What really ruined Egypt’s economy in 2011?

18 Min Read

By Amira Salah-Ahmed

CAIRO: It wasn’t the protests. Not the strikes. Not the revolution. And it definitely wasn’t an unidentified foreign object – the proverbial invisible hand.

The simple answer to what brought Egypt’s economy to its knees: a mismanaged and slow transition.

The long-winded version: Unwillingness on the part of the ruling powers to meet peoples’ demands in a manner that does not disrupt national economic affairs for prolonged periods of time. Coupled with haphazard decisions, unclear policies and a series of crisis management failures on the political and economic fronts, while creating a state of fear and chaos, this has caused uncertainty among investors and set off a domino effect of negative economic repercussions, all made worse by an extended and murky transition to civilian rule.

In power since Hosni Mubarak’s ouster, the Supreme Council of the Armed Forces (SCAF) is often criticized for failing to steer Egypt on a proper economic roadmap.

“The military has proven to be inflexible, much more reactionary and much less compromising — this sort of stalemate politically has impacted the economic situation,” said Hani Sabra, Eurasia Group’s Egypt analyst.

“Reality is, if you have a civilian authority in place with people that can make decisions then the economy wouldn’t be in the state it’s in,” Sabra added.

Hoda Selim, economist at Egypt’s Economic Research Forum (ERF), agreed, citing “uncertainty including the absence of a roadmap that sets a clear date for the handing of power from military to civilian rule and the unnecessary delay in legislative elections.”

Let’s start from the beginning.

At the onset of the 18-day uprising in January 2011, businesses came to a complete standstill, as if someone had switched off the economy button. It’s convenient to blame the mass protests for that, but logistically speaking, it was the measures taken by Mubarak’s regime that made it impossible for many sectors to function.

The telecom cut, internet blackout and stifling curfews meant to put pro-democracy activists in the dark disrupted the regular work flow by handicapping communication, shortening operational hours and hampering the transportation of goods.

Yes the stock market crashed and the pound slid to fresh lows, but these are predictable reflex reactions to any unexpected unrest. The overall economy, beyond the volatile realm of speculation on listed stocks and the value of the currency, was more or less crippled by the government itself.

As mass protest gained momentum, the government’s closure of banks and the stock market proved detrimental to capital flow.

The continued closure of the stock market — more specifically, repeatedly reneging on promises to reopen it for trading — showed how the government’s confused hesitation and indecisiveness can cause unnecessary panic and uncertainty in the market.

When banks opened, to everyone’s relief, the anticipated run on banks did not materialize. However, they promptly closed days later after protests by workers in the public sector banks. Why all banks, public and private, around the country had to shut down for a whole week remains a mystery, but the move prompted more wariness about access to liquidity. Local businesses had trouble paying employees’ salaries.

Essentially, people’s money was locked in vaults, adding another hindrance to business operations.

For almost two months the stock market remained closed despite frantic resounding calls by local and foreign investors, analysts and asset managers to open for trading and deal with the inevitable nosedive. What’s worse was the lack of clarity about the reasons behind the decision.

Egypt risked being delisted from the MSCI emerging markets index and the people in charge let it reach the brink, waiting until the last possible moment to reopen the stock exchange. The longer they waited, the worse the sentiment around the market became, and like a virus, the negativity spread to the overall economy.

“The greatest obstacle for investors at the start of 2011 was the restriction of capital flow, initially because of the closure of the banks, but chiefly in the unjustifiably long period during which the stock market was closed,” Roelof Horne, Africa fund manager at UK-based Investec Asset Management, told Daily News Egypt.

Investec Asset Management is the largest manager of third party assets in Africa. Horne manages the world’s largest Africa fund, excluding South Africa.

“As long term investors…we took a view from the start that a peaceful uprising in Egypt calling for democracy and accountability was a reason to be more excited about the country, not to capitulate,” he said.

Propping the pound

When Mubarak stepped down, the outburst of celebration was matched by palpable, though duly cautious, optimism on the economy.

