Weakened purchasing power decreased economic growth to 3.4% during Q1 of FY 2016/17 

Mohamed Ayyad
14 Min Read

The drop of the Egyptian pound against the US dollar by more than 70% put Egypt through a number of difficult economic circumstances. This pressured the rate of the population’s consumption, which is the main engine of the Egyptian economy.

Last Sunday, the Ministry of Planning issued its report on economic and social performance indicators during the first quarter (Q1) of fiscal year (FY) 2017/2016, which revealed a decline in GDP growth to 3.4% from July to late September 2016, compared to 5.1% in the same period of the previous year.

The value of the GDP reached about EGP 514bn in the first three months of the current FY, which ends in late June 2017.

Economic analysts explained the slowdown as the beginning of a period of stagflation, which means a rise in prices and a decline in supply in the market.

They predicted that the Egyptian economy will continue to slow in light of increasing inflation rates, especially after the government introduced the value-added tax (VAT), raised fuel and diesel prices, increased tariffs on imports of hundreds of goods, and limited imports.

The analysts believe that all the reforms—which President Abdel Fattah Al-Sisi described as harsh—will directly contribute to the inflated prices of the majority of products available in the markets of subsidies and services, especially since Egypt relies on imports to secure the majority of its needs.

Weak consumption decreases growth

The retreat in consumption has become one of the main reasons behind the decline in the growth rate after it had been a catalyst for economic growth. The rapid price hikes prompted people to reduce their consumption..

Consumption represents about 80% of the GDP in Egypt according to Prime Holdings.

The contribution of consumption to economic growth fell during Q1 to 2%, compared to 6.2% in Q1 of last fiscal year.

People are shocked of the prices of goods and services of which some rose to more than 100%. This was the main reason behind the significant decline in consumption in recent months, especially after the Egyptian pound’s flotation, according to Abobakr Emam, head of the research department at Prime Holdings.

This was confirmed by Mohamed Farid, chairperson and CEO of Dcode for Economic and Financial Consulting, who said that the high inflation in the prices of subsidised products, which was not accompanied by a simultaneous increase in wages, was a strong indication that people’s consumption will decline significantly during the current FY, and that consumption will grow at a slower pace than ever before.

According to the Ministry of Planning, the average annual inflation rate in Q1 of the current FY has reached about 14.5% compared to 8.5% in the same period in last FY, due to the devaluation of the pound.

From July to September 2016, the repercussions of the lack of foreign currency crisis led to the devaluation of the pound against the dollar on the unofficial market. The importers were forced to secure their needs of US dollars from the unofficial market, which led to the increase of import costs, especially for production inputs. Thus, the prices of local and imported products increased significantly.

The annual inflation rate in urban areas jumped to 24.3% in December compared to about 19.4% in November.

In a report issued two weeks ago, Prime Holdings expected that this dramatic rise in the inflation rate after the flotation of the pound would contribute to the decline in household consumption growth rate in the current and next FY, to record 3.5% maximum compared to 4.6% in the previous FY.

The report also predicted that the contribution of household consumption to the GDP growth would decline to 2.9% by the end of the current FY, compared to 3.8% in the last FY.

Emam said that the decline in consumption started before the flotation of the pound, as the increase of dollar’s price on the unofficial market increased most products’ prices. After the flotation, some commodities prices had increased by more than 100%, while the purchasing power of the pound has fallen by about 50%.

When the Central Bank of Egypt (CBE) liberalised the exchange rate of the pound in November, the local currency lost more than 100% of its value against the dollar, registering EGP 18.7 on Sunday at the National Bank of Egypt (NBE) compared to EGP 8.88 before the flotation. Meanwhile, the CBE increased the interest rate on the pound to 3%.

Emam added that the local consumer would change his pattern of consumption to face the recent price hikes in the market.

He explained that consumers now resort to buy less amounts of products, while others abandoned expensive products and are searching for cheaper alternatives.

Some companies started to offer smaller packages or reduce their products’ weight and maintained their prices to cope with the recent changes. According to the Income, Expenditure, and Consumption report issued in 2015, Egyptians spend 34.4% of their income purchasing food.

On the other hand, the government expected to achieve a growth rate of 4% during the current FY, instead of 5% as it expected at the beginning of the year.

1Lack of foreign currency and slowdown in the private sector

Hany Farahat, senior economist at CI Capital, said that the recent economic measures did not cause the slowdown in growth in Q1, but were linked to the challenges experienced in 2016, represented in the shortage of foreign currency and the decline of private sector growth.

