IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

March 13, 2014

Stalled reforms and sporadic violence kept growth weak for a third consecutive year A moderate recovery in real GDP growth is expected for FY2014/15, driven by the impact of the two stimulus packages nanced from grants from GCC countries The large and still rising scal decit, and the high and persistent ination, are key macroeconomic challenges facing Egypt Tax and subsidy reforms will be required to narrow the large scal decit The banking system is highly exposed to concentration risk on holdings of government debt Underlying macroeconomic conditions have continued to worsen. The interim government, which resigned in late February, adhered to a limited economic policy mandate and a populist approach, deferring any action on fundamental reforms. Real GDP growth in the scal year ending June 2014 is expected at 2.3% (Chart 1). This is far short of what is needed to bring down the high rate of unemployment of 13.4%. Key factors behind the continued weak growth include prolonged absence of structural reforms; a general atmosphere of uncertainty about the direction of and commitment to economic policy; and the continued sporadic violence. In FY2013/14, the scal decit, excluding grants, is expected to widen to around 15% (Chart 2), while public debt could rise to 98% of GDP. Growth could accelerate to 4% in FY2014/15, reecting the impact of the two stimulus packages. Tourism and private investment, however, are not expected to recover signicantly in an environment of political uncertainty and security issues. Prospects beyond the near term could deteriorate if a new government following the presidential election fails to undertake the difcult but needed structural and institutional reforms. Egypt urgently needs to rectify serious macroeconomic imbalances as a prelude to tackling deeply embedded structural distortions in the economy.

Garbis Iradian
DEPUTY DIRECTOR FOR MENA 1-202-857-3304 giradian@iif.com

George Abed
SENIOR COUNSELOR & DIRECTOR 1-202-857-3644 gabed@iif.com

Amanda Preston
STAFF ASSISTANT 1-202-857-3305 apreston@iif.com

Chart 1 Egypt: Weak Growth and High Unemployment percent 8 7 6 5 4 9 3 2 1 0 06/07 08/09 10/11 12/13 14/15f 8 7 6 5 Real GDP Growth Unemployment Rate 14 13 12 11 10

Chart 2 Egypt: The Fiscal Deficit, Excluding Grants, Will Widen percent of GDP 16 15 14 13 12 11 10 9 8 7 6 5 07/08 08/09 09/10 10/11 11/12 12/13 13/14f
Source: Ministry of Finance and IIF forecast (f).

Excluding Grants

Including Grants

Source: Authorities and IIF forecast (f).

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IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

POLITICAL TRANSITION AND NEW ROAD MAP
The demise of the Morsi presidency at the hands of the military has been followed by wide-ranging repression of the Muslim Brotherhood, which has seen numerous violent confrontations and the arrest of the entire leadership. A new constitution was drafted by a broad-based committee essentially selected by the military. The new constitution removed a number of amendments made under Morsi in 2012, and was approved in a referendum in January 2014. After eight months in ofce, the interim government unexpectedly resigned on February 24. A new government was sworn in on March 1, with Mr. Ibrahim Mehleb, an engineer who headed the largest contracting company in Egypt, as the new prime minister, and with more than half of the ministers reappointed. As a business executive, the new prime minister is viewed as capable of speedy implementation of long-delayed projects and thus boosting job creation, reversing prevailing negative public sentiment in the run-up to the presidential election to be held in May. The appointment of an experienced and pro-economic reform nance minister, Mr. Hany Kady Dimian, raises hope for tightening scal discipline and speeding up fundamental economic reforms. Minister Dimian was a long-standing senior ofcial in the Ministry of Finance who resigned 10 months ago during Morsis term. The upcoming presidential election is to be followed by parliamentary elections. Field Marshal al-Sisi, the armed forces chief and minister of defense, is most likely to run and to be the next president.
Chart 4 Egypt: CDS Spreads 5-year, in basis points 850 750 650 550 450

Chart 3 Egypt: Stock Market EGX 30 Index 8000 7000 6000 5000 4000 3000 2000 1000 0 Feb 11 Aug 12 Feb 14
Source: Datastream.

RECENT MARKET DEVELOPMENTS

Improved clarity on the political and economic course, via a Road Map with welldened landmarks, combined with the large nancial support from the GCC countries, has shored up investor sentiment (Table 1). The equity market continues its rally (Chart 3) and CDS spreads have narrowed (Chart 4). The spread between the ofcial and the black market exchange rates declined from 11% in June 2013 to 6% in February 2014. The ofcial exchange rate has remained stable around EP6.95/$ in the past three months (Chart 5). However, improved market sentiment has not been matched by economic performance as private investment remains weak, portfolio inows remain negligible, and the number of tourist arrivals declined by about 40% in the rst seven months of the current scal year, as compared with the same period of last scal year. The sharp fall in tourism revenue and foreign investment has kept supplies of foreign exchange short.
Table 1 Egypt: High Frequency Economic and Financial Indicators Dec 11 Dec 12 Jun 13 Sep 13 Stock Market, % change, oya Consumer Condence Index CDS Spread, bps Purchasing Manager's Index Ofcial Exchange Rate, EP/$, eop Black Market Rate, EP/$, eop Ofcial Reserves, $ billion T-bill Rate (3-months)
Source: CBE, Bloomberg, and IIF.
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350 250 150 50 Feb 11 Aug 12

Source: Bloomberg.

Feb 14

Chart 5 Egypt: Exchange Rate Egyptian pound/$ 5.7 5.9 6.1 6.3 6.5

Dec 13 22.8 100.8 610 52.0 6.97 7.35 17.0 10.8

Jan 14 Feb 14 32.5 112.8 576 47.8 6.95 7.33 17.1 10.2 44.9 na 485 50.0 6.95 7.37 17.3 10.3

-42.2 na 615 47.6 6.01 6.70 14.9 14.0

48.4 83.2 455 37.5 6.15 7.50 11.6 13.0

-13.0 77.0 844 47.4 7.05 7.80 14.9 14.4

9.1 101.8 650 49.3 7.00 7.40 18.7 12.0

6.7 6.9 7.1 2010 2011 2012 2013

Source: CBE.

