The faltering global economy has undermined forecasts made by Cairo in 2007 that gross domestic product (GDP) growth of 7 per cent could be expected until 2010.

Spurred on by impressive GDP growth of 7.2 per cent last year, analysts began predicting that Egypt’s GDP growth in 2008 could hit 8 per cent, forecasts that have recently been revised downwards.

Despite 10 years of high growth, increased foreign direct investment (FDI) and vast improvements to the business environment brought about by the economic reforms of Prime Minister Ahmed Nazif’s government, Egypt is having to face the fact that its economy, like that of every country across the world, is going to experience a major slowdown over the next few years.

Past mistakes Egypt’s Investment Minister Mohamed Mohieldin said in September that the government would be satisfied with 6.5 per cent GDP growth for this financial year, a downwards revision of 0.7 per cent on the previous forecast.

This revised figure is in itself evidence that Cairo is now prepared to confront a slow-down and that it has learned from any past mistakes.

The country’s reluctance to take any serious action in response to the Asian crisis in the
late 1990s resulted in a legacy of bad debt and billions of pounds worth of non-performing loans, which the government has only recently eliminated through measures introduced under the banking reform programme launched in 2003.

The government is determined that history will not repeat itself and recognises that state intervention is imperative if it is to mitigate the impact of a slow-down.

“We are going to be pre-emptive as opposed to reactive in our actions and policies throughout this upcoming phase,” Rachid Mohamed Rachid, Trade & Industry Minister, told MEED on 23 October.

The government has been holding a series of emergency summits with representatives of ministry bodies in order to work together to develop support packages, to ensure that Egyptian products and services remain competitive.

“We know there won’t be a one-size-fits-all solution for this because different sectors will be impacted in different ways,” says Rachid. “One measure we will take is to prioritise the insurance of exports and imports. We will also remove some of the export fees as we have done for cement and steel.”

The Trade & Industry Ministry has increased the Export Credit Guarantee Company’s capital by $54m to allow for more insurance coverage for Egyptian exports, as well as an expansion of the export sector.

Rachid says that bilateral trade relations with the GCC account for 10 per cent of Egypt’s total trade volumes, and that there is room for heightened co-operation with the Gulf.

He also wants to increase trade with emerging markets such as Turkey, South Africa, China and India, to balance the inevitable consumption slow-down in Egypt’s traditional export markets of the West.

Some 65 per cent of Egypt’s exports were sent to the EU and the US in the fiscal year ending June 2007, 33.8 per cent and 31 per cent respectively. Given that the EU and US markets are entering recession, Egypt’s exports trade is likely to be hit badly.

The profitability of the Suez Canal is also under threat from the rise in Somali piracy. There have been more than 60 pirate attacks off the Somali coast and in the Gulf of Aden so far this year – mre than twice the total for 2007. UK-based international affairs group Chatham House noted in a recent report that insurance premiums for shipping through the Gulf of Aden have increased tenfold.

Shipping rates have already plunged to a two-year low – the Baltic Dry Index, a measure of commodity-shipping rates, fell by 9.4 per cent on 9 October to 2,503, the lowest point since June 2006, when the index was at 2,478. So far in 2008, the index has dropped by 73 per cent, from a peak of 11,930 points seen in June.

Limiting exposure

While it is too early to see the impact of the financial crisis on Suez Canal revenues, such sharp declines in shipping rates will inevitably have a serious knock-on effect on the economy. Suez Canal trade contributed 3.3 per cent of GDP in the 2007-08 fiscal year, and proceeds rose by 23.6 per cent to $5.2bn in the same period.

One area the government is confident about in the face of the turmoil is the banking sector.

“This international crisis is a credit-based one and Egyptian banks are not suffering from a lack of liquidity,” says Rachid.

“On the contrary, our loans-to-deposit ratio is almost 50-50.” Rachid insists that Egypt’s banks are completely insulated from the mortgage crisis.

“Our banking system is not in any way involved with any sub-prime or mortgage loans in the US or Europe, or any place outside of Egypt.”

The Central Bank of Egypt’s restrictions on the amount banks can invest abroad means that they have limited exposure to the global crisis. Banks cannot invest more than 5 per cent of their loan portfolio in real estate overseas.

