Cairo may have avoided the real estate bubble that took hold in the rest of the region, but that does not mean it will escape the effects of the crash in other markets. Inflation has outstripped bank interest rates in recent years in Egypt, making it more attractive for consumers to borrow and speculate rather than save. But the country's banking and real estate sectors are still relatively underdeveloped and were not in a position to fuel such speculation.

By the end of 2005, the first full year that mortgages were legally available in Egypt, homeowners owed the banking sector £E500m ($91m). Today, total outstanding mortgage debt is just £E3.5bn, a little over 2 per cent of the country's £E167bn gross domestic product (GDP) for 2008.

International trade

But while the immaturity of Egypt's financial services sector may have saved the economy from the excesses of the property boom, the country now faces a more serious threat from the wider global economic slowdown.

Investment Minister Mahmoud Mohieldin, one of the central figures in the Egyptian government, forecasts growth of 5.5 per cent for the current financial year, which ends in June 2009. He is likely to be disappointed. The global slowdown is increasingly affecting Egypt, and US investment bank Citigroup forecasts growth of just 4.6 per cent.

Economic growth is slowing sharply from its high of 7.1 per cent in 2007. All the sectors that have helped Egypt grow quickly since 2004, when the economically liberal government of Ahmad Nazif came to power, are now under pressure as demand from key trading partners evaporates, says David Lubin, lead economist for the Middle East at Citigroup.

"Just about every aspect of Egypt's balance of payments is going to be under pressure," he says. "Capital inflows from the Gulf, revenues from the Suez Canal, foreign direct investment into the energy sector, tourism from Europe, and workers' remittances are all going to be low." Egypt's exposure to international trade means it could suffer more than most other Middle East states. Citigroup forecasts growth of 2.6 per cent in 2010 followed by 2.7 per cent in 2011. Even non-oil producers, such as Jordan and Lebanon, are expected to recover from the downturn more quickly. Jordan's economy will grow by 4.6 per cent in 2010 and Lebanon's by 5 per cent, according to Citigroup's forecasts.

The crisis has already prompted the Egyptian government to intervene with a £E7bn funding package. On 1 December 2008, Mohieldin, Finance Minister Youssef Boutros Ghali and Trade & Industry Minister Rachid Rachid announced a series of measures aimed at stimulating the economy. However, many of the measures had nothing to do with stimulating the economy during a downturn. Ideas such as further reform of the stock market are long-term policy goals of Nazif's administration that were repackaged to fit the mood of the times.

Simplifying regulation

Similarly, Mohieldin has been campaigning for Egypt's five non-banking financial services regulators to be merged into a single regulator since he was a professor in financial economics at Cairo University at the beginning of the decade.

One of the major achievements of the Nazif government has been the separation of monetary policy from banking supervision within the central bank. But Egypt would undoubtedly benefit from further improvements to the regulation of its financial sector.

While bank regulation will remain with the central bank under the proposed reforms, the new regulator will take over the regulatory powers of the Capital Market Authority, the Egyptian Exchange, the Mortgage Finance Authority, the Egyptian Insurance Supervisory Authority, and the General Authority for Investment & Free Zones, which regulates financial leasing. The new entity, which has yet to be named, will create a single rulebook in place of the five existing sets of regulations and, with a combined workforce of 1,000 people, it should bring more order to the financial services sector.

It is hoped that the new rulebook will persuade existing institutions to offer a greater range of products and encourage new institutions to enter the market.

Mortgage growth

The absorption of the Mortgage Finance Authority into the new entity should also aid the growth of Egypt's mortgage market, although the new regulator is still likely to take a cautious approach to lending, according to Mohieldin. "We take the issue of mortgage finance in a very conservative way," he says. "Mortgage debt will grow slowly but surely. "

Egypt's banks have no exaggerated lending, unnecessary extensions, and no toxic considerations," he adds, referring to the problems that have hit lenders in other markets around the world.

