Will Al Sisi Help Bring Egypt Back On Track?

Egyptians recently took to social media to find solace in dark humour and sarcasm as the country endured a crippling power outage in early September.

“Wonder how long it will take to blame the mass power cuts on the Muslim Brotherhood?,” tweeted a frustrated Egyptian as he and around 20 million people in and around Cairo sweltered in the heat.

The country’s latest power outages shed light on the creaking infrastructure and the massive investments required just to
keep the economic engine running in the Arab world’s most populous nation.

Egypt’s grim ground realities show that while President Abdel Fattah Al-Sisi has brought some political stability after three years of tumultuous rule of the interim and much-loathed Muslim Brotherhood governments, the country remains economically frail.

The country will need five years and $12 billion to resolve the electricity crisis, Al-Sisi told his 82-million-strong populace, urging patience.

“We should be aware that such a crisis cannot be remedied overnight,” the president said in a televised speech. “We as Egyptians are facing huge insurmountable obstacles and no one, the president nor the government, will be able to overcome them individually without your support.”

Egyptians are well aware of the economic plight of their country.

GDP growth rates have declined from five to seven per cent during the first decade of the century to a sub-par two per cent over the past few years. The country’s national output grew a paltry 2.3 per cent last year, but may see a stronger push to above 4 per cent for the first time in five years, the International Monetary Fund estimates.

“Business confidence is recovering, but the economic situation remains troubled,” the IMF says in a recent report. “Financial conditions have eased: the stock market index has rallied more than 70 per cent since July 2013, and yields on government debt have fallen.”

With Al-Sisi in the driver’s seat, Saudi, Emirati and Kuwaiti governments have readily piled funds into the country.

The aid and deposits serve as a fiscal guarantee and propped up the currency and general business sentiment.

Despite the cushion of Gulf aid, Egypt needs to embark on aggressive social and economic reforms – even if political reforms can wait.

In a major step towards reform, the government embarked on an aggressive energy subsidy cut in a bid to save $6 billion – widely seen as a bold move at a politically-sensitive time.

“The Egyptian government is under pressure to stand on its own feet – hence the bold subsidy cuts,” Anthony Skinner, director at Maplecroft, a risk management consultancy, told Gulf Business.

Despite these measures, Gulf aid remains crucial to Egyptian stability. In May 2014, Saudi Arabia, Kuwait and the UAE pledged $20 billion in financial assistance. In August 2014, the UAE agreed to extend a $9 billion loan to Egypt to finance the purchase of petroleum products.

Amr Adly, a non-resident scholar at the Carnegie Middle East Centre believes that the Egyptian state may soon wean itself off Gulf aid as the economy is showing signs of recovery and foreign reserves are building up.

“However, the Egyptian economy will be even more dependent on Gulf capital flowing into investment rather than budget support for economic recovery and fiscal restructuring in the coming years,” Adly says in an interview with Gulf Business.

“Talk has been about the total capital inflows of $120 billion in the form of new investments in the coming five years, mainly from Saudi, the UAE and Kuwait.”

The UAE’s Arabtec Holding secured a $40 billion deal with the Egyptian government earlier this year to build one million houses across 13 locations. Egypt also awarded contracts worth $4 billion in August to Saudi Arabia’s Dar Al-Handasah and other Gulf firms to expand the Suez Canal.

Gulf funding will likely be useful in other respects too, especially as Egyptian authorities are studying the possibility
of issuing international bonds backed by the GCC.

This would also help pay arrears owed to international oil companies operating in Egypt, and help investment, growth and foreign direct investments from oil majors.

BEST FOOT FORWARD

“The government is also preparing for a comprehensive donor and investment conference by year-end or first quarter of 2015, and is readying detailed sectoral proposals,” Jean-Michel Saliba, analyst at Bank of America Merrill Lynch says in a recent report.

Egyptian authorities want to put their best foot forward in the run up to the conference, and have asked the International Monetary Fund to prepare a so-called Article IV report, which assesses the country’s financial and economic state, after a gap of three years.

“This highlights that the government is looking to normalise and regularise its relations with the Fund in the near-term,” says BAML’s Saliba.