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IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

CONTINUED WEAK GROWTH DESPITE ECONOMIC STIMULUS
Large-scale nancial support from Saudi Arabia, the UAE and Kuwait has encouraged the government to adopt an expansionary scal stance with the hope of stimulating the economy and creating jobs for the rapidly increasing labor force. Two economic stimulus packages for a total of $9.2 billion (equivalent to 3.4% of GDP) have been announced. The rst stimulus, in the amount of $4.3 billion, was launched in September 2013; the second package, in the amount of $4.9 billion, was announced in early February of this year. Almost two-thirds of the stimulus packages are allocated to nance additional public investment in infrastructure and one-third to nance the increase in the public minimum wage (from $106 per month to $171, which started in January 2014) and other social programs. The target was to boost growth to 3.5% in the current scal year ending June 2014. With still no sign of the expectations of a signicant pickup in activity (Tables 2 and 3), we have lowered our real GDP growth forecast to 2.3% for 2013/14 (most of which will occur in the second half of the FY), far short of what is needed to bring down the high rate of unemployment (13.5% in Q4 of 2013). Key factors behind the continued weak growth include: (i) continued sporadic violence; (ii) delays in the implementation of projects related to the rst stimulus package; and (iii) stalled reforms and a general atmosphere of uncertainty about the direction of economic policy. Most of the growth is driven by consumption, which is underpinned by the large increase in wages, subsidies, and remittances, mostly from the GCC. Growth should accelerate to 4% in 2014/15, reecting mainly the impact of the stimulus packages. But the outlook for FDI (excluding UAE investment) and tourism remains weak. Energy and related input shortages are likely to continue to seriously constrain industrial production due to the lack of foreign investment to develop Egypts natural gas resources. Foreign energy companies are reluctant to invest in Egypt amid unreliable payments and political instability. While friendly GCC countries have provided $4 billion in petroleum products in grant form, future commitment remains uncertain.
Table 2 Real GDP Growth percent change oya 2012/13 Q1 Q2 Q3 Q4 2013/14 Q1 Q2 Q3f Q4f 2.1 2.6 2.2 2.0 1.5 2.3 1.1 1.4 3.2 3.7

Source: Ministry of Finance of Egypt and CBE and IIF forecast (f).

Table 3 Key Macroeconomic Indicators scal year ending June 2008/09 2009/10 2010/11 2011/12 2012/13e 2013/14f 2014/15f Real GDP (% change) CPI ination (% change; average) Receipts from Tourism, % GDP Remittances, % GDP Current Account Balance, % GDP Foreign Direct Investment, % GDP Ofcial Reserves, $ billion Fiscal Balance, incl. grants, % GDP Government Debt, % GDP 4.7 16.2 5.6 4.0 -2.3 3.6 31.7 -6.9 81.0 5.2 11.7 5.3 4.4 -2.0 2.6 35.8 -8.2 79.3 1.9 11.3 4.5 5.3 -2.6 0.5 27.2 -9.5 82.3 2.2 9.6 3.6 6.8 -3.9 1.4 16.1 -10.6 83.1 2.1 7.5 3.6 6.8 -2.1 1.0 14.9 -13.6 93.8 2.3 10.5 2.4 6.6 -1.5 1.3 19.3 -11.7 97.0 4.0 11.9 2.6 6.0 -1.9 1.7 21.0 -10.0 95.7

Source: Central Bank of Egypt (CBE); Ministry of Finance, and IIF estimates (e) and forecast (f).

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IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

FISCAL DEFICIT EXCLUDING GRANTS WILL WIDEN IN 2013/14
We expect the budget decit to overshoot the governments target of 10.4% of GDP in 2013/14 by a substantial margin. Our forecast shows a budget decit, excluding grants, of 15.4% of GDP and including grants 11.9% of GDP (Table 4). Grants are expected to jump to around EP70 billion, equivalent to 3.5% of GDP, as a result of the nancial support from Saudi Arabia, the UAE and Kuwait. The continued widening of the decit is due to weaker tax revenue and continued large increases in spending. Total revenues are expected to increase by 22% due mainly to higher grants. Tax revenues are being adversely impacted by continued weak economic activity. Total expenditures are projected to increase by at least 16% in 2013/14. The wage bill is projected to rise by 21%, due mainly to additional hiring in the public sector and the 64% increase in the minimum wage. Subsidies and social benets will remain very high at 11% of GDP. The increase in capital spending, by 1.1 percentage points to 3.4% of GDP, will be nanced largely by grants. We expect general government debt as a percentage of GDP to rise further to about 98% by end-June 2014. This continued deterioration, which reects both the larger borrowing requirements as well as weaker economic growth, raises concerns over public debt sustainability. The governments goal of reducing the decit to 6% of GDP by 2017/18 represents a reasonable medium-term consolidation plan. However, achieving this target would require strong implementation of long-discussed package of revenue enhancing and expenditure reductions measures. These include the following reforms that have been under discussion for decades: (i) shifting from GST to VAT; (ii) introducing a new mining law; (iii) broadening the tax base by bringing some of the informal sector activities to the formal sector; (iv) addressing the cross-debt between public entities; (v) revising the income tax law; vi) improved targeting of fuel subsidies (see Box 1, page 5); (vii) introducing a new cash management system; (viii) strengthening internal auditing; and (ix) reviewing the public procurement law. An important step would be to raise gasoline prices at a more accelerated pace, so as to ensure full cost recovery within a few years.
Table 4 Egypt: Summary of Government Fiscal Operations percent of GDP 2009/10 Total Revenues & Grants Tax Revenues Grants Other Revenues Total Expenditures ow: Wages and Salaries Interest Payments Subsidies, Grants, & Social Benets Capital Expend, incl. Net Lending Primary Balance, incl. grants Overall Balance, incl. grants Overall Balance, excl. grants 22.2 14.1 0.4 7.7 30.3 7.1 6.0 8.5 4.0 -2.1 -8.1 -8.5 2010/11 19.3 14.0 0.2 5.2 29.3 7.0 6.2 9.0 2.9 -3.8 -10.0 -10.1 2011/12 19.3 13.2 0.6 5.5 29.9 7.8 6.6 9.5 2.3 -4.0 -10.6 -11.3 2012/13 20.0 14.3 0.3 5.4 33.5 8.2 8.4 11.2 2.3 -5.2 -13.6 -13.9 Auth.* 2013/14 28.6 15.8 6.0 6.8 38.3 9.0 8.7 12.6 4.7 -1.7 -10.4 -16.4 IIF Proj. 2013/14 22.7 13.9 3.5 5.3 34.6 8.7 8.2 11.0 3.4 -3.7 -11.9 -15.4

