In the three years since popular protests across Egypt brought down the regime of Hosni Mubarak, Egyptians have been getting used to false starts. The first elected government after Mubarak fell to a military coup, which itself was widely backed by the public. A second poll in June elected the head of the army, Abdel Fattah el-Sisi, to the presidency, creating a flawed but apparently stable government for the first time since the revolution.
The economy has suffered during the chaos, but under Sisi, the Egyptian government has shown tentative signs that it is willing finally to countenance potentially unpopular social reforms to bring its finances back in order.
However, analysts and investors are split over how far they believe the new administration will go to bring its fiscal deficit under control, and whether it is truly willing to make the difficult compromises necessary to put the country’s economy on a stable footing. Analyst estimates of Egypt’s funding gap for 2014-15 range between $10bn and $15bn, while foreign currency reserves have fallen 50% since 2011.
Discussions between the government and the IMF over a $4.8bn support package fell apart in late 2013, mainly due to Egypt’s intransigence over subsidy reform.
“There is little doubt of the necessity for the structural reform of Egypt’s economy; public anger at high unemployment, inflation and crony capitalism played a central role in driving the 2011 January revolution and July 2013 military coup,” says Albert Arbuthnott, an analyst at Salamanca Group in London, which covers merchant banking and operational risk.
“Sisi appears to have identified this need for an economic restructuring, in particular scaling back Egypt’s extensive subsidy programme necessary for many citizens to maintain their current standard of living. However, the extent to which Sisi can stomach the inevitable public backlash against subsidy reform remains to be seen.”
Under the Mubarak government, Egypt gave heavy subsidies to food and fuel on which many of the population still rely. The country is a huge importer of wheat and its government budget is routinely stretched by international market movements.
The subsidy system was central to the survival of the previous regime because it maintained the standards of living of many ordinary Egyptians. Despite its relative wealth, the country still has more than a quarter of its population living below the poverty line, meaning that subsidised bread and cooking gas are a lifeline for many.
Sisi’s populism and the relief that greeted his rise to power have given him some latitude to make decisions that would otherwise be anathema to an Egyptian government. His election in May marked the end to three years of chaos in Egypt. After the fall of the Mubarak regime, the Muslim Brotherhood re-emerged from decades outside the formal political system, creating the Freedom and Justice Party, which won the 2012 elections.Their candidate, Mohamed Morsi, announced a new constitution based on a conservative interpretation of Islam and granted himself extraordinary executive powers prompting another round of civil protest. In July 2013, the army stepped in, removing Morsi and replacing him with an interim president, Adly Mansour.
GULF BACKING
Following the coup, Sisi, then head of the army, resigned from the armed forces and ran for president in 2014, winning more than 95% of the vote, according to official figures. His apparent popularity and his role in beating back and controlling the Muslim Brotherhood have given him access to important economic levers. First, he is able to swallow some of the negative public sentiment that would result from cutting salaries and subsidies. Perhaps more significantly, his administration has access to an almost bottomless pit of money from countries in the Gulf who are desperate to curtail the power of the Muslim Brotherhood.
Qatar, which has increased its role across the Middle East and North Africa in the wake of the Arab Spring, has given around $5bn in loans and aid. Libya added another $2bn in interest free loans, while Kuwait, Saudi Arabia and the United Arab Emirates between them have offered $12bn in support.
This money from the Gulf and Libya has given the Egyptian government the power to turn down support from the IMF and allowed it to choose finance with political motivations attached over funding with economic conditions.
“We know that the Saudis and the Qataris will support them because the last thing they want is the Muslim Brotherhood coming back. It’ll be unconditional support — such as their recent loans have been,” says Tom Elliott, international investment strategist at DeVere Group in London. “The problem with that is that it doesn’t come with strictures like the IMF would have for structural reform.”
The absence of an internationally sanctioned reform agenda has a consequent effect on private investment. IMF support, with its associated checks and conditions, might have reassured investors over the direction of the economy under Sisi.
During the previous government, financing the subsidy regime was made possible by continual economic growth, which was to a large extent driven by capital investment in real estate and infrastructure, and by foreign direct investment.
Since the revolution, investment has understandably fallen off a cliff, reducing the government’s tax take and its ability to grow its way out of its debts. The 2014 budget forecasts a 10% fiscal deficit, which some analysts think is ambitious.
The private sector has suffered too. Financial intermediation is poor for an economy of Egypt’s size and sophistication. The dominance of large industrial and financial conglomerates has long stunted the growth of smaller private sector entities. The tourism industry, a major foreign exchange earner, has suffered from the political instability.
As the most populous country in the Arab world, Egypt is unlikely to remain off investors’ radars forever, but analysts are split on how long it will be before portfolio flows and foreign direct investment will return in earnest.
“Over the next couple of years, if the military government is able to create some semblance of stability, then you will have investment coming back in,” Elliott says. “You have an educated workforce, you’ve also got quite a large industrial base engaged in textiles, manufacturing... But we’re going to have to wait a few years before investors and tourists come back.”
Henry Gabay, chairman of Duet Group in London, which manages a fund invested in Egypt, disagrees and believes that there are already signs in the public markets that interest is returning.
“Over the last four years, what happened in the market is that most of the companies had one thing in mind, which was survival,” he says. “Banks over the last four years didn’t find any lending opportunities to the private sector. Now the private sector is going to start borrowing again. I think you’re going to see massive investment coming into Egypt over the next few years.”
There have been some indications that Gabay is right — PepsiCo and the Saudi food company Almarai agreed in June to invest around $350m on a joint venture, adding to a tentative rebound in FDI — although the totals are a long way from the highs of 2007, when more than $5.5bn was invested in the fourth quarter alone.
“Egypt is a massive country,” Gabay says. “The market cap of Egypt should be three, four times what it is. It’s full of opportunities. As long as you have a back-to-business, normal business attitude, the potential is huge.”
Gabay believes that the Sisi government has been ill-served by the idea that without IMF conditions Egypt has no incentive to reform its economy. “You have a president who is very popular and his first priority is to put things back on track,” he says. “I think [subsidy reform] is essential in the long run. Obviously in the short term it will hurt the consumer. They will have less spending power but the game here is the long term.”
With all the attention on how the government will handle social pressures, it is easy to forget that Egypt has historically suffered from governance problems within its institutions. “Egypt’s problem is not just with the subsidised masses... but within the political and military elite that support the regime,” says Elliott.
MILITARY MUSCLE
The army has been an economic player in Egypt for decades but its growing political role means that it now has even greater access to civilian economic affairs. The Ministry of Defence won more than $1bn worth of contracts from other ministries to build hospitals, youth centres, roads and affordable housing in the first half of this year, according to research from the Carnegie Endowment. In August, the government announced plans to dig a new $4bn waterway alongside the Suez Canal. The military won the contract to oversee its construction.
The army has big competitive advantages over private companies. Military businesses are exempt from taxation and benefit from access to conscript labour, according to the Carnegie Endowment. A presidential decree dating back to 1997 gives it the right to manage all undeveloped land in the country.
As popular as Sisi is, it was the armed forces that gave him the platform to govern Egypt, meaning that it will take enormous political capital to challenge their hold on the economy.
“Sisi’s going to have to fight this if he’s going to liberalise the economy — he’s going to have to take the army out of industry, which they won’t want to do,” Elliott says. “He’s got to liberalise the utilities — the whole economy — which again means putting vested interests’ noses out of joint.”