The past 18 months have marked a historic turning point for Egypt. The resignation of former president Hosni Mubarak on February 11, 2011, marked the end of 30 years of autocratic rule and opened the doors to a new era promising change, freedom and, ultimately, democracy.
However, the political unrest that has ensued since Mr Mubarak's regime was ended has put the brakes on the country’s economic development, with real gross domestic product (GDP) recording a notable slowdown in growth from 5.1% in 2010 to just 1.8% in 2011. Furthermore, Egypt’s GDP saw negative growth of 4.2% in the first quarter of 2011, a contraction not seen since the Central Bank of Egypt began publishing quarterly data in 2001.
In particular, the sectors that constitute Egypt's main foreign currency earners have suffered a steep decline in revenues. Egypt posted FDI outflows of $482.7m in 2011, compared with inflows of $6.4bn a year earlier, while tourism, a key pillar of the economy that employs about 10% of the country's population, saw arrivals decline by 30% last year, according to central bank data. Receipts from Suez Canal traffic and exports also dropped considerably due to lower external demand.
“If you look at Egypt over the past 15 months, it would be fair to say that the economy fell off a cliff in the first quarter of 2011 and has been trundling along ever since,” says Andrew Long, chief executive of HSBC Egypt. “However, if you look at the published results of the banks, you would expect there to have been a lot more problems and provisions taken but our provisioning hasn’t changed dramatically and the banking sector seems to be in fairly good health.”
NBE's positive action
Indeed, in light of the tumultuous events in the country, the performance of the Egyptian banking sector has been surprisingly resilient, with a number of Egypt’s largest banks posting healthy growth.
National Bank of Egypt (NBE) – the country’s oldest bank (established in 1898) and its largest, with a 24% market share of total assets, saw its total loan book increase from E£92bn ($15.22bn) in June 2011 to E£96bn in March 2012. Meanwhile, its deposit base grew from E£244bn in June 2010 to E£265bn by December 2011. It has since grown further, to E£268bn, and Hisham Okasha, deputy chairman of NBE, forecasts it will have risen to E£270bn by June 2012. “The important thing was the role our bank played after the Egyptian uprising,” he says. “We held lots of meetings with businessmen and key industries to see what they needed and we provided special loans from the Social Fund for Development to help them maintain liquidity and working capital, especially within the tourism sector. We’ve also given customers a breather on their repayments.”
We’ll start seeing whether corporates are more confident from September onwards. But I don’t expect investment banking will kick off again before the start of 2013
NBE also shifted its focus to small and medium-sized enterprises (SMEs). Since the second quarter of 2011, it has been dispensing about 1000 loans per month with an approximate value of E£200m to SMEs.
SME importance
There are an estimated 2 million micro, small and medium-size enterprises in Egypt today, according to research conducted by the central bank in early 2012. Most of them (98.1%) are micro companies active in trade, manufacturing and services. Together they employ 6 million people and contribute to roughly 50% of Egypt's GDP. “The research was commissioned and paid for by the central bank as it is trying to boost the role of SMEs,” says Mr Okasha.
At the end of 2008, in a bid to encourage greater lending to SMEs, the Central Bank of Egypt exempted bank loans to small businesses from the 14% cash reserve requirement. Potential sources of funding have also been boosted by the establishment of the Nile Stock Exchange (Nilex), the first small and mid-cap stock market in the Middle East and north Africa region.
“SMEs are the lifeline for industries, the labour market, the economy and smaller families living on a lower income," says Mr Okasha. “One of the focal points of NBE’s strategy today is to increase financing to SMEs. We have been building up our internal capacity over the past three years and trained more than 8000 staff members. We became ready to deploy this labour force and infrastructure early last year, which luckily coincided with the time that the country needed it most.”
According to senior Egyptian bankers, SMEs played a key role in keeping the country's economy afloat during the uprising. “We think the grey economy is equal in size to the actual registered economy,” says Hisham Ezz Al-Arab, chairman and managing director of Commercial International Bank (CIB), Egypt’s largest private sector player and the third largest bank by asset size. “When the formal economy slowed down, it was the grey economy that kept us going as a lot of trade was still being done between farmers and other small businesses.”
CIB's commercial salvation
While investment banking revenues, capital gains and trading profits at CIB all recorded a drop in the months following the uprising, the commercial area of the bank’s operations compensated for this, according to Mr Al-Arab. “While other banks were still assessing the situation, our strategy was to focus on increasing our market share in the commercial area,” he adds.