At the time, most analysts and investors cited two longstanding risk assessment nightmares as having been removed along with the ousted president: the question of succession and rampant corruption. These two factors had for years tainted the reputation of the market and made Egypt a risky investment destination. While the former was whispered about, the latter was noted on every outlook or assessment report on Egypt.

The overriding sentiment in February 2011 was that if people’s demands are met, if their political aspirations are fulfilled, then investors, tourists and businesses will want to be part of the “new Egypt” story.

The night Mubarak stepped down, Beltone Financial’s Angus Blair told DNE, “The army [council] has to realize that there has to be good microeconomic governance of Egypt.”

That didn’t happen, and even the term “new Egypt” soon turned sour.

On February 11, the Egyptian pound was at 5.879 to the dollar and the country’s foreign reserves totaled more than $30 billion. Today, the pound is steadily sliding, at around 6.04 with reserves at $18.1 billion and swiftly depleting. Throughout the year, much of the reserves went to propping up the pound instead of letting it gradually devalue to its real rate.

According to an ISI Emerging Markets Blog from April 2011, “The Central Bank of Egypt (CBE) intervened to control the depreciating pound against the dollar.” This while the CBE repeatedly stated that it has not and will not artificially support the pound.

“Foreign reserves have dropped because they’ve burned through the reserves to prop up the currency. But if they stop doing that, then the value of the Egyptian pound nosedives and basic food prices will rise, that’s very sensitive politically,” Sabra said.

At the same time, several downgrades from ratings agencies have affected Egypt’s ability to borrow from abroad and increased the cost of doing so. The budget deficit mushroomed before being repeatedly revised and reined in to an expected LE 144 billion, or 8.7 percent of GDP — still quite high.

Beltone Financial reported in the last quarter of 2011 that foreign investors began dumping Egyptian debt as a result of increasing concern over the country’s widening deficit, also citing a messy political transition.

“Foreign reserves are … being depleted, adding fears of additional losses for foreign investors from a currency devaluation. The high budget deficit is unsustainable, is covered by borrowing, and will lead to unsustainable indebtedness if not addressed soon,” said Horne.

Selim, however, said that compared to costs incurred by Eastern European economies during their political transformation, “the pressure on the exchange rate and the depletion of reserves, as well as pressure on external and public finances — such costs in the short-term were not too drastic.”

Political economy

On the political side, it took a while for the ruling military council to announce its first Cabinet reshuffle, after continued pressure from protesters. Since then, Egypt has seen a series of Cabinets occupied by ministers lacking any real authority or policymaking power.

The result? Stagnant and murky economic policies that left investors, both local and foreign, scratching their heads.

The ERF’s Selim said, “Four governments since January 2011 made it very difficult to infer the economic orientation of the government…[and they] failed to take any short-measures to mitigate the economic slowdown.

“This uncertainty was transmitted to investors and consumers who became more reluctant to take new production and spending decisions, especially in the absence of security.”

Investec’s Horne agrees. “The current interim government seems confined by its ‘care-taker’ status. Foreign tourists still don’t know if the country is safe. Investors fear reprisal actions against companies that could lead to shareholder losses.”

At first, the SCAF promised a transition to civilian rule within six months. The prolonged transition at one point looked like it would last well into 2013, but was shortened to June 2012 after mass protests demanded a swift handover of power.

“The decision to bring forward the presidential elections from 2013 to mid-2012, as a response to sit-ins, was a welcome development,” Horne said.

This counters the propagated idea that protests are bad for the economy and slow down the mythical “wheel of production.”

Escalating crackdowns on pro-democracy activists brought blood back to the streets several times in 2011 as the relationship between protesters and the army became irreconcilable. The blame game began as the official rhetoric changed, with ruling powers putting the onus of the faltering economy on continued protests.

“It’s convenient for the military, using powerful tools such as state media, to portray protests as slowing down the economy…even if there is no real connection between the two,” said Eurasia Group’s Sabra.

