the military council will close a deal to share power, as the Brotherhood has shown signs of willingness to compromise on demands by the military establishment.

All this will directly influence the further developments - smooth or otherwise - of the transformation process, including such steps as drafting a new constitution and the presidential elections expected to be held in June 2012.

The underlying challenge for any future administration will be the introduction of further economic reforms to raise living standards and generate new jobs [graduate unemployment stands at 40%]: thereby maintaining civil peace and countering the appeal of the more radical Islamism.

A subdued economic performance in 2012

An economic rebound will depend largely on a return to political stability. Currently, GDP is expected to grow by 2.3% in 2012. The fiscal position will remain poor [a deficit of more than 10% of GDP in 2012] and domestic debt will remain very high, while inflation will decrease slightly: to about 8.5%. A potential deterioration of the global economy, due to the Eurozone crisis and a cooling of the Chinese economy, would hurt Egypts export performance and decrease its Suez Canal receipts. There is still the danger of a double dip, with Egyptian businesses already affected by the events of the revolution and transition period exposed to any further deterioration, which could lead to further disruptions and difficulties for companies seeking foreign exchange.

The ongoing political uncertainty adds to the risk of a balance of payments crisis. While the domestic political situation remains tense, there will no significant rebound of either FDI or tourism revenues in the short term. It can take several months for tourism to recover after negative events, and therefore the renewed violent street clashes in November 2011 were a major blow to the sector.

At the same time, the rapid drop in foreign currency reserves is increasing the risk of a disorderly devaluation, especially if the central bank were to attempt to defend the currency for too long. A steep devaluation could lead to rising inflation and even more social unrest. To prevent a balance of payments crisis, external financial support is needed.

A US$ 3 billion IMF stand-by agreement was already considered in July 2011, but finally refused by the military-led government amid fears of strict IMF conditions restraining the economic policy. However, as in December 2011 and early 2012 foreign reserves continued to shrink and the currency has come under mounting pressure, on January 15 the administration finally turned to the IMF for a US$ 3.2 billion loan. It will probably take several weeks to work out the technical details until a final agreement will be reached. It remains to be seen if an IMF agreement alone can avoid sharp currency depreciation or will lead to a rebound of [urgently needed] investment.

However, as IMF support is generally tied to restrictions and a credible economic programme, it should help to reassure potential Western and Arab donors. Egypt has been promised budgetary support and other aid above US$ 10 billion in total from several Gulf states like Saudi Arabia and other countries, but little of this financial support has materialised, as those donors are wary of supporting Egypt without serious efforts to get its budget and balance of payments deficits under control. But given the current political situation it will probably be tough for any Egyptian government to impose unpopular austerity measures potentially demanded by the IMF, such as cutting subsidies.

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