CIB grew its share of sector deposits from 6.7% in 2010 to 7.2% in 2011, while its loans increased from 8% to 8.8% over the same period. But there is no denying that banks’ operations have been challenged by the turmoil of the past 18 months, with CIB’s provisions having grown from E£6.2m at the end of 2010 to E£320.6m at the end of 2011.
“Of course, we were impacted. We had a shut-down period and it took a while for things to return to normal. As a result, our top-line revenues in December 2011 matched those of the year before and some areas are still slow,” says Mr Al-Arab.
The bank’s overall lending has weakened in the first quarter of 2012, mainly in the corporate sector. While gross loans grew 10.2% year on year to E£42bn, they contracted 2.2% quarter on quarter as corporate lending fell 3.5%.
We definitely need more FDI as this is where we’ve been hardest hit. But I’m hopeful because the relationship between Egypt and Arab countries is very solid
“In terms of corporates, whatever momentum we had in 2011, most of them aren’t undertaking more capital expenditure under the current political climate. Loan applications should start to come in between July to September this year so we’ll start seeing whether corporates are more confident from September onwards. But I don’t expect investment banking will kick off again before the start of 2013.”
EFG-Hermes, the Arab world’s largest publicly traded investment bank, posted revenues of E£3bn at the end of 2011, which is close to 2008 levels, while its net income is about one-fifth of the level recorded then. Its investment banking division lost E£26m in the first quarter of 2012, leaving the commercial bank to carry the group, while its shares have fallen 60% since the uprising began, and trade at 0.9 times book value, nearly a 50% discount to other Egyptian banks.
Mr Al-Arab sees the key growth opportunities today being in the commercial sphere, particularly in the areas of consumer goods, healthcare, private education and construction. “Egypt’s consumption power is huge so we are in talks both with existing companies in this space or those that are looking to move into it,” he says.
Consumer lending currently comprises about 20% of CIB’s profits and losses, but it is looking to double this over the next five years. “It still constitutes a very small amount but our 2016 target is to grow it to close to 40% on both the assets and liabilities side,” says Mr Al-Arab.
AlexBank's youthful hope
Like CIB, AlexBank sees the consumer and corporate sectors – in particular retail, microfinance and SMEs – as high-growth areas of lending. “The young demographic bulge is the positive side of Egypt’s growth story today,” says Yaser Gamali, deputy chairman and managing director of AlexBank. “One-third of the population is aged between 15 and 34 years old and it is this demographic that are the net borrowers and who have a real demand for for education, housing, car and consumer durables such as white goods, etc... These demands will need to be partly met by accessing finance, both conventional and Islamic, from the banks.
“I am more cautious on sectors where demand has been curtailed. Obviously, financial stress and liquidity concerns are developing because of the adverse environment, especially in capital-intensive areas such as real estate, tourism and consumer durables. Banks are sensitive to this and are having to reschedule loans to these hard-hit sectors.
“The difficult economic conditions have created liquidity issues for some borrowers and those who are highly leveraged are obviously finding it harder. We are still seeing continued difficult trading conditions – a good company can withstand these for maybe two or three years but a poorly capitalised and/or performing company will only be able to tolerate the current adverse conditions for a significantly shorter timeframe.”
Public debt worries
Some among the Egyptian banking community have also expressed concern over banks’ growing exposure to the public debt. The budget deficit stood at 9.8% of GDP in 2011, according to the International Monetary Fund (IMF).
Since the resignation of Mr Mubarak in February last year, Egypt’s ruling military council has shored up the economy and the currency, principally by drawing on its foreign reserves. These reserves shrank from about $36bn at the start of 2011 to $16.3bn at the end of January 2012. They had fallen by a further $600m by March to $15.12bn.
Concerns over Egypt’s ability to pay off its debts have pushed up borrowing costs in the country, as witnessed when the Ministry of Finance offered a record-high yield of 15.92% on a nine-month bond and treasury bill it floated in early February this year. Even so, investor appetite was only lukewarm, with final sales 31% lower than what had been targeted.
Consequently, the government has relied heavily on borrowing from domestic banks, which has sent interest rates to historic highs as funds grow tighter. During 2011, Egyptian banks’ government debt holdings rose to 550% of equity from 430% in December 2010.
“Rising concentrations in government assets link the banking system’s credit profile directly to the credit risk of the sovereign,” noted a Moody’s report published in May 2012 in which the international credit rating agency maintained its negative outlook on Egypt’s banking sector. “In view of the government’s financing needs stemming from its large budget deficit (equivalent to 10% of GDP in fiscal year 2012), we expect that the banking system will further increase its already significant exposure to the government and public sector.”