The budget decit, excluding grants, is expected to widen to 15.4% of GDP

Fiscal adjustment could be achieved through introduction of VAT and reforming the untargeted subsidies on fuel

Source: Ministry of Finance of Egypt, and IIF forecast (f). * As reported in the MOF Mid-Year Economic Review, February 2014, p. 19.
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IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

BOX 1: FUEL SUBSIDIES ALONE ACCOUNTED FOR 6.8% OF GDP

For decades, Egypt has relied on generalized price subsidieson food and fuels as the main tool to provide social protection (Table 5). Government spending on subsidies has increased dramatically in recent years and now far exceeds outlays on education and health. While subsidies have been motivated by social concerns, preliminary data indicate that the share of the population below the poverty line has nevertheless increased from around 20% in 2010 to 25% in 2013. Our estimates show that fuel subsidies alonemeasured as the difference between the value of consumption at world and domestic prices of petroleum products (gasoline, kerosene, diesel, fuel oil, LPG, and natural gas)amounted to $17 billion in 2012/13, equivalent to 6.8% of GDP and 20% of total government spending. Retail prices of petroleum products are among the lowest in the world (Chart 6). Unlike Jordan and Morocco, Egypt has not yet taken steps to address the problem of fuel subsidies. In addition to aggravating the scal imbalance, fuel subsidies crowd out priority government spending, distort resource allocation by encouraging excessive energy consumption, and articially promote capital-intensive industries. Fuel subsidies are also inefcient as a social protection tool because they benet mainly the betteroff, whose energy consumption is much higher than that of the poor. While subsidies on food and petroleum products (7.6% of GDP) will remain about the same in 2013/14 as in the previous scal year, expenditures on social benets are expected to increase sharply to the equivalent of 1.9% of GDP. Reforming and reducing subsidies through better targeting to needy people will be a key element of scal consolidation in the coming years. The authorities have been discussing subsidy reform for years but only recently have they begun addressing the issue, initiating a largely administrative measure by introducing smart cards last year to ration subsidized fuel and make smuggling more difcult.
Chart 6 Gasoline Price, Feb. 2014 $ per liter Saudi A. Egypt USA Indonesia Russia Tunisia South Jordan Lebanon Morocco France Turkey 0 1 2 3

Source: GlobalPetrolPrices.com.

Table 5 Egypt: Subsidies and Social Benets percent of GDP 2009/10 2010/11 Subsidies & Social Benets Subsidies GASC: Food EGPC: Fuel Other NFPE* Financial Public Enterprises Grants Social Benets 8.5 7.8 1.4 5.5 0.7 0.2 0.4 0.4 9.0 8.1 2.5 4.9 0.5 0.2 0.4 0.4 2011/12 2012/13 2013/14f 9.5 8.6 1.9 6.1 0.4 0.2 0.3 0.6 11.2 9.7 1.9 6.8 0.9 0.1 0.3 1.2 11.0 9.0 1.7 6.3 0.9 0.1 0.3 1.7

Source: Ministry of Finance, IIF calculations and forecast (f). *NFPE = Nonnancial public enterprises.

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IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

CPI INFLATION REMAINS CLOSE TO DOUBLE DIGITS
Despite subdued global commodity prices and weak economic activity, CPI ination remains high. The headline CPI ination rate increased from 8.3% (year-on-year) in February 2013 to 9.8 % in February 2014 (Chart 7). Supply bottlenecks (worsened in recent years), spillover from higher public wages, and the easing of the monetary policy stance have intensied inationary pressures. Unless binding supply constraints are decisively addressed, high ination and weak growth will continue to undermine macroeconomic and nancial stability, necessitating a tighter monetary policy stance. The CBE has cut interest rates by a total of 1.5 percentage points in the second half of 2013, and real interest rates are now substantially negative (Chart 8). In its recent meeting (February 27) the CBE left its key rates unchanged. The ingrained nature of ination and ination expectations means that reducing inationeven over a protracted horizonwill require a signicant increase in policy rates, which may weigh on economic recovery. Food prices have been rising at a rapid pace for several years. This pattern is not a transitory phenomenon and reects both consumption demand and supply constraints. Empirical evidence shows that food price shocks propagate strongly and rapidly into core prices. It would be feasible and desirable for Egypt to adopt explicit ination targeting over the medium term, including steps to shore up CBE independence. The target may initially have to be set within a gradually descending target zone towards the low single digits. Introduction of ination targeting could reduce uncertainties about the CBEs objectives and enhance the transparency of monetary policy. The main advantage of an inationtargeting framework would be to raise the chances of attaining a low and stable rate of ination, with potential simultaneous benecial effects on economic growth. An inationtargeting framework could also help the CBE escape the pressures to conduct expansionary monetary policies usually encouraged by short-term considerations. However, the forward-looking nature of an ination-targeting framework implies that the CBE would have to develop both a decent ination forecasting model and policy instruments that affect ination with reasonable precision.
Chart 7 Egypt: CPI Inflationary Pressures Intensify percent change on year ago 14 13 12 11 10 9 8 7 6 5 4 3 2009 2010 2011 2012 2013 Headline CPI Core CPI Chart 8 Egypt: Interest Rates Decline percent per annum 15 14 13 12 11 10 9 8 7 6 5 2010 2011 2012 2013 2014 Discount Rate

High ination may continue to undermine macroeconomic and nancial stability, necessitating a tighter monetary policy stance

Adopting explicit ination targeting would reduce uncertainties about CBEs objectives

3-Month T-Bill Rate

Source: Central Bank of Egypt.

