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Country Report

Egypt

May 2006

The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

Egypt at a glance: 2006-07OVERVIEW The Egyptian government seems to have backtracked on its promise to deliver political reform following recent violent crackdowns on public protests. The Economist Intelligence Unit believes that the tightening of political control is partly motivated by the strong performance of the illegal Muslim Brotherhood in the parliamentary election in late 2005. The group�s members, standing as independents, won some 20% of the seats, despite the fact that the regime turned both to the apparatus of state and to violence to ensure that its own supporters prevailed in later voting. The ruling National Democratic Party secured around 70% of the seats, ensuring that the government will be able to pass the legislation it deems necessary. The government is, however, likely to press ahead with the programme of economic reform launched by the cabinet of the prime minister, Ahmed Nazif, on its appointment in mid-2004, assessing that strong and sustainable economic growth to raise living standards is the best way to undercut the Islamists� appeal. However, the strong performance of the Islamists may prompt the president, Hosni Mubarak, to proceed more cautiously with potentially painful reforms. Economic growth picked up in fiscal year 2004/05 (July 1st 2004-June 30th 2005) and is forecast to accelerate in 2005/06 and 2006/07 to 5.7% and 5.9% respectively.

Key changes from last month

Political outlook • A sharp tightening of political control in recent months has made us more

sceptical of the government�s stated intention to deliver political reform. On April 30th the government extended for another two years the country�s emergency laws, which have been in place for the past 25 years, another reason for our scepticism.

Economic policy outlook • Our economic policy outlook is unchanged.

Economic forecast • The bomb attacks in the resort of Dahab on April 24th are likely to result in

a decline in the number of tourists in the fourth quarter of fiscal 2005/06 (April-June 2006). Even so, we still expect to see real GDP growth of 5.7% in 2005/06, as slower expansion in the tourism sector is offset by strong investment growth.

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Egypt 1

Country Report May 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006

Contents

Egypt

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2006-07 7 Political outlook 8 Economic policy outlook 10 Economic forecast

13 The political scene

18 Economic policy

23 The domestic economy 23 Economic trends 26 Financial and other services 29 Manufacturing 31 Oil and gas 32 Infrastructure 33 Tourism

35 Foreign trade and payments

List of tables 10 International assumptions summary 12 Forecast summary 18 Fiscal projections 20 State finances, Jul-Jan 23 GDP by expenditure, quarterly data 25 Domestic credit 26 Inflation 26 Money supply 27 Suez Canal 34 Tourism 36 Quarterly current account 37 Quarterly capital account 37 Foreign reserves

2 Egypt


List of figures 13 Gross domestic product 13 Consumer price inflation 29 Hermes Financial Index

Egypt 3


Egypt May 2006

Summary

The government seems to have backtracked on its promise to deliver political reform following recent violent crackdowns on public protests. The Economist Intelligence Unit believes that the tightening of political control is partly motivated by the strong performance of the illegal Muslim Brotherhood in the parliamentary election in late 2005 in which the group�s members won some 20% of the seats. The ruling National Democratic Party took around 70% of the seats, ensuring that the government will be able to pass necessary legislation. The government is likely to press ahead with economic reform, assessing that strong economic growth to raise living standards is the best way to undercut the Islamists� appeal. However, the strong performance of the Islamists may prompt the president, Hosni Mubarak, to proceed more cautiously. Economic growth picked up in fiscal year 2004/05 (July 1st 2004-June 30th 2005) and is forecast to accelerate in 2005/06 and 2006/07 to 5.7% and 5.9% respectively.

The violent crackdown on protesters in early May, in addition to a tightening of political control, signalled that the political liberalisation of 2005 has come to a standstill. Three explosions in the Sinai resort town of Dahab on April 24th prompted the government to extend the 25-year-old emergency laws for another two years. The US Congress cut aid to Egypt by 10% in early May.

The government�s budget for 2006/07 was passed by parliament in early May. Revenue is projected at E£162bn (US$28bn), up from a budgeted E£130bn in 2005/06. The deficit, however, is still projected to be 9.2% of GDP. Large subsidy costs, boosted by high oil prices, are one of the main reasons for the budget deficit. The privatisation of the Bank of Alexandria was launched in April.

Real GDP growth reached 6.1% year on year in the second quarter of 2005/06, up from 5.7% the previous quarter. Strong credit and money growth imply the existence of underlying inflationary pressures. The Dahab bombings are likely to have a negative impact on tourism revenue in 2006. Suez Canal receipts rose sharply in 2005. The stockmarket held up well in the first four months of the year. 20% of EgyptAir is to be privatised in an initial public offering in 2007.

The current-account surplus narrowed in calendar 2005, to US$2.2bn, down from US$3.2bn in 2004, owing to a widening of the trade deficit. Foreign direct investment inflows rose strongly to US$3.3bn.

