Egypt’s diverse economy and lack of integration with international financial markets has meant that it has suffered less from the global downturn than many of its neighbours in the Middle East. Growth has remained positive over the past two years, and in the first half of 2010, there were signs of recovery even in those sectors hard hit by the crisis.

Our three main priorities are growth, growth and growth. We need to create 850,000-870,000 jobs a year

Hany Damian, deputy finance minister

“The economy has held up pretty well,” says Simon Kitchen, senior economist at EFG Hermes in Cairo. “It is relatively unleveraged, so it didn’t suffer the stresses related to the financial crisis, the construction sector has been surprisingly resilient, tourism has recovered quickly, and remittances in the first quarter of 2010 were at record levels.”

Europe slowdown

But Egypt has not been immune to the impact of economic slowdown in Europe, where recession has crushed demand in Egypt’s key export market. “The EU is our biggest customer, and both oil and non-oil exports have been hit by the downturn,” says Hany Dimian, Egypt’s deputy minister of finance. “If Europe grows at 1-1.5 per cent this year and next, we will hit our growth targets. If it is lower, there could be implications for our exports of goods and services.”

Cairo is focusing on two key objectives: to improve the efficiency tax collection, and to develop infrastructure

The external impact on Egypt’s economy has forced Cairo to abandon, at least temporarily, the 7 per cent GDP growth target that it had successfully attained in the previous two fiscal years. In 2008-09, growth slid to an estimated 4.7 per cent, from 7.2 per cent in 2007-08. “Before the crisis we were growing at or slightly above our [sustainable growth] potential, which was helping to reduce unemployment and increase per capita income,” says Dimian. “We were on the fast track of structured reform. Then we were hit by the crisis.”

A quick return to growth of close to 7 per cent is essential to Egypt’s economic well-being. “Our three main priorities are growth, growth and growth,” says Dimian. “We need to create 850,000-870,000 new jobs a year to sustain current levels of unemployment. This requires growth of 6-6.5 per cent. We hope that if we can reach at least 5.5 per cent, we will start to gain momentum and unemployment will soon be back under control.”

Unemployment fell from 10.9 per cent in 2005-06 to 8.1 per cent in 2007-08, but increased to 8.8 per cent in 2008-09, according to the Washington-headquartered International Monetary Fund (IMF).

There are signs that economic growth is on an upward curve. According to official figures, growth climbed in each quarter of 2009, from 4.1 per cent in the first quarter to 5 per cent in the final quarter. It has continued to rise in 2010, with first quarter growth at 5.8 per cent, the highest since the first half of 2008.

The government estimates overall growth of 5.25 per cent in 2009-10 – higher than the 4.5-5 per cent targeted at the beginning of the year – and 6 per cent in 2010-11. Independent estimates are more conservative, but analysts still expect an acceleration of growth. Cairo-based Beltone Financial forecasts GDP growth to rise from an estimated 5.1 per cent in 2009-10 to 5.4 per cent in 2010-11.

Egyptian demand

The impact of the global downturn has been mitigated by underlying demand from the country’s 80 million population. “Domestic demand is booming,” says Dimian.

“When the crisis hit, the economy automatically shifted to the domestic sector. In the middle of the crisis, we imported steel and cement for the first time in a decade, which shows how fast the domestic economy is growing. It has also given an impetus to the growth of the manufacturing industry.”

Egypt’s success in diversifying its sources of external income has also helped. The country’s oil and gas earnings were hit by falling global energy prices in 2008-09, but while many other Middle East economies have become overwhelmingly dependent on hydrocarbons exports for foreign currency earnings and economic growth, Egypt has developed a more balanced revenue portfolio.

“In the 1980s, we were reliant on oil exports and Suez Canal traffic, but since the 1990s, we have seen an increase in tourism and non-oil exports,” says Dimian. “We are continuing to focus on the diversification of both our economic growth drivers and our export markets for goods and services.”

Despite a slight upturn in recent months, Suez Canal traffic has still not recovered to the levels seen in the 2007-08 fiscal year, and in the first three quarters of 2009-10, revenues from the canal were down 10 per cent. But other sectors have been surprisingly robust. “During the first three quarters of the 2009-10 fiscal year, tourism receipts were up 10 per cent compared to the same period the previous year, and even during the year of the crisis, we only lost 1-2 per cent, which is not significant,” says Dimian. “Remittances were up 7 per cent during the same period.”