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Source: Central Bank of Egypt.

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IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

THE BANKING SYSTEM IS GENERALLY SOUND
In general, the banking system remains sound despite an unsettled security and political climate, and the weak economy. Capital adequacy ratios have been declining in recent years but still remain quite high. The rates of return on assets and on capital have trended upwards in the past two years (largely due to high yields on holdings of government securities), nonperforming loans (NPLs) have been declining as a share of total loans, and liquid assets to total assets remain comfortable (Table 6). Banks remain well-funded because of their strong deposit base, which increased by 16% in 2013, supported by remittances from Egyptians working abroad. However, the environment of uncertainty and the large and rapidly growing banks holding of government securities has prompted rating agencies to downgrade several banks in Egypt (Chart 9). Financial intermediation in Egypt is limited. Only 10% of adults have an account at a formal nancial institution and the ratio of private loans to GDP is 52%, well below the average for other countries in the region. Almost 70% of privately owned companies in Egypt have capital of less than $0.2 million but employ about 75% of Egypts private sector workforce. World Bank surveys show that bank loans to SMEs in Egypt accounted for about 6% on average of total loans, much smaller than the average for emerging economies (18%). The prevalence of lending to large, well-connected businesses appears to be at the expense of adequate credit to SMEs. Egypt could follow the examples of Morocco and Lebanon in their recent measures to encourage lending to SMEs, including strengthening nancial transparency, improving risk assessment tools, and providing collateral instruments tailored to the needs of SMEs. Like other MENA countries, domestic debt markets in Egypt are weak. Encouraging deepening of their markets could reduce reliance on banks, help lower funding costs, and make nancial intermediation more efcient, resilient and diversied. Development of the public debt market could facilitate the establishment of a yield curve, and pave the way for greater issuance of corporate bonds. It could also enhance corporate governance as capital markets demand more rigorous nancial disclosure and transparency.
Table 6 Indicators of Financial Soundness percent, unless otherwise indicated 2010 Capital Adequacy (%) Tier 1 Capital (%) NPLs (% total loans) Provisions (% NPLs) Return on Assets (%) Return on Equity (%) Liquidity Ratio, LC (%) Loans-to-Deposits (%) 16.3 12.7 13.6 92.5 1.0 14.3 44.7 51.8 2011 15.9 13.3 10.5 94.5 0.8 11.7 55.6 50.2 2012 14.9 12.9 9.8 97.1 1.0 13.9 58.4 48.1 2013 14.0 11.8 9.5 99.5 1.0 13.9 61.9 43.6
Chart 9 Egypt: Banks' Claims on Government and Private Sector Egyptian pound, billion 1100 1000 900 800 700 600 500 400 300 200 100 0 2007 2008 2009 2010 2011 2012 2013 Private Sector Central Government

Liquidity buffers are high and NPLs to total loans continues to decline

Domestic debt markets in Egypt are weak and if developed could reduce reliance on banks

Source: Central Bank of Egypt and IIF estimates.

Source: IIF calculations from Central Bank of Egypt database.

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IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

STRUCTURAL POLICIES TO ACHIEVE AND SUSTAIN HIGH GROWTH
The longer-term prospects for the Egyptian economy hinge on the achievement of political stability and structural reforms. The experience of many emerging economies shows that successful economic reforms require broad political consensus and support for a coherent reform strategy. In the absence of such consensus it would be difcult to address the conicting objectives of a signicant reduction in the scal decit with political demands for higher social benets (including subsidies) and employment opportunities, which would likely further increase the scal decit. The upcoming elections and the possible continued availability of unconditional nancing have so far postponed the hard decisions that a typical IMF program would require. However, nancing from the GCC may not be sufcient and is unlikely to continue beyond the near term without the implementation of major reforms. An agreement with the IMF, which may become a requirement for continued external support, could provide a credible framework for economic policy and help secure additional nancing, including from a broader range of sources. Ambitious structural reforms are needed to reduce supply bottlenecks and achieve higher, sustainable, and inclusive growth to reduce unemployment and poverty. Such reforms include: (i) addressing challenges in the energy sector; (ii) easing strict labor regulations and skills mismatches; (iii) enhancing health and education outcomes by improving the quality of spending; (iv) raising the efciency of social programs; and (v) improving the business, trade, and investment climate and enhancing governance. According to a range of business environment indicators, Egypt underperforms in most areas necessary to run a business. The World Banks 2013 Doing Business indicator ranks Egypt 118th out of 183 countries (Table 7). The Global Competitiveness Report (prepared by the World Economic Forum) also ranks Egypt 118th out of 144 countries, well behind most emerging economies and most countries in the region. Enhancement of internal competitiveness requires reducing the power of large, dominant businesses with interlocking ownership and management control. In this regard, further reforms will be needed to break the iron grip of a privileged few on the economy in order to achieve the more inclusive, higher growth that would signicantly reduce unemployment and inequality.
Table 7 Competitiveness Indicators (2012(2012-2013) Malaysia Thailand South Africa Turkey Morocco Jordan Ease of Doing Business* Global Competitiveness Report** Macroeconomic environment Infrastructure Health & primary education Financial Market Development Labor market efciency 12 25 35 32 33 6 24 80 38 27 46 78 43 76 39 52 69 63 132 3 113 71 44 76 56 59 44 130 97 77 90 57 82 63 122 106 64 112 60 56 65 101 Egypt 118 118 140 98 100 102 148

Successful economic reforms require broad political consensus and a reform strategy

Key structural reforms are needed to reduce supply bottlenecks and achieve higher, sustainable, and inclusive growth

*The ease of doing business indicator is the average of the economys ranking by the World Bank on the following 10 topics: starting a business, getting credit, paying taxes, resolving insolvency, registering property, trading across borders, dealing with construction permits, protecting investors, enforcing contracts, getting electricity. **The rankings are out of 144 countries. The global competitiveness ranking is based on the following indicators: institutions, infrastructure, macroeconomic environment, education and health, goods market efciency, labor market efciency, nancial market development, technological readiness, market size, business sophistication and innovation (see The Global Competitiveness Report, 2013-14, World Economic Forum). iif.com Copyright 2014. The Institute of International Finance, Inc. All rights reserved.

