- Egypt’s economic situation has seen relative improvements since late 2013. This is largely owing to financial assistance from the Gulf Cooperation Council (GCC) countries and increased political stability. Support from the GCC countries has given the government some breathing space, helping to shore up reserves, ease pressure on the currency and allow for the introduction of two fiscal stimulus packages. However, macroeconomic fundamentals remain weak, with a large fiscal deficit and persistently high inflation posing significant challenges.
- Substantial energy subsidy reforms have been implemented. These reform measures will bring energy prices closer to cost recovery levels and ease the current subsidy burden (of about 7 per cent of GDP) on the budget, while reducing market distortions.
- A number of revenue enhancement measures have also been introduced to reduce the fiscal deficit. A reduced budget containing a series of tax increases has been approved for the 2014-15 fiscal year. The budget seeks to lower the fiscal deficit to 10 per cent of GDP and tackle the crowding out of credit to the private sector.
Key priorities for 2015
- The key immediate challenges are to restore macroeconomic stability and achieve job-creating growth. Further reforms to the business environment are needed in order to unleash the private sector’s potential and yield more inclusive growth.
- The state’s role as regulator and competition enforcer needs to be strengthened. There is a lack of a level playing field in the private sector. Currently, only a few oligopolies and monopolies dominate the entire mining sector and some areas of the manufacturing sector (cement, steel and textiles).
- The banking sector’s high exposure to sovereign credit risk needs mitigation. Rising concentration risks – due to the large government debt – have significantly crowded out credit to the private sector.
EGYPT’S ECONOMIC SITUATION HAS SEEN RELATIVE IMPROVEMENTS SINCE LATE 2013
SUBSTANTIAL ENERGY SUBSIDY REFORMS HAVE BEEN IMPLEMENTED
A NUMBER OF REVENUE ENHANCEMENT MEASURES HAVE BEEN INTRODUCED TO REDUCE THE FISCAL DEFICIT
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.
Main macroeconomic indicators %
|Current account balance/GDP||-2.0||-2.6||-3.9||-2.5||-0.4|
|Credit to private sector/GDP||37.8||35.2||34.3||32.4||n.a.|
Note: All figures are for the fiscal year July-June.
In the past year economic conditions have shown some signs of stabilisation. Financial assistance from the GCC countries has allowed the government to shore up reserves, ease pressure on the currency and finance two fiscal stimulus packages (each 1.6 per cent of GDP). In addition, stabilisation on the political front has helped improve economic conditions. After reaching 2.1 per cent in 2012-13, real GDP growth started to recover in the third quarter of the 2013-14 fiscal year (which runs from July to June), rising to 2.5 per cent year-on-year mostly owing to increased government consumption and investment, and a rise in private consumption. Exports, however, are still a drag on growth. Growth will have to pick up significantly in order to reduce the unemployment rate, which remained high at 13.4 per cent in the third quarter of the 2013-14 fiscal year.
Egypt’s fiscal balance has remained under pressure. The fiscal deficit reached an estimated 12 per cent of GDP (excluding grants) in the 2013-14 fiscal year. This was largely due to higher interest payments and increases in public sector wages, along with a major shortfall in tax revenues. The government has continued to rely heavily on domestic borrowing at a high cost, increasing banks’ exposure to sovereign credit risk and significantly crowding out private sector credit.
The balance of payments has improved thanks to foreign grants. The current account deficit narrowed in the first three quarters of the 2013-14 fiscal year compared with the same period last year, thanks to official grants. However, this has masked the continued weakness of exports and tourism. Nevertheless, further outflows were cushioned by the strength of remittances and Suez Canal receipts. Net foreign direct investment (FDI) inflows have improved, but were dominated by investments in the oil sector rather than the non-oil economy. Foreign exchange reserves have remained steady, covering more than three months of imports.
The central bank unexpectedly raised policy rates by 100 basis points in July 2014. This was a pre-emptive move to anchor inflationary expectations in light of the announced increases in fuel and electricity prices (see below). Prior to this move, the central bank eased monetary policy through three cuts to its policy rates over the past year, in an effort to stimulate economic growth. While the move may help limit a generalised increase in inflation, there is a risk that higher rates will adversely impact investment and growth.
