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AfricaApril 3 2018

Sisi's reforms start to pay off for Egypt

President Abdel Fattah el-Sisi has pushed through business-friendly reforms that would have been unthinkable in Egypt a few years ago, including cutting fuel subsidies. The results have been impressive, bringing praise from the IMF. So is the optimism prevailing in the country justified? James King reports.
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Cairo

In 1977, the then-president of Egypt, Anwar Sadat, lifted state subsidies on a range of basic foodstuffs. Under a policy of 'Infitah', or openness, the reforms were introduced as part of a wider programme of economic liberalisation. The result was catastrophic; cities across the country erupted in riots in what became known as 'the Bread Intifada'. Nearly 80 people were killed and hundreds were injured in the ensuing violence. In the intervening years, no Egyptian government has dared to tackle the country’s subsidy regime – until now.

Since being sworn into office in 2014, current president Abdel Fattah el-Sisi has embarked on one of the most striking economic reform programmes anywhere in the world. The president, whose reputation is akin to that of a demanding chief executive, has shaken the foundations of the Egyptian economy in his pursuit of a more business-friendly market. The end goal is Vision 2030 and the attainment of a balanced, competitive and diversified economic model.

Bold reforms

To get there, Mr Sisi’s government has enacted what, historically, were deeply unpopular policies. “Hydrocarbon subsidies and the exchange rate peg were among the ‘taboo’ reforms that no one thought the government would touch. It was incredibly bold of the government to address these issues,” says Karim Awad, chief executive of EFG Hermes, a financial services group headquartered in Cairo.

The fuel subsidy bill has, for instance, fallen from 5.9% of gross domestic product (GDP) in 2013/14 to an expected 2.4% in 2017/18, following a government programme to tackle the broader subsidy regime. But the authorities have not stopped there. Since Mr Sisi’s inauguration, advances have been seen in almost every area of the country’s economic framework. New legislation has cut bureaucracy for Egyptian businesses and infrastructure spending is transforming Egypt’s physical landscape, while the introduction of value-added tax will contribute to an expected fiscal surplus in 2017/18.

“I think what we have seen over the past couple of years has been, quite honestly, revolutionary in terms of the extent of the reforms,” says Mr Awad.

This sentiment is echoed across Egypt’s financial sector. “The government has been bold enough to take seemingly unpopular decisions; subsidies reforms and the currency flotation redressed an earlier stalemate that stalked the economy,” says Hassan Abdalla, chief executive of Arab African International Bank (AAIB).

Better communication

So why is the government now able to make these changes where its predecessors could not? Mr Awad attributes this to popular support, as well as the administration’s efforts to explain to the public the need for these changes.

“I think the government realises that its popularity is strong enough to take these kinds of actions. It has also communicated the need to reform to the population very well. Today, people are expecting further changes to hydrocarbon and electricity subsidies in the second half of 2018. It’s no longer a surprise,” he says.

Nevertheless, Mr Sisi’s government has its critics. For all of its progress on economic reform, the same cannot be said for its commitment to political liberalisation. Many opponents point to changes to the country’s anti-terror and security legislation, which they have labelled as ‘draconian’. In the build up to its presidential election, scheduled for March 26 to March 28, some major opposition campaigns withdrew from the race, claiming they were subject to intimidation. The president now faces one opponent who is himself, according to various sources, a Sisi supporter.

Improved security

But the administration does have some political achievements under its belt. For one, the president’s meritocratic approach to cabinet appointments included six women as of mid-March 2018 – for the first time in Egypt’s history. In addition, Cairo’s private sector leaders tend to agree that the security situation is improving, particularly in the Sinai, where local populations are aligning against extremist groups in the area.

“The security situation has improved and this is a big achievement. We are getting back to normal,” says Hisham Ezz Al-Arab, chairman of Commercial International Bank (CIB), Egypt’s largest private bank.

The government is not satisfied with the progress it has achieved. Complacency hasn’t set in

Hisham Ezz Al-Arab

For now, however, the economy is clearly the government’s focus. And its crowning achievement to date has been the free float of the Egyptian pound, which was executed in November 2016. “The free float of the Egyptian pound has probably been the most impressive reform so far,” says Mr Awad. “Before this happened, international investors would talk to us and acknowledge the economy’s strong fundamentals but few would be willing to take the currency risk associated with Egypt, which was huge.”

The benefits for Egypt’s economy have been profound. Bankers in Cairo are seeing rising production and consumption of domestic goods and services, employment is increasing in tandem and all the right numbers are emerging at the macroeconomic level.

“Previously, the currency was overvalued; [the result was] that many businesses found imports cheaper than local production. They flooded the country with imports because they were coming in at half the price,” says Yasser Hassan, managing director of the National Bank of Kuwait in Egypt. “The negative and very serious consequence of that was that local production continued to shrink and the unemployment rate went up. The current monetary policy has put Egypt on the right track to remedy these problems.”