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IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

The Egyptian economy is in urgent need of market-based reforms designed to stimulate private sector investment and job creation. The public sector already employs nearly one-third of the labor force and dominates banking and other traditional sectors. Therefore it is important, as part of a broader reform strategy, to reconsider the role of the public sector in the economy; to restructure and, if necessary, to privatize public sector enterprises; to implement fundamental reforms in the business climate to reduce red tape; and to project an open attitude towards FDI and a general liberalization of the economy. The newly appointed prime minister has just declared his support for restructuring the public enterprise sector, but he is likely to face stiff opposition to any efforts to downsize the sectors bloated work force. Tellingly, he specically excluded privatization as a policy instrument.

The Egyptian economy is in urgent need of market-based reforms designed to stimulate private sector investment and job creation

OUTLOOK REMAINS UNCERTAIN

Egypt faces formidable challenges on both the political and economic fronts. Surmounting these challenges would be a daunting task for any leadership in any circumstances. In Egypt, the steady deterioration in economic and social conditions over the past three years, compounded by a tense political climate, has created exceptionally difcult circumstances for formulating and implementing economic policy. The apparent widespread relief at the demise of the Morsi presidency has raised the publics expectations, which have been pinned almost entirely on the person of the presumptive next president, General Abdel Fattah al-Sisi. However, going beyond the immediate, tackling Egypts deep-seated problems will require a reform-minded, inclusive, open, and accountable government with the requisite political authority to tackle these challenges. As was noted earlier, market sentiment seems to have improved since the militarys ouster of Morsi nine months ago, and considerable external assistance has made it possible for the interim government to undertake added spending and spike domestic demand. There are also indications that the business and investor community in Egypt has turned positive on the countrys prospects and has begun to put some capital to work. Private sectors from the GCC states that have supported the new regime in Egypt are already in discussions with local counterparties on potential acquisitions and investment projects in real estate and tourism facilities. It is quite likely, therefore, that the jump in growth rates in the second half of the current scal year noted earlier (see Table 2, page 3) could endure through FY 2014/15 as both government and private sector spending on infrastructure and real estate development extends into next year. These apparent improvements, however, will not be lasting and may even complicate policymaking if they are allowed to breed complacency. Available nancing and goodwill towards a likely al-Sisi presidency should provide some breathing space to design and initiate policy reforms aimed at, rst, rectifying macroeconomic imbalances, and then at addressing long-delayed structural reforms.

It is important to implement fundamental reforms in the business climate to reduce red tape, and to project an open attitude towards FDI and a general liberalization of the economy

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page 10

IIF RESEARCH NOTE

Egypt: Sustaining Economic Recovery Hinges on Reforms

Most of the needed reforms have been identied, analyzed and publicly discussed but have not achieved any political traction as governments have focused on immediate challenges. There is a risk that a newly elected government, mindful of the political cost of some of the needed reforms, may follow a gradual approach, possibly falling behind the curve and losing momentum. In this case, expectations will be quickly deated and the publics disappointment could usher in yet another cycle of instability and social conict. It is, therefore, critical that needed reforms be initiated with the urgency and resolve that they require. A newly elected president should immediately leverage his political capital to set in motion a series of reforms that would allow for a more efcient allocation of public resources, inspire the condence of private investors, and reignite the hopes of the Egyptian people for a better future.

A newly elected president should immediately leverage his political capital to set in motion a series of reforms

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IIF DATABASE: EGYPT

13-Mar-14 Page 1 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13e 2013/14f 2014/15f

Code

DOMESTIC ECONOMY & EXTERNAL TRADE DOMESTIC ECONOMY (2001/02 prices)

E100 E101 E201 E211 E221 E231 E301 E311 E322 E400 E401 E500 E501 E505 E510 E600 E601 E605 E610 E801 E901

Real GDP (pounds billion) Real GDP % change Domestic demand % change Private consumption % change Public consumption % change Gross fixed capital % change Exports of goods and services % change Imports of goods and services % change Change in net foreign balance % GDP Real GNP (pounds billion) Real GNP % change Nominal GDP (pounds billion) Nominal GDP % change GDP deflator % change Nominal GDP ($ billion) Nominal GNP (pounds billion) Nominal GNP % change GNP deflator % change Nominal GNP ($ billion) Industrial & mining production % change Agricultural production % change
EXTERNAL TRADE

521.5 7.2 7.5 5.7 2.1 15.5 27.6 26.3 -0.6 529.9 6.9 895.5 20.2 12.2 162.4 909.9 19.9 12.2 165.0 5.9 3.3

546.0 4.7 2.1 5.7 5.6 -9.1 -14.1 -17.9 2.4 549.8 3.8 1042.2 16.4 11.2 188.7 1049.5 15.3 11.2 190.0 4.7 3.2

574.4 5.2 5.0 4.1 4.5 8.0 -3.0 -3.2 0.1 575.2 4.6 1206.6 15.8 10.1 218.5 1208.1 15.1 10.1 218.7 3.1 3.5

585.3 1.9 2.6 4.6 3.8 -4.4 -5.0 -2.7 -0.7 585.0 1.7 1371.1 13.6 11.5 235.6 1370.3 13.4 11.5 235.4 -0.2 2.7

598.2 2.2 6.0 6.5 3.1 5.7 -2.3 9.7 -3.9 597.6 2.1 1575.5 11.8 9.6 262.6 1573.8 14.8 11.4 262.3 1.0 3.0

