US report optimistic, despite slowdown
The US Embassy in Cairo issued its annual Economic Trends Report on Egypt, forecasting improved growth rates should current reform attempts gain momentum. Niveen Wahish reports
It has been an eventful year for the Egyptian economy. A continued slowdown, the war on Iraq, a newly liberalised foreign exchange regime and a host of revamped laws are some of the issues that are shaping the direction of the economy. All these questions and more have been tracked by the Economic Trends Report, an annual publication by the US Embassy in Egypt analysing current trends and offering an outlook for the future. The newly released report examines the situation in fiscal year 2002/03, both on the macro economic level and for key individual sectors. The report offers an optimistic outlook for the Egyptian economy despite a "mixed record of economic growth and reform performance".
The embassy calculated the overall economic growth for fiscal year 02/03 as around two per cent, but said growth rates of three to four per cent are possible by the end of this year or early next year. Invigourated growth, however, is contingent on economic reform measures, such as the liberal forex regime and new banking and labour laws, gaining momentum, without any further negative external shocks. Describing the reforms of the past year as "significant, if incomplete", it said that they "point to a new reform activism after three years of policy drift".
And the report said that the "benefit of these measures will come only with the effective implementation" which it said has been lacking in some areas.
The lingering extended slowdown of the economy was blamed by the report on a combination of governmental delays in implementing long-overdue reforms and external shocks.
The report assessed the major external factor of the year, the American-led war on Iraq, as having only a limited effect on the Egyptian economy. It said that "the economy weathered the Iraq war better than expected and signs of a modest recovery exist," attributing this to the swift end of major combat operations. The net negative impact of the war on the economy was quantified at around one billion dollars. The report also predicted that while the post-war situation in Iraq is still evolving, any further negative impact on the Egyptian economy is likely to be negligible. Meanwhile, "in the mid- to long-term, Egypt is likely to benefit from increased business opportunities in a rebuilding Iraq."
Looking at the various aspects of the economy, the embassy praised the substantial improvement in the overall balance of payments over the past year. The narrowing trade deficit was due to the fact that "imports were low due to continuing recession and the difficulty in obtaining foreign currency while the value of exports, particularly oil, increased." And it highlighted the importance of the decision to float the pound as contributing to the improved trade balance saying that "the pound's depreciation should begin to be seen in higher export earnings and a slower recovery of import levels over the next year."
According to the report, the current account could see further improvement as the potential growth areas of tourism and gas export fulfil their promise. Tourism is also on course to rebound, absent more exogenous shocks or domestic problems. However, it warned that revenues of gas exports coming on stream may be offset by "stagnant or decreasing oil revenues absent substantial increases in world oil prices".
Highlighting some of the positive aspects of the economy, the report pointed out that foreign debt and debt service remain low, while foreign reserves alone are sufficient to cover 10 months of imports.
On the downside, the budget deficit was cited as one of biggest challenges facing the government, and is an obstacle to economic recovery. The FY 03/04 budget puts total expenditures at LE159.6 billion, an increase of 10 per cent over the planned budget of previous years. Total revenues are forecast at LE130.9 billion, leaving a LE29 billion deficit on the Egyptian government's hands. One particular factor in the deficit highlighted in the report is the hefty sum of LE16.7 billion earmarked for indirect subsidies of energy products, including below-cost sales of butane gas and diesel to consumers and of natural gas to utilities and industry. "Even this figure may understate the true cost of providing below-market price energy," the report remarked.
To tackle the inflating deficit, the embassy suggested a comprehensive review of Egypt's fiscal policies, on both the revenue and expenditure sides. Addressing the growing size of direct and indirect subsidies for commodities such as energy will be a particularly charged issue as Egyptian consumers reel from the combination of inflation and economic downturn. It pointed out that the NDP's economic platform issued in September 2002 called for more targeting of subsidies, "but little progress has occurred since then. And the government has committed at the Donors Consultative Group meeting in February 2002 to perform a public expenditures review, but has not yet set a date to begin it."
Furthermore, the report estimates that the budget deficit could be one or two per cent higher than the government projections, both for FY 02/03 and 03/04, due to overestimating revenue growth. While planned sovereign revenues had been placed at over LE65 billion for the three fiscal years from 2000 to 2003, actual figures showed they remained at LE51 billion "as Egypt's recession reduced imports, incomes and sales".
The growing deficit, the report said, "could crowd out credit for the private sector as the economy recovers". It showed that economic analysts estimate that the government and the public sector consumed 70 per cent or more of new bank credit in 2002, "due to weak private sector demand which is likely to change if the economy turns around". Moreover, the report said, the growing fiscal deficit could affect the CBE's ability to control monetary policy.
Addressing the new foreign exchange regime, the report stressed that the pound has not yet been fully floated "as restrictions on external pound-denominated financial transactions limit the potential for offshore transactions". As Egyptians trying to obtain dollars or euros have noticed, government and businesses "hoped the move to a more flexible rate would ease access to foreign currency, but foreign exchange liquidity and turnover remain problems".
On the sectoral level, the report praised the banking sector's recent performance, mentioning that "there have been a number of significant and mostly positive events." These developments are new management at the largest banks, efforts to improve supervision and capital adequacy, renewed talk of decreasing government ownership in the sector, and a new banking law. The law is likely to force wide-scale consolidation in the sector as a result of the new minimum capital requirements which stipulate that domestic banks must raise their capital from LE100 million to LE500 million, and branches of foreign banks must raise their capital from $15 million to $50 million. It estimated that "many, if not a majority, of Egypt's 57 banks eventually will be forced to close, merge or otherwise consolidate".
While the general outlook of the report on the Egyptian economy is a positive one, it said that the government's ability to tackle fiscal, customs, and other key reforms will be essential if the Egyptian economy is to attract the domestic and foreign investment deemed necessary to return annual growth rates to pre-2000 levels of four to six per cent.