External concern
Egypt’s external funding requirements are estimated to amount to $11bn until April 2013, at a time when many countries across the world are firefighting their own debt crises. This makes the approval of the IMF’s $3.2bn loan all the more urgent for two reasons. First, foreign donors are showing reluctance to provide financial assistance without the IMF’s involvement, and second, it should help regain the confidence of international investors.
FDI is continuing to fall – after dropping by 68% in 2011 it declined 72% year-on-year during the first quarter of 2012. Aside from investors’ concerns over the lack of visibility within Egypt, the drop in investment has been further exacerbated by the deepening eurozone crisis that has led to a spike in international borrowing costs and tightening liquidity.
Furthermore, the potential devaluation of the Egyptian pound is also a big concern for foreign investors who have steadily withdrawn billions of dollars from Egyptian equities since May 2011, reversing the trend of steady inflows in 2009 and 2010, according to EPFR Global, a fund flow data provider.
“The IMF loan is just a rubber stamp to help open the door to others who are potentially looking to invest,” says Mr Al-Arab. “The $3.2bn won’t turnaround the economy but it will help encourage the private sector to go and invest. But I think it’s wise of the IMF to postpone the decision to grant the loan until we have a newly elected government.”
Of foreign investment, Mr Okasha says: “We definitely need more FDI as this is where we’ve been hardest hit. But I’m hopeful because the relationship between Egypt and Arab countries is a very solid and fruitful one. The Gulf has a lot of money and Saudi Arabia’s support is obviously a positive move.”
On May 10, the Saudi government transferred an eight-year $1bn deposit to the Central Bank of Egypt to ease foreign reserve pressures and has also pledged a $2.7bn aid package. A memorandum of understanding has also been signed for an additional $500m of financial aid aimed at shoring up a range of sectors. Saudi Arabia has also confirmed that it will fund $250m of butane exports to Egypt as well as $200m in support for SMEs.
“The important thing to recognise is the readiness of the economy to grow,” says Mr Okasha. “We have all the key ingredients – demand from consumers, labour force availability and the need to grow the infrastructure. Egypt needs to develop a better rail and road network, expand its gas grid, its resource utilisation and so on.
"I expect infrastructure projects will grow tremendously once stability kicks in. We will direct a lot of our corporate capital expenditure here – we recently signed an agreement with the Ministry of Transport to build a 40-kilometre extension of the ring-road around Cairo.”
A return to stability
Of course, the one thing that no one can be sure of is when stability will return to Egypt. The announcement on May 28 of the final two presidential candidates – the Muslim Brotherhood's Mohammed Mursi and former prime minister Ahmed Shafiq – saw crowds return to Tahrir Square, the original birthplace of the Egyptian uprising, amid new protests to contest their eligibility. The run-off election was due to commence in mid-June.
“It had been hoped that the completion of the presidential elections would mark the end of the transition,” says Mr Long at HSBC Egypt. “But people are now saying that this will only be the start of the second phase of the transition. Investors want certainty and with so much uncertainty, they are holding back. We are still awaiting a constitution.”
The new constitution has emerged as a sharp point of conflict between Egypt’s fractious political parties; it aims to resolve crucial questions such as the powers of the president, the relationship between Islam and politics, and the military’s involvement in civilian rule.
Re-establishing political stability and overall security will be integral to attracting foreign investment and returning the economy to its former healthy growth. In turn, this will enable a restoration of the balance of payments and reserve currency at the central bank, relieving the pressure on the banking sector, which is facing increasing liquidity challenges, as indicated by a reduction in the sector’s core liquid assets to 17% of total assets at December 2011, down from 23% a year earlier.
“Some banks are struggling to access short-term liquidity,” says Mr Long. “And companies that have been sitting on cash reserves have been running them down and loans will have been extended. That’s why you tend to have more problems at the end of a recession than at the beginning.”
Clearly, there will be many more bumps in the road to economic recovery. After posting real GDP growth of 1.8% in 2011, the IMF is forecasting even weaker growth for Egypt this year of just 1.5% before rebounding to 3.3% in 2013.
Home to the Arab world’s most populous nation, 40% of the country's 84 million-strong population lives on $2 or less a day. Egypt’s long-term challenge will be to generate jobs and a more equitable distribution of wealth in order to stamp out the problems that were at the root cause of the revolution.
“Looking forward, I am cautiously optimistic,” says Mr Gamali at AlexBank. “We’ve been through a revolution. We were crawling, and we’re now trying to run, but we need to slow down in certain areas to be able to go faster. What is clear is that Egypt has overwhelmingly rejected autocracy and is now beginning the process of discovering the rights, responsibilities and limitations of accepting democracy."