610.8 2.1 0.5 3.0 3.5 -9.6 4.1 -1.1 1.6 610.0 2.1 1753.3 12.6 10.5 271.8 1751.0 11.3 10.3 271.5 3.0 3.5

624.8 2.3 3.3 3.4 6.0 1.5 -1.0 2.7 -1.2 624.2 2.3 1976.8 12.7 10.4 282.6 1974.8 12.8 10.2 282.3 4.0 3.5

649.8 4.0 3.9 3.9 3.2 4.3 3.6 3.3 -0.1 649.3 4.0 2237.9 13.2 9.2 319.7 2236.1 13.2 8.9 319.4 5.0 3.4

Merch. exports: value % change T103 T105 T203 T205 T305 T400 T410 T420 T430 T440 T441 Merch. exports: volume % change Merch. exports: unit value % change Merch. imports: value % change Merch. imports: volume % change Merch. imports: unit value % change Terms of trade % change Exchange rate, end-period (LE/$) Exchange rate, average (LE/$) Parallel rate, end-period (LE/$) Nominal effective rate, average (2000/01 = 100) Real effective rate, average (2000/01 = 100) Real effective rate % change average f = IIF forecast; fiscal year ending June 30

33.3 9.0 22.3 37.8 14.4 20.4 1.6 5.35 5.52 .. 55.6 68.6 3.0

-14.3 -4.1 -10.6 -4.6 6.9 -10.8 0.2 5.60 5.52 .. 59.1 81.6 18.9

-5.1 -8.5 3.6 -2.7 -5.1 2.5 1.1 5.67 5.52 .. 58.6 88.1 8.0

13.1 -8.1 23.0 10.4 -5.0 16.3 5.8 5.95 5.82 .. 55.4 89.1 1.1

-7.1 -10.5 3.8 9.5 7.9 1.4 2.4 6.03 6.00 .. 54.8 92.6 3.9

3.7 4.1 -0.4 -1.1 -1.1 0.0 -0.4 7.05 6.45 8.10 52.5 92.4 -0.2

0.5 -1.0 1.5 2.5 2.7 -0.2 1.7 7.00 7.00 7.10 48.4 90.8 -1.8

5.3 3.6 1.7 3.8 3.3 0.5 1.2 7.00 7.00 7.10 48.4 89.2 -1.8

IIF DATABASE: EGYPT

13-Mar-14 Page 2

Code

EXTERNAL BALANCE ($ million)

2007/08 2008/09 2009/10 2010/11 2011/12 2012/13e 2013/14f 2014/15f -23415 29356 -52771 24304 27211 23922 7560 10827 3289 0 -12245 -10315 -1620 -2895 -675 -1255 9338 8377 961 888 0.5 9016 12124 -3108 -467 0 74 -541 36 2282 519 -4891 -3025 -225 -4133 -25173 25169 -50342 20741 23801 21865 7481 10488 1937 0 -11307 -9524 -1492 -2739 -621 -1163 8247 7632 614 -4433 -2.3 -2.7 -1835 6773 -8608 1101 0 595 506 -1168 -847 -101 9614 -1238 -586 -506 -25120 23873 -48993 20802 23563 22734 7217 11591 829 0 -13224 -8030 -1230 -2328 -554 -4640 10463 9509 954 -4318 -2.0 -2.4 11781 5782 6000 812 0 693 119 -1058 -1106 1211 -705 -652 -720 -5245 -27103 26993 -54096 21016 21873 21454 8069 10589 419 0 -13994 -7526 -1385 -2113 -554 -5914 13137 12384 753 -6088 -2.6 -2.9 -1438 1231 -2669 471 0 77 394 -418 -402 -1078 -112 -1001 -671 10736 -34139 25072 -59211 24001 20872 20626 8585 9419 246 0 -15279 -8563 -1375 -2498 -535 -6181 18408 17776 632 -10138 -3.9 -4.1 -1441 3733 -5174 13 0 160 -146 -1326 4384 -3230 3855 -2155 -247 10285 -31542 25971 -57513 25960 22222 22024 9188 9748 198 0 -15530 -9582 -1659 -2929 -556 -5392 19268 18432 836 -5582 -2.1 -2.4 4320 2821 1499 504 0 100 404 5256 2782 -4500 -525 -3868 637 976 -34599 26101 -60700 30369 19471 19161 9234 6824 310 0 -17403 -9893 -1700 -3075 -590 -6920 28301 18801 9500 -4230 -1.5 -4.9 2850 3700 -850 700 0 520 180 6816 584 0 -2582 0 365 -4502 -37412 27484 -64896 31419 21861 21521 9723 8530 340 0 -17995 -10275 -1765 -3198 -600 -7120 27553 19553 8000 -5993 -1.9 -4.4 5650 5600 50 937 0 600 337 4897 516 0 -4411 0 0 -1596

B100 B110 B120 B200 B210 B212 B214 B216 B220 B222 B224 B226 B230 B232 B234 B250 B252 F280 F281 F282 F300 F310 F320 F330 F340 F350 F360 F400 F450 F480 F500

Trade Balance Merchandise exports Merchandise imports Balance on Services, Income & Transfers Services & income receipts Exports of services Transportation Tourism Interest receipts Other income receipts Services & income payments Imports of services Transportation Travel Interest payments Other income payments Transfers, net Private transfers, net Official transfers, net Current Account Balance % GDP % GDP, excl. official grants Equity investment, net Direct equity investments Portfolio equity investment International financial institutions IMF IBRD Other multilateral creditors Official bilateral creditors Commercial banks Other private creditors Resident lending abroad, net Errors and omissions, net Monetary gold (- = increase) Reserves (- = increase) f = IIF forecast; fiscal year ending June 30

IIF DATABASE: EGYPT

13-Mar-14 Page 3

Code

EXTERNAL DEBT AND ASSETS ($ million)

