Egypt faces inflation risk

At Cairo's largest shopping mall, Egyptians watch films from La-Z-Boy reclining chairs, shop for Escada handbags and sip coffees at Starbucks.

Betting this is just the beginning of a spending boom, Gulf Arab and European companies are pouring money into the most populous Arab country, despite a global credit crisis and a slowdown in Europe, its main export market.

However, business analysts warn rising inflation could eventually curb consumer spending, stall reforms that have excited investors and anger the poor majority who have not yet seen the benefits of buoyant growth.

Gulf Arab petrodollars, cuts in taxes and duties and a surging stock market have unleashed consumer optimism among the wealthier sectors of Egyptian society.

"When you've been in a bad state and things get a bit better, it feels great," said Sherif Idris, 41, while shopping at a glass-panelled mall overlooking the Nile.

The Canadian-Egyptian, who moved back to Cairo a year ago to work for a private equity firm, said lower classes had yet to feel much benefit.

"Things could be ten times better than they are now."

Spending on consumer goods is still limited to a small but growing middle class in a country where the United Nations says about one-fifth of the population of roughly 75 million lives on less than $1 per day, and most people do not have bank accounts.

"Because of the new government, you can feel the change in the economy," says Elhamy El Kerdany, general manager of Citystars mall, opened in 2004 with funding from Saudi investors. "This is having a parallel impact on consumer spending."

Some analysts say inflation, which reached an 11-month high in the year to February at 12.1 per cent, has not yet noticeably slowed spending in an economy that last year grew at 7.1 per cent, the fastest rate in at least two decades.

"Consumer spending has much farther to run despite the high inflation," said Angus Blair, head of research at the Cairo-based investment bank Beltone Financial.

"There is enormous momentum because of the growth in the economy and the tax cuts."

Government officials have said Egypt is on track to match last year's growth, with foreign investment outweighing any negative effects from a global slowdown.

"If the government remains committed to reforms, you will see this growth continue," said Mary Nicola, Middle East economist at Standard Chartered Bank.

HEALTHY PICTURE

The rise in consumer spending spells record profits and rapid expansion for companies including banks, car makers, retailers and property developers. It also means Gulf Arab companies, flush with cash, are swooping on Egyptian assets for access to the country's large population.

Egyptian car distributor and manufacturer Ghabbour Auto said it was expecting net profit and revenue to grow by 50 per cent in 2008 on brisk demand for vehicles.

Lender Credit Agricole Egypt plans to double its network of branches by 2010 and estimates the number of Egyptians eligible for a bank account is growing by 25 per cent a year.

MasterCard says annual growth in the number of card users is among the highest in the world at more than 40 per cent.

"Egypt is insulated from what is going on outside the region, like the subprime crisis," says Denzil Lawson, MasterCard's regional director. "The picture for Egypt is very healthy."

President Hosni Mubarak appointed a market-oriented government in 2004 and Egypt has outshone regional rivals in attracting investment, especially from the Gulf. The stock market jumped 51 per cent last year and is up about 8 per cent this year. Foreign investment surged to a record $11.1 billion last fiscal year.

Lebanon, a traditional destination for Gulf Arab investment, is locked in a political crisis, Morocco's economy stalled last year because of a drought and markets in Jordan and Tunisia are too small to lure much foreign cash.

However, inflation remains a threat to the consumer boom.

RISKS

The central bank has already raised rates twice this year, saying inflation figures had exceeded its comfort zone. It said inflation had originally been driven by increases in food prices but had spread to other items.

"This is the great threat to the boom this year: that households are no longer able to afford discretionary consumer spending because of inflation," said Simon Kitchen, economist at EFG-Hermes, a Cairo-based investment bank.

Inflation could also make it politically more difficult to proceed with the free-market reforms, such as cutting expensive subsidies for products like petrol and diesel, that have helped the economy expand, some analysts say.

Egypt has slashed income taxes and customs duties and has sold state companies, but higher inflation and rising food costs have aroused popular discontent with the liberalisation.

Thousands of workers have gone on strike in the past year, usually demanding wage rises and in some cases protesting against possible job cuts from privatisation.

Another possible worry for investors is what happens to these reforms if Mubarak, in power for a quarter of a century, dies in office without appointing a successor.

He has refused to appoint a vice-president, the route to the top job in Egypt's only two successions in more than 50 years. He is widely believed to be grooming his son Gamal, a former investment banker seen as a driver of the economic policy changes launched in 2004, to succeed him.

Some analysts say Mubarak has kept a lid on social pressures, caused by income disparities and high population growth, that could challenge a successor.

So far, investors have shrugged off the possibility of political disruption, but the future of Mubarak's reforms is seen as key.

If Egypt wants to upgrade its credit rating, it needs to persuade people that the economic reforms would continue in Mubarak's absence, rating agency Standard and Poors said last year. It rates Egypt a BB+ for foreign currency and BBB- for local currency with a stable outlook. (Reuters)