Of the $50bn invested abroad by Egypt, only $15bn has been invested by Egyptian banks, with the remaining $35bn comprising the government’s international reserves, mainly in the form of treasury bills, which are government secured.

Meanwhile, the government plans to boost activity in the building materials sector, given the importance of construction in stimulating other key drivers of the economy, such as tourism. Tax breaks on the materials have helped construction companies to reduce costs.

Cutting subsidies

The importance of sustaining economic growth was driven home by Rachid’s admission that if this year’s GDP growth slips below 6 per cent, the government will be unable to provide jobs to graduates or increase the living standards of its citizens.

The latest International Monetary Fund (IMF) forecast puts Egypt’s growth at 6 per cent in 2009, which analysts agree will result in a negative impact on the drivers of Egypt’s economy – Suez Canal trade, oil and gas exports, tourism revenues, remittances from Egyptians living abroad, and FDI, particularly from the US and Europe.

Egypt attracted $13.2bn in FDI from July 2007 to July 2008, but the government is forecasting this will fall to $10bn for the same period ending in July 2009.

The global slow-down aside, the general opinion is that the government’s abolition of the tax-free status of the free zones and the reduction in fuel subsidies in May this year has severely undermined investor interest and confidence, which will impact investment flows.

These legislative changes have eroded some of Egypt’s core operational advantages, causing the Kuwait’s Kharafi Group to cancel a $5bn oil refinery project in July.

Similarly, the government’s cancellation in early August this year of its joint venture with Agrium Investment to build the planned $1.4bn E-Agrium fertiliser plant has also sent worrying signals to foreign investors. Licences for the plant had already been granted, financing had been closed and ground had been broken.

“The business-related developments that have occurred since the beginning of 2008 have shed significant doubt on the coherency of government plans, its ability to juggle economic and social objectives and to recognise the sensitivity of investor sentiment to its decisions,” says Reham El-Desoki, senior economist at Beltone Financial.

“This took everyone by surprise. People mind when the rules of the game change overnight.” The abolition of corporate tax and the cut in fuel subsidies were part of a government bill, which aims to raise $3.6bn to help the government finance the 30 per cent public sector salary increase made earlier this year.

The bill also authorised a 10 per cent rise in the price of cigarettes and higher licensing fees on cars.

In cutting its subsidies, the government hopes that it can maintain its growth momentum amid the financial crisis, and remain on target to cut the country’s budget deficit to 3 per cent of GDP by 2011.

Egypt’s budget deficit stood at 6.9 per cent of GDP in 2007, compared with 11 per cent in 2004 when the reforming government of Egypt’s Prime Minister Ahmed Nazif came to power.

However, despite the negative ramifications of the May bill, Egypt remains a competitively priced cost base for manufacturing and exporting to rapidly growing markets, particularly eastern Europe and the Middle East.

While economic forecasts remain a dark art in the current climate, analysts seem more forthcoming in agreeing that investment will continue to flow from the Gulf.

“The Investment Ministry has said that it is going to look for alternative sources of investment from Gulf countries that it has not tapped,” says El-Desoki.

“Maybe from countries such as Bahrain and Oman, and also from North African and Asian countries.

“Furthermore, there is a momentum of investment from projects already in the pipeline that have a time-line that stretches as far as 2013 and beyond.”

However, El-Desoki forecasts that FDI will gradually decline to around $5-6bn over the next five years.

Rachid maintains that Egypt’s private sector remains the biggest source of investment for the country, followed by the government and then FDI. “We would like to see more FDI and we will act in a very aggressive way to increase that, but we also need to make sure that Egyptian companies and the government is continuing to invest.”

The government has been investing up to £E30bn ($5.4bn) a year in major infrastructure projects, including schools, hospitals and other service sectors.

According to Rachid, in the future that investment has to increase, while also stressing the need to increasingly engage with emerging markets, which he believes will be more active in the investment field in the coming years.

“It is ironic that as other countries across the world revert to state ownership, Egypt is focusing on the importance of a free, open market and reducing controls,” says Rachid who warns that the government should take heed of the lessons it has learned from the current global turmoil.

“Government has a bigger role in a free market through continuous, vigorous monitoring, a factor the US lacked, which lead to the economy’s collapse,” Rachid says.

“We have to use this crisis to accelerate and deepen the reform that needs to take shape in our country.”