2007/08 2008/09 2009/10 2010/11 2011/12 2012/13e 2013/14f 2014/15f 50843 31.3 89.9 36074 14769 7446 0 1255 6191 21829 21098 470 3037 60.3 48691 25.8 99.4 34855 13836 8412 0 1850 6562 20156 19766 357 -1136 60.7 47194 21.6 99.5 34511 12683 9019 0 2543 6476 18542 18118 1515 -1356 61.3 48706 20.7 99.7 35483 13223 9978 0 2620 7357 19325 18890 513 2938 61.2 42185 16.1 91.8 32948 9237 9696 0 2780 6916 17307 13195 1987 -1641 61.7 48031 17.7 99.7 37264 10767 10080 0 2880 7200 22307 13459 2185 -555 61.5 56151 19.9 123.2 44953 11198 10750 0 3400 7350 29000 13997 2404 -207 61.6 62919 19.7 127.5 51273 11646 11718 0 4000 7718 34000 14557 2644 185 61.8

D100 D102 D105 D202 D203 D300 D310 D320 D330 D340 D350 D360 D600 D610

External Debt % GDP % Exports goods, services & income Medium/Long term Short term By creditor: International financial institutions IMF IBRD Other multilateral creditors Official bilateral creditors Commercial banks Other private creditors $ Exchange rate valuation effect % Total external debt in $
EXTERNAL ASSETS ($ million)

A500 A505 A506 A510 A512 A600 A700

Reserves including gold % Imports goods and services Months imports goods, services & income Reserves excluding gold Gold value Gold price yr-end $/ounce Gold (million ounces) Deposit money banks' foreign assets Deposits in BIS banks f = IIF forecast; fiscal year ending June 30

31881 50.5 6.1 30188 1693 696.7 2.43 27941 37890

31672 52.9 6.3 29393 2279 938.1 2.43 19653 28669

35821 62.8 7.5 32821 3000 1234.5 2.43 21757 24211

27183 44.1 5.3 23512 3671 1510.8 2.43 23347 33392

16070 23.7 2.8 12152 3918 1612.3 2.43 18946 26096

14920 22.2 2.7 11640 3281 1350.0 2.43 16885 24337

19340 27.4 3.3 16424 2916 1200.0 2.43 17054 25067

21000 27.9 3.4 18084 2916 1200.0 2.43 17565 25819

IIF DATABASE: EGYPT

13-Mar-14 Page 4

CODE DEBT SERVICE PAYMENTS ($ million)

2007/08 2008/09 2009/10 2010/11 2011/12 2012/13e 2013/14f 2014/15f 2596 4.6 766 1.4 1830 3.2 1.6 -16.9 2998 6.1 621 1.3 2378 4.9 1.2 13.3 2397 5.1 554 1.2 1843 3.9 1.2 -2.4 2643 5.4 552 1.1 2091 4.3 1.2 -17.8 2973 6.5 681 1.5 2293 5.0 1.5 -2.2 3133 6.5 628 1.3 2506 5.2 1.4 1.8 3397 7.5 691 1.5 2706 5.9 1.3 -0.2 3682 7.5 760 1.5 2922 5.9 1.3 -0.4

P100 P105 P110 P115 P120 P125 P204 P214

Total debt service % Exports goods, services & income Interest payments due % Exports goods, services & income Amortization paid % Exports goods, services & income Average interest rate on external debt Average real rate on external debt
WORLD ECONOMIC FRAMEWORK

W101 W204 W304 W410 W420 W430 W505 W515 W603 W615

Industrial country real GDP % change $ LIBOR (six-month, average) Brent spot oil price ($/bbl, average) SDR/$, end-period /$, end-period /$, end-period World price commodities index (2000=100) World price commodities % change World price manufactured goods index (2000=100) World price manufactured goods % change Export market volume % change Trading partners' $ prices % change
COUNTRY TRADE BY COMMODITY

1.71 4.10 95.1 0.62 0.63 106.2 152.98 14.57 127.45 6.28 0.2 -10.9

-3.3 2.3 70.3 0.65 0.71 96.4 128.2 -16.2 127.3 -0.2 -11.5 2.4

-0.1 0.7 75.3 0.68 0.82 88.4 145.1 13.2 124.5 -2.2 11.7 -3.3

2.3 0.5 96.6 0.63 0.69 80.6 184.9 27.5 130.3 4.7 5.2 -4.3

1.5 0.6 112.2 0.66 0.79 79.8 175.7 -5.0 133.8 2.7 1.0 -2.2

0.6 0.6 108.9 0.66 0.77 99.1 171.6 -2.3 133.3 -0.4 1.0 -0.4

1.7 0.4 108.0 0.67 0.77 102.0 164.8 -4.0 133.3 0.0 3.9

1.8 0.5 103.4 0.67 0.77 99.0 162.3 -1.5 137.8 3.4 4.4

C100 C102 C103 C300

Exports: Crude and Refined Petroleum ($ million) Crude Oil Production, Volume (thousand b/d) % change Imports: Crude and Refined Petroleum ($ million) f = IIF forecast; fiscal year ending June 30

14473 723 1.8 9561

11005 736 1.8 7032

10259 730 -0.8 5161

12136 735 0.7 9262

13129 735 0.0 11775

12742 735 0.0 11892

12633 735 0.0 11892

12095 735 0.0 11892

IIF DATABASE: EGYPT

13-Mar-14 Page 5

CODE FISCAL & MONETARY SECTORS GOVERNMENT SECTOR (pounds million)

2007/08 2008/09 2009/10 2010/11 2011/12 2012/13e 2013/14f 2014/15f

G200 G202 G210 G211 G212 G220 G221 G222 G250 G500 G502 G510 G520

General government balance General government balance % GDP General gov't balance, excl. grants, % GDP General government revenue General government revenue % change General government revenue % GDP General government expenditure General government expenditure % change General government expenditure % GDP General government primary balance % GDP General government debt General government debt % GDP General government gross domestic debt General government gross external debt
MONETARY SECTOR (pounds million)

-67556 -7.5 -7.7 248762 21.1 27.8 316318 20.8 35.3 -3.0 715329 79.9 599603 115726

