By Ahmed Abou El Saad and Eric Swats
The Egyptian economy
Since 2011, Egypt has been hit hard by both ongoing political volatility and social unrest. Four key economic indicators have underscored this reeling economy: an increase in T-Bill rates, a decrease in Net International Reserves, the depreciation of the Egyptian pound (EGP) and a decline in stock market indices, with budget and balance of payments (BoP) deficits being the two main drivers of this decline.
However, since July 2013, some coordinated steps in three directions have helped to try and pave the way for a more stable future, beginning with $18bn in financial aid from Saudi Arabia, the United Arab Emirates and Kuwait. The Central Bank of Egypt then lowered the yield on T-Bills by cutting the key policy rate three times by 50 basis points each. Finally, a fiscal stimulus package of more than EGP 60bn (3% of GDP) was implemented by the government in September 2013.
Looking forward: A better picture
Significant and ongoing financial assistance from the GCC will continue to ease the pressure on Egypt’s exchange rate and its budget deficit, which in turn will help spur business confidence. Interest-free deposits have lifted reserves to more than four months of imports and allowed the repayment of $3bn in remunerated deposits to Qatar.
Historically, foreign direct investment (FDI) along with volatile public securities portfolios, were the main source of surplus of Egypt’s BoP. Since 2011, both of these sources have been a drag on the external position of Egypt. Investment in the oil sector is, historically, the largest component of FDI and we estimate that this will continue to be the case. FDI in the oil sector is likely to recover in 2014, but other sectors might not, so we believe that it will take the economy approximately three years to reach an average FDI level of $6bn ($4.7bn is estimated in 2014). According to our research, Egypt’s external position will require the expected continuation of GCC aid, albeit at lower levels.
Through the first half of 2013, T-Bill yields were significantly high. This trend reversed in the second half, as the new government focused on stimulating growth. The Egyptian Central Bank is likely to aim to keep rates at a low level to help lower borrowing costs for both the government and private sector.
A new government was put in charge in early March 2014. This new cabinet is regarded as “non-interim”, which means it will likely continue after the anticipated election of Field Marshal Abdel Fattah Al-Sisi. He is likely to win the election by decisive majority, which will enable him to push for much needed, albeit harsh, economic reforms. Egypt will depend on large-scale projects as the means of economic recovery and restoring stability, so we hope that the increased spending in focus sectors, such as housing, construction, energy and transportation – already announced by officials – will benefit those Egyptians who are in the most need of financial help.
The government’s priority in spending toward housing projects is reflected by the recent $40bn, five-year project agreed as a joint venture between UAE-based Arabtec and Egypt’s Ministry of Defence. So far, it is not clear how the project will be financed; however, Arabtec will likely manage the source of finance for the first phase of the project.
Parallel to this, the government is preparing a number of reform initiatives, mainly targeting fuel subsidy rationalisation and value-added tax (VAT). It is worth noting that these reforms have been required by the IMF since 2011, while the Minister of Finance confirmed that an IMF loan is not a short term option.
Possible growth sectors in the economy
In the decade prior to 2011, the sustainable housing needs of Egypt’s young population, coupled with higher government spending on infrastructure, was the central theme of Egypt’s economy. We anticipate a renewal of this trend on an even larger scale. Beside the significant $40bn project referenced above, the banking system is preparing an EGP 10bn financial package to be channelled toward mortgage finance. As a result, amendments to the mortgage law are expected in the short term, leaving real estate and building material sectors the ultimate beneficiaries.
The government response to rising social needs by applying a minimum wage of EGP 1,200 per month in government and public sectors will most likely boost household consumption. Accordingly, industries that cater to local consumer demand are likely to continue growing at rates higher than the overall economy.
EFSA reform and new rules
Egypt’s financial regulator, the Egyptian Financial Supervisory Authority (EFSA), has also started to aggressively change many regulations. These include new mutual funds legislation and new listing rules, as well as other regulations to encourage the inward investment activity and appetite of insurance companies and private pension funds. Their ultimate aim is to attract more investment, more stock market listings and boost trading on the bourse.
Banking and finance sector
The effect of the government’s expansionary policy in the short term coupled with the EFSA reforms and new regulations should also be positive on private investment, which is critical to initiate a recovery in CAPEX investment and job creation. We anticipate the banking sector will benefit from financing higher CAPEX in the private sector, which should compensate for lower yield on its T-Bill portfolio.
We also anticipate an improvement in the Islamic banking sector prospects in Egypt. The Islamic banking sector accounts for 7% of total banking assets in the country, with 14 banks licensed to provide Sharia-compliant products – 3 full-fledged Islamic banks and 11 conventional banks with Islamic branches.
Islamic banking assets were valued at EGP 114bn in 2013, up 11% from the previous year, according to data from the Egyptian Islamic Finance Association. Islamic financing extended by banks rose 6% to EGP 76.4bn in 2013 while deposits grew by 13% to EGP 103bn in the same period.
Islamic banking assets in Egypt are expected to reach around EGP 128bn in 2014, realising an impressive average growth of 10% to 12% – a trend which we believe could continue over the next few years.
Whilst we expect to see a continuation of some market and economic volatility in the short to medium term, we remain bullish overall on the Egyptian market outlook as we continue to believe in the country’s long-term growth prospects. Our outlook is based on Egypt’s attractive demographics and other resources, as well as the clearly proven ability of its companies, across a wide range of sectors, to deliver double-digit growth rates. There are many significant on-the-ground investment opportunities that, when realised, will facilitate the growth of a nation which has endured a difficult few years yet hopefully faces a brighter future.
This article was originally published in Banker Middle East
Ahmed Abou El Saad, MBA, CFA , is chairman of EIIB-Rasmala Egypt
Eric Swats, MBA, CFA, is head of Asset Management at EIIB-Rasmala