Egypt: What Revolution?

Two years to the day when Egyptians ousted President Hosni Mubarak, the baying crowd returned to Tahrir Square. But unlike last time, when the mood was triumphant, the public were now venting their anger against an elected president who they believed no longer represented the aspirations of the revolution.

The latest political tensions came just as Egypt was showing signs of economic improvement and President Mohamed Morsi was being hailed as an influential mediator after brokering a ceasefire between Hamas and Israel.

The president had also seemingly secured a much-needed $4.8 billion IMF loan, which is viewed as crucial in injecting investor confidence back into the country.

But Morsi appears to have overplayed his hand by trying to push through a constitution that was deemed too Islamic by many Egyptians. The country has been in a state of despair since, and the liberal movement which led to the Arab Spring believes the ruling Muslim Brotherhood party has hijacked the revolution.

“In the absence of a broad-based political consensus, President Mohamed Morsi will struggle to tackle police sector reform and other fundamental problems faced by post-Mubarak Egypt,” says Oxford Analytica in a note. “This will translate into continued low levels of policing, and increased instances of political protests degenerating into serious street violence.”

Companies looking to invest in the country must factor in Egypt’s instability. The country has lurched from one crisis to another and has teetered on the brink of disaster many times over the past two years. But the latest political disaster has compelled the government to postpone reforms that were considered pre-requisites before the IMF released the $4.8 billion loan.

This is a blow to the Egyptian government, as the 22-month funding programme was seen as the centrepiece of the country’s effort to repair its economy and attract investors.

The IMF programme was to be supported by a financing package of $14.5 billion in loans and deposits from bilateral and multilateral partners. However, the IMF said it will need more guarantees from the government before it releases the funds.

After a meeting with Egyptian officials in January, Masood Ahmed, director of the Middle East and Central Asia Department of the IMF, remains non-committal.

“We agreed that an IMF technical team would visit Cairo in the coming weeks to resume discussions on possible IMF financial support.”

The World Bank believes the IMF loan would unlock substantial additional aid flows from other multilateral and bilateral donors “and improve Egypt’s reserve position significantly in 2013, while reforms undertaken as part
of the programme would contribute towards enhancing fiscal and external sustainability.”

However, domestic tensions could make implementation difficult, deter private investment, and dampen growth in the near term, said the bank.
Ratings agencies have already made their verdicts clear.

Standard & Poor’s cut Egypt’s long- term credit rating in December. “A further downgrade is possible if a significant worsening of the domestic political situation results in a sharp deterioration of economic indicators, such as foreign exchange reserves or the government’s deficit,” S&P says.

Fitch Ratings, which also downgraded the country’s sovereign ratings, notes that the depreciation in the Egyptian pound is unlikely to provide much support to the balance of payments, which has suffered from the impact of political unrest on tourism and capital inflows. “However, if the pound stabilises and capital controls are removed, uncertainty for foreign investors and local companies will reduce.”

Meanwhile, the political transition has at times been mishandled and serious divisions have opened within society, contributing to sporadic outbursts of violence, says Fitch analyst Paul Gamble.

“Parliamentary elections, likely in April, are a potential flashpoint. Political conditions are complicating economic policymaking, as evidenced by the backtracking on IMF fiscal prior actions in December. An IMF programme could be delayed until after the election.”

GCC INVESTORS

Gulf investors, no strangers to unstable economic environments, are already positioning themselves in the new Egypt.

Qatar is leading the way and recently announced it would double its pledge of $2.5 billion in aid and loans to the embattled country.

“There was an initial package of $2.5 billion, of which $0.5 billion was a grant and $2 billion a deposit,” Qatari Prime Minister H.E. Sheikh Hamad bin Jassim Al Thani said in early January, “We discussed transferring one of the deposits into an additional grant so that the grants became $1 billion and the deposits double to around $4 billion.”

Saudi Arabia had also disbursed nearly $2.5 billion to the country and has promised private sector investments as well.