Short-term inflation hike

But these benefits have also come with serious but short-term drawbacks for ordinary Egyptians. Inflation skyrocketed in the aftermath of the pound’s flotation, as well as the lifting of key subsidies, with consumer price inflation reaching as high as 35% midway through 2017. This has hit Egyptian consumers, particularly the middle class, hard, reflecting their extensive obligations from school fees to the use of private vehicles. Nevertheless, the inflation story has hit every strata of society.

Encouragingly, inflation is now on a downward trajectory. In January 2018 annual urban consumer price inflation dipped to 17%, while core inflation fell to about 14% (from 19% in January 2017). Renaissance Capital, an emerging markets investment bank, expects inflation to hit between 11% and 12% by the middle of 2018, though further subsidy reductions may keep it somewhere around this level for a while longer.

But the net gains from the pound’s flotation have been significant. For one, foreign currency liquidity has improved dramatically. Egypt faced a dearth of hard currency following the political upheaval of 2011 as tourists and investors limited their exposure to the country. It was also subject to a fixed exchange rate (E£8.8 to the dollar) that did not reflect the market value of the pound. This contributed to a multi-billion-dollar backlog of foreign currency requests from foreign entities and importers operating in the country, which has since been cleared.

Improving dollar liquidity in the system is also opening up new opportunities for foreign investment. “I believe that the economy is now open for foreign direct investment [FDI] after several years during which the gate of investment – the foreign exchange market – was closed,” says AAIB’s Mr Abdalla.

Local and foreign investment

In May 2017, the Egyptian parliament approved the passage of the ‘new investment law’. Designed to promote additional FDI, the law grants investors new rights and protections, including residency permits for the duration of their investments in Egypt and the right to repatriate profits and receive international financial assistance without restriction. Similar efforts are being made to improve the domestic operating environment for Egyptian companies.

The government has been bold enough to take seemingly unpopular decisions; subsidies reforms and the currency flotation redressed an earlier stalemate that stalked the economy

Hassan Abdalla

“What is really promising is that the government of Egypt is not only addressing foreign investment, but local direct investment as well. It is also trying to give local businessmen a better business environment,” says Mr Abdalla.

Indeed, the administration appears to be getting the basics of the domestic business environment right. These include substantial investments in key infrastructure, including transport networks, and the wholesale reform of the electricity sector. In previous years, both of these components were something of a hit-and-miss affair.

In 2014, for example, Egypt saw power demand peak at 27,000 megawatts, almost 20% above total capacity, according to research from HSBC. Under these conditions, power outages were common for households and businesses alike. But the current administration is completely revamping the country’s energy sector by encouraging local and foreign investment, introducing a liberalised regulatory regime, diversifying the energy mix and investing in new power generation facilities.

Ambitions for energy

The results have been outstanding. According to a number of sources, Egypt is expected to double its generation output by the end of 2018. “What the Ministry of Electricity has achieved is historic. It has transformed the market over the past three years. Now Egypt can even export electricity. And the government is not satisfied with the progress it has achieved. Complacency hasn’t set in. The government is currently building the Benban Solar Park, soon to be the biggest solar installation in the world,” says Mr Ezz Al-Arab at CIB.

In a boost for Egypt’s plans to become a regional energy hub the country’s offshore Zohr gas field, the largest hydrocarbon discovery in the Mediterranean, began production in December 2017. With daily production goals of 760 million cubic metres by the end of 2019, production from the Zohr field will go beyond meeting domestic demand and could potentially position Egypt as an exporter of natural gas. This comes as a private sector deal between Israeli and Egyptian companies, signed in late 2018, will see about 64bn cubic metres of Israeli natural gas supplied to Egypt over the next 10 years.

Various projects are under way to fulfil Egypt’s regional energy ambitions, including hydrocarbon tanker refuelling stations, petroleum storage facilities and pipeline infrastructure. The country has two underused gas liquefaction plants that could export new gas as it arrives into the country. And, at a time of growing tensions between Russia and the EU, this could be fortuitous. 

IMF recognition

All of this bodes well for Egypt’s future. Confidence is growing among Egypt’s business community as the reform programme opens up new opportunities for development. GDP growth has picked up from 3.5% in 2015/16 to an expected 4.8% in 2017/18 before strengthening to 6% over the medium term, according to the International Monetary Fund (IMF). Little wonder then that IMF managing director Christine Lagarde singled out Egypt as a positive example of economic reform in comments made at the World Government Summit in February.

Nevertheless, it may still take some time for the success of Egypt’s reform story to reach a wider audience. “When Egypt last executed a major devaluation in 2003, it took a while before real FDI started coming in to the country. It takes time for investor awareness to develop and the same will be true under the current reform programme. But to hear the IMF talking positively about the country will certainly help,” says Mr Awad.

Egypt’s economy is clearly on the right track and the government has a credible plan in place to improve it further. Though the real benefits of this reform may not be felt for a number of years, the authorities are at least making the kind of hard choices now that will benefit the country in decades to come.

“When you sit down after four years and you look at what has been achieved, it is quite significant. I am comfortably optimistic about the coming few years,” says Mr Ezz Al-Arab.

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Read more about:  Africa , Egypt