“I don’t think protests have been a cause to slow tourism, but if there’s violence that results in death, well that scares off tourists and investors. … The lack of security or the perception of lack of security hurts the economy,” he added.

Expectedly, tourism numbers dropped drastically in early 2011, looked like they may recover by mid-year, but then faltered again after violent crackdowns on protests in October (Maspero), November (Mohamed Mahmoud) and December (Cabinet).

According to the latest numbers announced by the tourism ministry, the sector saw a 30 percent drop this year, actually much better than what was expected. While Cairo tourists are scarce, the Red Sea resorts performed better throughout the year.

All the while, investors, both domestic and foreign, have repeatedly said that all they were looking for in 2011 was a clear timetable for the transition to an elected civilian power — they are still waiting.

“In the short term, we worry that any further delay in the transition to a civilian government can pose higher fiscal and therefore currency risk and continue to slow the process,” Horne added.

Compounding these problems is uncertainty over which contracts will be honored by the state and which are vulnerable to be disputed in courts — be it land deals, factory licenses, or previously privatized companies. Until there’s a clear answer and confidence over terms of contracts, investors are left bidding their time.

“New investors will probably wait until a representative civilian government, with a mandate to take bold policy decisions and which shows a willingness to honor existing contractual agreements, is in place before committing capital,” Horne said.

Similarly, Sabra said that the “biggest obstacle [to foreign investors] is lack of clarity about politics — investors by and large prize predictability above everything.”

To IMF or to not

Meanwhile, a flighty courtship between Egypt and the International Monetary Fund over a $3.2 billion loan was the talk of the town in 2011. Egypt, essentially SCAF, first rejected the loan in June, then it was on and off the table for months before Egypt finally made an official request for it at the turn of the new year.

At the same time, little has trickled in of the billions in promised aid from Gulf countries and the G8.

“The military council is so intent on playing the role of the good guy, so on their watch they don’t want the currency to devalue,” Sabra said, or grow Egypt’s foreign debt.

“It’s not for nothing that you’re now seeing the IMF engage more, because the military now has cover — there’s a parliament and transitional government so they can start to withdraw to the power behind the scenes and have the people up front taking those decisions,” he added.

Agree or disagree with borrowing from the IMF, the on again off again negotiations have been a laughable reflection of the government’s decision-making power, or lack thereof. It’s also slow in coming, and now Egypt’s needs are much more than the announced $3.2 billion.

“Borrowing from international institutions could finance some of the reforms during the transition as long as the funds are used prudently and adequately,” Selim said. “Dependence on foreign borrowing should be considered temporary until reforms create an environment that attracts private capital.”

With foreign reserves down, Egypt has increasingly less import cover, a factor that’s beginning to manifest into supply shortages of vital necessities. But lack of transparency around this issue is only fueling concerns.

Left unexplained are an ongoing butane gas shortage and, most recently, a sudden fuel crisis that left car owners scrambling to fill their tanks and queuing up for hours at gas stations. If confidence in the state to provide the most basic and most socially sensitive goods falters, analysts believe Egypt will see unrest of a different kind this coming year.

Economists have long urged Egypt to gradually scale back energy subsidies to alleviate pressure on the national budget. However, this will likely be delayed given the current circumstances.

“If you look 2012 forward, the economic situation is actually quite grim. Any incoming government is inheriting a mess economically…[and] has limited political capital — they can’t use it up making unpopular decisions,” Sabra said.

Still, it was true in February 2011 and it’s true today: The fundamentals of Egypt as an investment destination remain unchanged: a massive consumer market of mostly youth, skilled labor with a lot of unrealized potential, a strategic geographic location — as well as control of the vital trade route through the Suez Canal — and ample touristic treasures.

All that’s needed is for the nation’s youth — the human capital that has been talked about for years, but poorly utilized — to recapture the sense of ownership it had when Mubarak was ousted.

More urgently, as Horne said, “The country needs decisive leadership to stabilize the economy, currency and fiscal situation.”

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