“Given the reserves of the GCC at over $1 trillion and the importance of stability in Egypt to Gulf monarchs, it would be surprising to see Egypt run out of dollars,” says Emad Mostaque, strategist at Noah Capital Markets.

“With [the Qatari] aid coming in over the next few months (the IMF’s $4.8 billion is to be paid over two years), Egypt can now comfortably make it through elections in a couple of months, after which the increasingly Islamist government will introduce economic reform through subsidy cuts and tax increases.”

There are fears, though, that Qatar’s open support for the Muslim Brotherhood is alienating Saudi Arabia and the UAE, who are wary of the Islamist party. Still, Egypt remains a crucial state for both Saudi Arabia and the UAE, and they would prefer to retain some influence over Egyptian affairs rather than let Qatar lead Gulf policy in Egypt.

And while global investors may fret about the short-term instability in the country, regional investors are eyeing the country’s underlying fundamentals: 84.5 million people, mostly young and educated, billions of dollars needed for infrastructure, its unique tourism proposition, and opportunities in the banking sector.

Qatar National Bank expects to finalise its $2.8 billion stake in National Societe Generale Bank soon.

Meanwhile, Emirates NBD, the UAE’s largest bank by assets, picked up BNP Paribas’ Egyptian operations for a cool $500 million.

“The growth in the (Egyptian) economy is stellar,” says Kevin Flannery, ENBD’s general manager for international operations. “It’s a key market in our region and we anticipate that growth continuing.”

Gulf investors are also eyeing other areas, especially in real estate and tourism sectors.

Al-Futtaim Group and Emaar Properties, two of the UAE’s largest developers, have also teamed up to develop Cairo Gate, a $830 million mixed use development on 16 acres near the Cairo-Alexandria artery.

Emaar Hospitality Group, a unit of the real estate giant, also sealed a contract to manage The Address Marassi Golf Resort & Spa in Egypt.

ECONOMIC CROSSROADS

While Gulf investors are piling into Egypt, global investor interest hinges on the IMF’s $4.8 billion loan.

“Foreigners are still largely absent from trading and likely to come in post-IMF aid,” says Mostaque.

Egypt, which clocked a five per cent GDP in 2010, saw growth of a mere 1.8 per cent in 2011 and is expected to eke out a two per cent growth in 2012, according to the IMF.

“Egypt’s economy has yet to fully recover from the erosion of confidence that triggered a sharp reversal of capital flows, an abrupt decline in tourist arrivals, and a standstill in investment in the aftermath of the January 2011 revolution,” says the IMF.

Meanwhile, the World Bank expects Egypt’s GDP to rise a mere 2.2 per cent this year, much lower than the 3.5 to four per cent forecast by the Egyptian government.

And there are fears that the latest political crisis could spiral out of control.

“The fiscal position has worsened,” says Fitch’s Gamble. “The general government deficit widened to 10.7 per cent of GDP in FY12 (year ending June) and data for the first five months of FY13 show a further deterioration.”

Spending on subsidies, interest payments and the public-sector wage bill are rising and a weak economy is hitting revenues. Fitch forecasts the deficit to rise to 11.2 per cent in FY13 and general government debt to reach 84 per cent of GDP at end-FY13, double the ‘B’ median.

Still, there are hopes that the government can set the economy right and ensure robust reforms maintain its attractiveness. Indeed, economic reforms are crucial to tackle the 13 per cent unemployment figure, or 700,000 new entrants to the labour force each year.

“In particular the service sector has a strong potential for growth and job creation,” writes C. Muthuthi, chief country economist at the Africa Development Bank.

“A comparison of Egypt’s economy to those of Turkey and Jordan suggests that Egypt can grow the services sector substantially. Services are the leading source of output for all three economies, but the sector is more dominant in Turkey (64.7 per cent of output) and Jordan (65.6 per cent) than in Egypt (49 per cent).”

Meanwhile, activities with strong potential include financial services, ICT, tourism, transportation, logistics and construction.

Given Gulf investors’ natural affinity with Egypt, they will likely remain buyers and weather the volatility, while Western investors may prefer to remain on the sidelines before the investment picture clears up.