The economy is expected to gradually recover. Economic growth is expected to reach 3.2 per cent in the 2014-15 fiscal year, up from 2.2 per cent the previous year. Growth will not only be supported by the implementation of the government’s fiscal stimulus programmes, but will also rely on continued strong domestic demand. In addition, FDI is expected to pick up, driven in part by an increase in investments from the GCC. The outlook is subject to downside risks associated with a deterioration in the security situation or a further flare-up in regional turmoil, with adverse effects on tourism and investor confidence.
Major structural reform developments
The government announced an overhaul of energy subsidies in July 2014. Authorities have begun implementing a broad restructuring plan to bring energy prices closer to cost recovery levels, raising the prices of gasoline, diesel and natural gas for consumers and selected industries. In addition, electricity prices have been raised both for commercial and residential use under a plan to eliminate power subsidies by 2018. These substantial reform measures will ease the current subsidy burden (of about 7 per cent of GDP) on the budget and reduce market distortions. Nevertheless, the impact on the most vulnerable groups will hinge on successfully rolling out an appropriate social safety net, which is crucial for sustainability and to secure support for reforms.
Fiscal consolidation measures have been introduced to reduce budgetary imbalances. A reduced budget containing a series of revenue enhancement measures has been approved for the 2014-15 fiscal year. The budget seeks to lower the fiscal deficit to 10 per cent of GDP by implementing a number of tax increases in the new fiscal year. These include: (i) an increase in taxes on cigarettes and alcohol; (ii) the introduction for three years of an additional 5 per cent tax on profits exceeding EGP 1 million made by individuals and companies; (iii) the introduction of a new 10 per cent tax on capital gains and dividends of companies listed on the local stock market; and (iv) the introduction of a 10 per cent tax on profits resulting from investment in securities abroad. In addition, the government has sent the value added tax (VAT) draft law to the President for ratification. Lastly, some outstanding laws await amendments, including a modification to the income tax law to incorporate about 7 per cent of the informal sector and plans to implement the long-awaited 10 per cent property tax.
Progress on reforms to the business environment has been limited. Egypt ranked 112th out of 189 countries in the World Bank Doing Business 2015 report for ease of doing business. The business environment is hindered primarily by weak contract enforcement and a burdensome bureaucratic process that results in substantial delays for most types of transactions. There have been no significant regulatory changes on competition policy, which still needs to be reinforced in order to level the playing field for all businesses. The competition authority is not fully independent, and the extent of its enforcement authority and mechanisms is unclear. In addition, foreign companies wishing to operate in Egypt still face numerous hurdles. For example, the lack of protection of intellectual property rights remains a major impediment to foreign direct investment in Egypt.
A number of measures have been adopted to attract investments. Egypt’s new 2014 constitution contains a clause calling on the state to protect intellectual property rights in all fields and to establish a body that regulates these rights. In addition, a new law limiting third-party challenges to government privatisation deals has been approved in April 2014. The law is intended to accelerate business procedures, and to reassure investors and business partners conducting transactions with the state. However, this remains to be seen. An appeals court halted all privatisation cases until a decision is made by the Supreme Constitutional Court on the constitutionality of the law preventing third parties from challenging contracts between the government and investors. Lastly, in March 2014, after nearly 20 months of interruption, the Egyptian Regulatory Reform and Development Activity initiative was reactivated, with the goal of supporting the government in its review of regulations related to the business environment in Egypt.
Progress has been made towards strengthening competition in the telecommunications sector. In April 2014 the National Telecommunications Regulatory Authority (NTRA) issued its newly-approved unified licence to three mobile operators – Vodafone, Mobinil and Etisalat Egypt – allowing them to offer landline services in addition to mobile services. This follows the NTRA’s issuance in December 2012 of a fourth mobile licence, which will allow the main landline operator, state-controlled Telecom Egypt, to enter the mobile market. The cabinet approved these licences in September 2014. The Ministry of Communications and Information Technology is also in the process of finalising its national strategy for 2014-18, which, among other things, will focus on creating an enabling environment for foreign investments, forging deeper public-private collaborations, and providing incentives for small and medium-sized enterprises to move up the value chain in mobile and open-source applications.