-72158 -6.9 -7.7 288447 16.0 27.7 360605 14.0 34.6 -2.7 844301 81.0 699667 144634

-98713 -130010 -167371 -237864 -235016 -240507 -8.2 -9.5 -10.6 -13.6 -11.9 -10.7 -8.5 -9.6 -10.6 -13.9 -15.4 -13.5 303275 301833 303621 350323 450251 513286 5.1 -0.5 0.6 15.4 28.5 14.0 25.1 22.0 22.6 20.8 22.8 22.9 401988 11.5 33.3 -2.1 431843 7.4 31.5 -3.8 470992 9.1 33.3 -4.0 588187 24.9 34.4 -5.2 685266 16.5 34.7 -3.7 753793 10.0 33.7 -3.1

957295 1128460 1309644 1645225 1944013 2227552 79.3 82.3 83.1 93.8 98.3 99.5 808384 148911 967290 1155312 1444370 1694133 1928564 161170 154332 200855 249880 298987

M100 M200 M201 M210 M250 M300 M400 M401 M411 M500 M501 M805 M815

Net foreign assets Domestic credit Domestic credit % change Claims on public sector Claims on private sector % change Other liabilities Money + quasi-money (M2) M2 % change M2 velocity % change v = GDP/(M2(t-1) + M2(t))/2 Money (M1) M1 % change Consumer prices % change average Consumer prices % change end-period
FINANCIAL MARKETS

303680

254134

282408

253507

157636

120715

151466

154823

570953 695326 805108 936773 1114400 1387103 1617172 1862064 7.5 21.8 15.8 16.4 19.0 24.5 16.6 15.1 200902 370051 12.63 107969 306268 389058 5.14 118249 386101 419006 7.70 170057 513440 423332 1.03 180869 666656 453292 7.08 177628 895617 1036626 1180931 491486 525890 567961 8.43 7.00 8.00 212132 212132 212132 7.1 1295686 1556506 1804755 18.4 20.1 15.9 -6.0 -6.1 -2.4 1.35 1.27 1.24 343700 372915 404612 25.2 8.5 8.5 7.5 9.8 10.4 10.1 9.2 8.7

766664 831211 917459 1009411 1094408 15.7 8.4 10.4 10.0 8.4 3.9 7.3 4.9 3.3 6.0 1.17 1.25 1.32 1.36 1.44 170579 182991 214040 248707 274510 29.9 7.3 17.0 16.2 10.4 11.7 20.1 16.2 10.0 11.7 10.7 11.3 11.5 9.6 8.7

K100 K101 K120

K200

Hermes Financial Index, end-period Hermes Financial Index, % change Equity market capitalization ($ billion) Discount rate, end period Lending rate, average Deposit rate, average Real deposit rate f = IIF forecast; fiscal year ending June 30

85660 22.9 139.3 10.0 12.2 6.1 -5.0

52902 -38.2 85.7 9.0 12.4 7.0 -7.9

56107 6.1 90.5 8.5 11.3 6.0 -5.1

53438 -4.8 83.8 8.5 10.8 6.5 -4.3

56800 6.3 56.7 9.5 11.6 7.3 -2.1

49290 -13.2 53.0 10.3 12.0 7.8 0.3

72700 47.5 82.1 8.8 11.3 7.4 -2.8

K210 K220 K230

IIF DATABASE: EGYPT

13-Mar-14 Page 6

CODE STRUCTURAL FACTORS EXTERNAL TRADE

2007/08 2008/09 2009/10 2010/11 2011/12 2012/13e

S100 S102 S112 S113 S115 S120 S122 S132 S133 S135

Merchandise Exports ($ million) Export composition % total: Crude and Refined Petroleum Export destination % total: European Union United States Arab Countries Exports % GDP Merchandise Imports ($ million) Import composition % total: Crude and Refined Petroleum Import origin % total: European Union United States Arab Countries Imports % GDP
REAL GDP BY ORIGIN: 2001/02 = 100

29356 49.3 26.1 5.8 12.0 18.1 52771 18.1 18.3 9.5 16.1 32.5

25169 43.7 31.0 4.9 20.7 13.3 50342 14.0 21.2 10.8 12.8 26.7

23873 43.0 23.6 6.7 27.3 10.9 48993 10.5 26.2 10.6 10.1 22.4

26993 45.0 26.1 5.9 26.4 11.5 54096 17.1 26.7 9.4 10.7 23.0

25072 52.4 29.5 5.4 21.8 9.5 59211 19.9 23.0 9.7 10.1 22.6

25971 49.1

9.6 57513 20.7

21.2

S210 S220 S230 S240 S250

Agriculture (16% GDP in 2001/02) Mining & manufacturing (28% GDP in 2001/02) Electricity & water (2% GDP in 2001/02) Construction (5% GDP in 2001/02) Services (49% GDP in 2001/02)
INVESTMENT AND SAVING (% GNP)

121.5 133.7 148.9 159.3 143.5

125.3 140.0 157.2 177.5 149.1

129.7 144.4 175.1 200.8 158.7

133.2 144.0 182.8 208.2 162.8

S305 S315 S325

Gross domestic investment Gross national saving Net foreign balance

POPULATION & EMPLOYMENT

22.4 18.1 -4.3

19.2 13.2 -6.0

19.5 14.4 -5.1

17.1 13.1 -4.0

17.1 12.5 -4.6

17.6 13.0 -4.6

S400 S401 S411 S420 S430 S431 S440

Population (million) Population % change Per capita real GDP % change Per capita $ GDP Employment (million) Employment % change Recorded unemployment rate (%)

75.2 2.2 4.9 2159 22.5 3.7 8.7

76.8 2.1 2.5 2457 23.0 2.2 9.4

78.7 2.5 2.7 2776 23.8 3.5 9.2

80.4 2.2 -0.3 2930 23.3 -2.1 12.1

82.2 2.3 -0.1 3192 23.5 1.0 12.6

84.1 2.3 -0.2 3231 23.9 1.5 13.8