He added that the growth rate in the current FY will be lower than last year due to the negative short-term impact of the recent economic measures, despite their positive long-term effects.

Arqaam Capital investment bank had issued a report in November after the flotation, expecting that low- and middle-income societal segments will witness great pressure due to the recent economic reforms, but will benefit on the long-run.

Arqaam Capital said that most of the burden will fall on middle-class consumers, while the high-income societal segment will not change its pattern of consumption. The report expected that the higher segments of the middle-class would abandon their unnecessary expenses for a period of three to six months following the flotation.

Estimates of the fund reveal that the contribution of consumption in GDP growth will decline from 4% from 2011 to 2016 to 2.6% from 2017 to 2021, against an increase of the contribution of investment from 0.3% to 2%, and an increase of exports contribution from 0.6% to 1.2%.

Farid expressed his concern about the increase of the banks’ interest rates and its negative effect on investment plans of private companies over the upcoming period; however, he believes it is a necessary step to enhance the demand on the Egyptian pound, and thinks of it as a complementary step to the flotation. “Increasing private sector’s investments will not be easy without strong motivation by the government,” he added.

3Does investment compensate the slowdown of consumption?

In a press conference to announce the indicators of economic growth by the end of Q1 of 2017, Minister of Planning Ashraf El-Araby said that the contribution of investment during Q1 of this FY was estimated at 1.8% compared to 1% in the correspondent quarter.

“The source of growth during Q1 came through investment, although it usually comes from consumption. An unexpected growth took place in private investments,” El-Araby said.

The rate of consumption contribution to growth during Q1 has declined to 2%, compared to 6.2% during the same quarter in FY 2015/2016.

El-Araby said in the press conference on Monday that private investments have acquired 69% of total investments in Q1, while the plan was for them acquire only 51%. He added that he considered that a success of the model adopted by the government to plan large projects and assign their implementation to the private sector.

“This quarter has witnessed a noticeable growth of mega projects which the state is implementing, in addition to a noticeable improvement of the business environment. This reflected on increasing the contribution of investment in economic growth and the growth of exports and foreign trade,” El-Araby noted.

According to a previous statement by the cabinet, the investment rate increased during Q1 of FY 2016/2017 to 12.1% compared to 11.3% during the same period last year, as a result of the growth of the private and public sectors’ investments.

Farid believes that the consumption slowdown will be compensated by the increase of private and public investments, especially with the activation of economic reforms to improve the business climate and the issuance of the new investment and bankruptcy laws, as well as a gradual provision of hard currency.

He said that both the increase in investments and the inflation rate’s gradual decrease will contribute to getting back consumption growth, especially since investment contributes to the creation of new jobs and the increase of incomes.

For his part, Farahat believes that the country’s success in attracting foreign direct and indirect cash inflows, in addition to the legislative amendments to the Investment Law for instance, are able to improve economic growth rates starting next FY.

Documents released by the International Monetary Fund (IMF) on Egypt’s loan, which it posted on a site about the Egyptian economy’s indicators in the next five years, reveals that the IMF believes that local and foreign investments and exports will lead the way for the recovery of economic growth, raising it to 5-6% in the medium-term.

Sectors that shrank and those that achieved growth

The ministry’s report notes that the sectors of hotels and restaurants, extractives, the Suez Canal, and manufacturing industries shrunk in Q1 of the current FY, compared to the same period last year. The sector of restaurants and hotels shrunk by 37.5%, while the manufacturing industries shrunk by 1.6%. As for the extractives sector, it contributed to the growth rate after it shrunk by 3.4%, while the Suez Canal’s contribution was negative, after it shrunk by 1.8%.

Farid said that industry in particular suffers from the problem of resorting to importing to meet its needs of production inputs, as its work does not only depend on local production. Moreover, the industrial sector in general saw a break in the chain of production due to the currency crisis.

In contrast, the sectors of building and construction, communications, wholesale and retail, and public government were the ones that grew the most in the same period. The building and construction sector grew by 8.2%, contributing to the growth rate by 20.8%. As for the communications sector, it grew by 11.2%, contributing to the growth rate by 19.3%.

The Egyptian government has relied on infrastructure projects, such as paving roads and building bridges and power plants on a large scale, in order to push growth forward.

Both sectors of trade and retail, and the public government are the largest contributors to the growth rate by 39.2% and 31.2%, respectively, registering growth of 5% and 5.7%, respectively.

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