The major drawback of pursuing a growth-driven economic policy during a global downturn is that it has relied heavily on government investment. Planned subsidy cuts have been delayed, and a $2.7bn stimulus package introduced in December 2008 was followed three months later by the injection of a further $2.7bn for the 2009-10 fiscal year. Overall government spending in 2009-10 was an estimated £E356bn ($63bn) in 2009-10, exceeding the budgeted £E334bn, itself a £E15bn increase on the previous year. In 2010-11, spending is set to increase once again, to a budgeted £E403bn.

Reducing Egypt’s deficit

As a result, Cairo has had to postpone plans to reduce its budget deficit. In an interview with MEED in March 2007, Yousef Boutros-Ghali, the finance minister, said the government planned to reduce the gap between expenditure and revenue to 3 per cent of GDP by 2010-11. But the government has now revised its target, and aims to cut the deficit to 3.5 per cent by 2015, Boutros-Ghali announced on 23 May.

The government’s expansionary fiscal policy has also made it difficult to bring down inflation. Although it has fallen from a peak of 16.2 per cent in 2008-09, inflation in 2009-10 was still an estimated 12 per cent, compared to 4.2 per cent in 2005-06. “We are not comfortable with 12 per cent inflation, but if the current trend continues we hope to see it come down by July or August,” says Dimian.

Cairo is also optimistic that it can prevent a further widening of the budget deficit in the coming year. “At the start of the year, we predicted the deficit would be 8.4 per cent of GDP [compared to 6.9 per cent in 2008-09], but we anticipate we can outperform this. It could be 8.1-8.2 per cent,” says Dimian. In 2010-11, the government envisages a slight narrowing of the deficit from 7.5-7.9 per cent.

But the recent slackening of fiscal control will not detract from the government’s efforts to promote more sustainable growth over the past five years, which include the reduction of corporate tax rates, banking reform, and the removal of bureaucratic red tape. Egypt has become a regular on the top 10 list of economic reformers ranked by the International Finance Corporation in its annual ‘Ease of Doing Business’ report.

However, if the government is to hit its deficit reduction target, it needs to build an economy in which growth is less reliant on government spending. Aware of the challenge, Cairo is focusing its efforts on two key objectives: to improve the efficiency of government tax collection, and to develop infrastructure. The first is designed to improve the link between economic growth and government revenue, while the second is intended to underpin an increase in the country’s growth capacity.

In recent weeks, the government has introduced an amendment to the 2005 income tax law that will make it illegal for service providers not to invoice their customers, removing a loophole that enables people to avoid income tax payments. Taxes will also be increased under the 2010-11 budget, which includes a new 5 per cent tax on cement sales to replace the nominal excise duty currently in force, a hike in the sales tax on steel from 5 per cent to 8 per cent, and an increase in taxes on cigarettes and molasses.

The income tax amendment has its weaknesses. It does not apply to much of the parallel economy, which accounts for a significant proportion of earnings, and compliance will be dependent on proper enforcement. “The effectiveness of the new measure will come down to how well compliance is monitored,” says Angus Blair, head of research at Beltone Financial in Cairo. But it is a step in the right direction. The government is confident the measure will deliver the bulk of incremental revenue in the coming year, which is forecast to rise to £E280bn in 2010-11, from £E260bn in 2009-10.

Private participation

The government’s efforts to increase private participation in the economy revolve around the implementation of a multibillion-dollar public-private partnership (PPP) programme. The first major project under the scheme, the $110m New Cairo wastewater treatment plant, reached financial close in early February.

The poorly developed state of Egypt’s infrastructure makes the programme’s success crucial to both the country’s aim to raise its growth ceiling from 7 per cent to 8.5 per cent by 2015 and its efforts to reduce the economy’s reliance on government spending. But barriers remain.

The banking sector’s long-term lending capacity is severely limited, while bureaucracy and corruption still hinder the award and development of contracts.

If the government is to entice overseas companies, whose appetite for new work and attitude to risk have been eroded over the past two years, it must focus on addressing these shortcomings.