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Egypt GDP to reach 7.4% in 2008

By Waheed Abbas



The Egyptian economy has increasingly become broad based over the past five years, thanks to strong private sector investments and consumption expenditure, according to the latest Merrill Lynch research report on the nation.


The country’s export market is increasing its reliance on European and Asian markets and decreasing its dependence on the US market. Egypt’s exposure to the US market is one of the highest in the region, and a US recession will take its toll on Egypt’s exports, Merrill Lynch said in its country report.


Back in 2002, the United States was the main export market, accounting for 37 per cent of exports and 25 per cent of imports.


Last year, the share of the US in Egypt’s exports and imports dropped to 31 per cent and 22 per cent, respectively. Egypt’s exports to the European Union rose to 40 per cent in 2007 against 34 per cent in 2002; while exports to Asia accounted for 13 per cent of the country’s exports, a rise of two per cent over the past five years.


Merrill Lynch expects Egyptian gross domestic product (GDP) to accelerate further from 7.1 per cent in 2007 to 7.4 per cent in 2008 on the back of strong investment-driven domestic demand. But the growth is likely to lose some steam and drop to 6.3 per cent in 2009.


However, the trade deficit is expected to reach 14 per cent of GDP in 2008 from 12.5 per cent in 2007, due to strong domestic demand and accelerating capital and consumer goods imports. However, high oil prices, increasing remittance inflows and tourism receipts continue to prop up the current account, which came in at 2.1 per cent of GDP in 2007.


Egypt’s external financial position is strong, and its current account balance is likely to remain in the black in the coming years. FDI inflows reached nine per cent of GDP in 2007, and net international reserves were up $5.6 billion (Dh20.5bn) over the past 12 months to $28.6bn in 2007, equivalent to nine months of imports. The trend is still intact, as foreign exchange reserves reached $32bn last month.


Egypt’s budget deficit improved to 7.5 per cent of GDP in 2007, from 8.2 per cent of GDP in 2006, but still remains the “soft belly”, as the gross public debt-to-GDP ratio stands at 95 per cent.


The government’s structural reform and privatisation agenda are promising. In the banking system, the priorities are the recapitalisation and privatisation of state-owned banks. State-owned Banque du Caire is expected to be privatised in 2008, and that should further consolidate the banking sector, while filling the coffers of the government. Booming privatisation revenues are helping the country to lower the sector borrowing requirement, but, still, the key is nationalising public expenditure. In this sense, the pressing issues are subsidies and social transfers.


As Egypt has a young and poor population with a per capita GDP of $1,750, social issues are very important. A recent IMF survey revealed subsidies and transfers are largely inefficient. The government spent 12 per cent of GDP last year on social protection (more than half on fuel and food).


However, contrary to the level of social support, the population is subsisting on less than $2 per day in PPP-adjusted terms. But this is almost double the level in similar countries across the region. The main culprit seems to be the asymmetric benefits of such subsidies on food and energy. Hence, there is room for the government to cut the subsidies, while simultaneously increasing the social benefits.


The Egyptian economic recovery has been in full swing since 2004. As of H1-FY08, gross domestic product growth has averaged at some six per cent over the past five years, mainly on expanding domestic demand. This investment-driven high growth is promising and improves the country’s absorption capacity. Exports are likely to lose steam going forward with the global slowdown, but Egyptian growth should stay strong in 2008 and 2009 financial years.


Egypt’s strong macro performance is a home-made success story rather than just oil. Since Prime Minister Ahmed Nazif took office in 2004, Egypt’s competent economic administration has been implementing a well-designed, ambitious and effective reform programme with the assistance of the IMF and the World Bank. As reforms are paying off, Egypt’s medium-term growth is set to remain more than six per cent.


The government’s mandate of sustaining high growth is clear and will pressure inflation. The Central Bank of Egypt’s (CBE) aim of inflation-targeting is heartening but is an extravaganza at this stage. Domestic demand keeps underlying inflation high, and food and energy prices present upside risks. The CBE will probably hike rates, but gradually. Recently, the CBE increased overnight deposit and lending rates by 25 basis points to nine per cent and 11 per cent, respectively, following the surprising surge in CPI inflation from 6.9 per cent year-on-year in December to 10.5 per cent in January, corresponding to a significant four per cent month-on-month increase.