Part of the discussion with donors may also include talk of $4.8 billion IMF loan that has been mothballed in the absence of reforms.

But the IMF funds come with too many demands attached and may handcuff Al-Sisi as he picks and chooses his economic policies.

In contrast, “Gulf Arab nations are more prepared to give the Egyptian government the room for manoeuvre that it desires,” Maplecroft’s Skinner says. Indeed, reforms remain a tricky balancing act for the Al-Sisi government. The government has initiated at least two stimulus packages valued at EGP63.6 billion ($8.8 billion) along with business-friendly reforms in the past year, but it’s still too early to determine whether the effort has pulled the Egyptian economy out of its lethargy.

“They are running contradictory plans as a matter of fact,” Adly says.

On one hand, the fiscal situation requires austerity measures such as subsidy cuts, but on the other hand, the government is committed to raise state investment to regenerate growth, employment and get the economics wheel spinning again.

“Austerity measures combined with more taxation can potentially deepen the recession,” Adly says. “The government has been counting on investment or aid (forms of capital inflows) primarily from the Gulf to be able to inject money into the economy through stimulus packages while carrying out fiscal restructuring. Whether this formula can hold or not is unclear.”

INVESTOR SENTIMENT IMPROVING

Despite the turmoil of recent years, investors are slowly returning to the country.

The Egypt Stock Exchange index was up 40 per cent by the third week of 2014, while GDP growth stood at 2.5 per cent in the first quarter, up from just 1.3 per cent in the fourth quarter of last year. Early estimates show the second quarter may see a 3 per cent expansion.

“Credit growth has also been accelerating during the first half of 2014, with year-on-year growth reaching 7.4 per cent in June,” notes National Bank of Kuwait in a report.

While Markit’s Purchasing Managers Index (PMI) has not consistently sustained levels above 50, it too has shown improvement from recent lows and recorded a new 2014 high in August, coming in at 51.6.

Egypt’s current account deficit, which had peaked at 3.9 per cent in 2012, shrank to 0.7 per cent by the end of the first quarter.

But a number of areas are languishing due to poor business sentiment, with tourism and the energy sector hardest hit.
Tourism figures are 23 per cent lower compared to the same period last year, as tourists from Europe and Asia look for safer destinations such as Casablanca and Dubai.

“Natural gas has been another source of weakness, with natural gas output shrinking significantly,” notes NBK Capital.

Production of the resource was down nine per cent year-on-year in May, following a 2.4 per cent decline the year before with energy companies holding back on investments as the government has been slow to pay their dues.

The weak economic activity has taken it toll on unemployment which has reached a record 13 per cent – the official figure that’s widely expected to be much lower than actual numbers.

“Mitigating unemployment is a serious economic as well as political challenge to Al-Sisi and his government,” Adly says.

“They have been counting on a number of mega infrastructure projects that are naturally labour intensive to generate jobs and to engage the broader base of small and medium-capital through subcontracting and outsourcing.”

While major projects may lower unemployment rates in the short to medium-term, long-term improvement hinges on economic recovery and higher private investment rates.

Maplecroft’s Skinner believes that despite Egypt’s continuous exposure to political risk, investor confidence is back.

“Notwithstanding terrorist attacks, the relative stability (end to large-scale protests) that Al-Sisi has brought back to Egypt counts for a lot.”

Many investors are also heartened by the safety net of Gulf investments, which are unlikely to be withdrawn abruptly.

Parliamentary elections, to be called before year-end, would likely feature a house of representatives that’s broadly co-operative with the presidency, adding to political stability.

Yet, the goodwill that the president enjoys may not last, if issues like power cuts continue to crop up.

President Al-Sisi has also not announced a clear economic plan for the next four or five years, but at some stage the restive citizens will demand a more concrete economic path forward.

“Al-Sisi is using his political capital to press ahead with painful reforms. Egypt is still undergoing a very difficult transition,” Skinner says.

“It will remain a challenge to hit the balance between austerity and not hitting Egyptians too hard in the pocket. The government is already in the danger zone.”