Rules governing publically listed companies are also set to change. The new regulator will draft a single code of governance for companies listed on the Egyptian Exchange. At the moment, listed firms have to juggle regulations imposed by the exchange, the Capital Market Authority and, in the case of insurance companies, the Egyptian Insurance Supervisory Authority. The insurance regulator spent the final few months of 2008 expanding its own code of corporate governance, even though it will be consigned to the rubbish bin if the new regulator is created, as planned, early this year.

Egypt's parliament needs to pass a law before the new regulator can open for business in the headquarters of the Capital Market Authority in Smart Village, a campus close to Cairo that is used as a base for government ministries and major foreign investors.

Parliament has also been asked to approve a new company code and a bankruptcy law in 2009, but it can be slow to act. "A new law for bankruptcy has been sought for four or five years," says Mohieldin.

The wider stimulus package, which contains measures to directly help the most recession-prone parts of the Egyptian economy, should go ahead nonetheless. The government is making it easier for exporters to gain access to finance by increasing the budget of state agencies such as the Industrial Development Authority and the Export Development Fund. The two grant-making bodies had £E2.4bn in funds before the stimulus package was announced. They now have £E4bn.

The export sector is crucial to Egypt. The recession in parts of the eurozone, which started in the second half of 2008, has caused demand for Egyptian goods to plunge. When he announced the support package on 1 December, Rachid acknowledged that Egyptian exporters would suffer as a result of the financial crisis.

"What we can do is work with industry and trade to mitigate the impact of the crisis," said Rachid. "This package is designed to reduce the cost of industrial production in Egypt, to increase the presence of Egyptian products internationally, and to stimulate the domestic market." All the same, Egypt's growth remains tied to that of Europe. "Egypt is a very European-oriented economy," says Lubin. "Two-thirds of Egypt's tourists come from Europe, and so does 40 per cent of its trade."

If the Egyptian economy's growth slows to about 2.5 per cent a year, as Citigroup forecasts, the country will find it harder to make the important changes needed to strengthen its economy, including the reduction of subsidies, a slimming down of the 6.2 million-strong civil service, and education reform. Egypt's wheat and diesel subsidies are a major factor in the country's huge budget deficit of 6.3 per cent of GDP. The deficit is larger as a proportion of GDP than it is in any other Arab country except Lebanon.

The stimulus package, combined with lower revenues from sources such as the Suez Canal as international trade drops off, means the government is unlikely to be able to make any meaningful cuts to the budget deficit this year or next.

Egypt has little room to manoeuvre. Its population, with a GDP per head of $2,172, is poorer than those of Algeria, Jordan, Lebanon, Libya, Morocco or Tunisia. The people who rioted when state-run bakeries ran out of cheap bread in April 2008 would be unlikely to keep quiet if the government started removing food subsidies during a prolonged economic downturn.

Capital shortage

The need for government spending to continue even as its income drops raises fears that Egypt could suffer a shortage of capital, particularly if its currency requires extra support. The Central Bank of Egypt has never said how it determines the exchange rate for the Egyptian pound and its governor, Farouk el-Okdah, does not discuss currency movements with the market, but it is thought to be tied to a basket of currencies. The central bank probably also smoothes the exchange rate to ease the pain of sudden depreciations in the currency.

Egypt has some leeway to protect its currency - a cornerstone of central bank policy - because it has built up foreign exchange reserves of $35bn. Reserves have doubled in the four years since Nazif came to power. The only worry is that the bank will spend too much money protecting the pound during a downturn.

"I hope that the central bank allows the exchange rate to take a bit more of the strain this time around," says Lubin. "You cannot rule out the possibility of a capital shortage completely, but they are going into this with a much stronger balance sheet than before."

For Egypt, slower economic growth and tight government finances are inescapable for the foresee-able future, but it is in a better position to weather the storm than it has been in the past. The question for the government is whether the severity of the downturn will derail its wider reform plans.