The short announcement that followed the hikes mentioned the increase in food prices and strong economic activity, but the surge in prices is likely to continue affecting the index in the coming months. Hence, Merrill Lynch expects the CBE to continue normalising rates. But, as it is evident with the currency, the reaction is likely to be a very gradual one.


Egypt’s budget deficit is improving. Booming privatisation revenues are helping to lower the public sector borrowing requirement, but the key is rationalising public expenditures.

Egypt’s trade deficit is likely to reach 14 per cent of GDP in 2008. However, the current account (CA) is still in the black, thanks to tourism, Suez Canal fees, official transfers and Egyptian workers’ remittances. Together with a surging FDI of nine per cent, Egypt’s foreign exchange reserves are likely to further increase. Still, the “dirty float” is likely to keep the Egyptian pound competitive.


The main challenge is to keep reform pace, and geopolitics is the main risk. The government’s reform agenda and privatisations, which keep growth strong and create a real convergence story, are the main assets of Egyptian macro story.


The strong recovery since 2004 has reversed its previous underperformance. The country’s real GDP expanded 7.1 per cent in 2007 compared to 6.8 per cent in 2006. It was the fastest pace of growth in more than a decade. GDP growth as of the first-half of 2008 suggests that was not the peak though.


Despite strengthening signs of global slowdown elsewhere, the Egyptian economy posted an average 7.5 per cent GDP growth in H1-FY08. The main contribution to this high GDP growth came from domestic demand, which enjoys double-digit figures.


Following a 25-per cent year-on-year real increase in 2007, investments continue growing at full speed, surging by some 30 per cent year-on-year thus far in 2008. With import growth outpacing that of exports, the trade balance continues to deteriorate, shaving off GDP growth. In fact, consumer goods imports increased by 50 per cent year-on-year in 2007, confirming the fact strong domestic demand and inflationary pressures are building up.


Looking at the supply side, the growth performance is broad-based. This should provide a bulwark against possible shocks. While hydrocarbon production  has stabilised at three per cent year-on-year, non-oil sectors such as construction (15.8 per cent year-on-year), tourism, financial services (seven per cent year-on-year), and transport and communications (9.9 per cent year-on-year), are mainly driving GDP growth.


It is worth noting an administration with a big appetite for reform is a rare commodity in the Mena region, and Egypt’s performance over the past five years confirms this is well received by the investor community. Merrill Lynch attributes the recent strength of GDP growth to a series of structural reforms, such as more liberalised external accounts, lower tax rates, a better investment environment, financial sector reform, public sector reform and privatisation.


Yet, Merrill Lynch still believes  seven per cent growth is unsustainable for Egypt. Structural reforms, privatisation and FDI should be supportive to sustain GDP growth at around six per cent on an average over the coming years.


As growth has become more broad-based, unemployment figures have begun to decrease rapidly. With population growth of two per cent, and more than 40 per cent of the population at the working age, Egypt’s main priority is creating jobs.


Demographics are a window of opportunity for now. However, with a growing labour supply, Egypt needs to sustain employment growth of around 650,000 annually to lower the unemployment rate. This means Egypt needs to sustain an average GDP growth of around six per cent in the medium term.


Hence, the government’s reform efforts to enhance the investment environment and to increase potential output by improving fiscal deficit and inflation are key challenges for the medium-term outlook. Increasing the amount of green field investments is creating a real convergence play for Egypt, and the current reform momentum is the fuel for this process. Hence, the medium-term outlook is very much leveraged to the government’s reform agenda.



The Numbers



FDI inflows into the country touched this mark in 2007, and net international reserves were up $5.6 billion (Dh20.5bn) over the past 12 months to $28.6bn in 2007



Merrill Lynch expects Egyptian gross domestic product (GDP) to accelerate from 7.1 per cent in 2007 to this mark in 2008 on the back of strong investment-driven domestic demand



Structural reforms, privatisation and foreign direct investment should be supportive to sustain GDP growth at this mark on an average over the coming years