Editors: Ania Thiemann (editor); Keren Uziyel (consulting editor) Editorial closing date: May 14th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Outlook for 2006-07

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 Egypt


Political structure

Arab Republic of Egypt

Based on the constitution of 1971

Formally bicameral: the Majlis al-Shaab (People�s Assembly) has 444 directly elected members and ten additional members nominated by the president. Deputies serve a five-year term. The president may dissolve the Assembly only if he gains the support of the people in a referendum. The Majlis al-Shura (the Shura Council, or �upper house�) was established in 1980 and has 264 members. 176 directly elected and 88 are appointed. Currently, the ruling National Democratic Party controls 255 seats

September 2005 (presidential); November-December 2005 (legislative). Next elections due in 2011 (presidential) and November 2010 (legislative)

President, directly elected. Current president is Hosni Mubarak, who was elected for a fifth six-year term in Egypt�s first multi-candidate elections in September 2005

Council of Ministers headed by the prime minister. The president is responsible for appointing and dismissing ministers. The Assembly can require a minister to resign if it passes a motion of no confidence. Should a motion of no confidence in the prime minister be passed against the president�s wishes, the matter may be put to a referendum. Last cabinet reshuffle: December 2005

National Democratic Party (NDP, the ruling party, 324 seats); New Wafd Party (6); National Progressive Unionist Party (Tagammu, 2); al-Ghad (1); the Muslim Brotherhood (officially banned: standing as independents, its members won 88 seats in parliament in 2005 election); Democratic Nasserist Party (no seats in 2005 election)

Prime minister Ahmed Nazif

Administrative development Ahmed Darwish Agriculture Amin Abaza Defence Mohammed Hussein Tantawi Education Youssry al-Gamal Electricity & energy Hassan Ahmed Younes Finance Youssef Boutros-Ghali Foreign affairs Ahmed Abul Gheit Foreign trade & industry Rashid Mohammed Rashid Health Hatem al-Gabaly Housing & new communities Ahmed al-Maghrabi Interior Habib al-Adli Information Anas al-Feki Investment Mahmoud Mohieddin Justice Mahmoud Abu Leil Manpower & Immigration Aisha Abdel Hadi Abdel Ghani Parliamentary & legal affairs Mufid Shehab Petroleum Sameh Fahmy Planning Osman Mohammed Osman Public works & water resources Mahmoud Abdel-Halim Abu Zeid Social solidarity Ali El-Sayed Al-Moselhi Telecommunications & IT Tarek Kamel Tourism Zoheir Garana Transport Mohammed Mansour

Farouk al-Okdah

Official name

Legal system

National elections

Head of state

National legislature

Central Bank governor

National government

Main political parties

Key ministers

Egypt 5


Economic structure

Annual indicators

2001a 2002a 2003 a 2004 a 2005a

GDP at market prices (E£ bn) 358.7 378.9 417.5 485.0 536.4

GDP (US$ bn) 90.4 84.2 71.5 78.3 92.8

Real GDP growth (%) 3.5b 3.0b 3.1 4.2 4.9

Consumer price inflation (av; %) 2.3 2.7 4.5 11.3 4.9

Population (m) 68.6 69.9 71.3 72.6 b 74.0b

Exports of goods fob (US$ m) 7,249 7,250 8,987 12,274 16,073

Imports of goods fob (US$ m) -15,750 -14,709 -15,156 -21,586 -27,200

Current-account balance (US$ m) 249 849 3,723 3,237 2,207

Foreign-exchange reserves excl gold (US$ m) 12,926 13,242 13,589 14,273 20,609b

Total external debt (US$ bn) 29.3 30.0 31.4 34.2 b 37.7b

Debt-service ratio, paid (%) 9.4 10.3 11.7 6.4 b 5.8b

Exchange rate (av) E£:US$ 3.97 4.50 5.84 6.20 5.78

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2004/05 % of total Components of gross domestic product 2004/05 % of total

Manufacturing 18.2 Private consumption 71.3

Mining (incl oil & gas) 14.8 Government consumption 12.2

Agriculture 13.9 Gross fixed investment 16.6

Trade 11.0 Exports of goods & services 30.5

General government 9.7 Imports of goods & services -30.6

Transportation & communication 6.0 Changes in stocks 0.1

Principal exports 2004/05 US$ m Principal imports cif 2004/05 US$ m

Petroleum & products 5,276 Intermediate (semi-processed) goods 6,803

Aluminium, iron & steel 915 Investment (capital) goods 4,895

Raw cotton, yarn, textiles & garments 858 Petroleum & products 3,975

Pharmaceuticals 215 Consumer goods 3,202

Agricultural products 209 Raw materials (excl petroleum) 2,688

Main destinations of exports 2004 % of total Main origins of imports 2004 % of total

Italy 12.8 US 12.5

US 11.6 Germany 6.8

UK 7.3 Italy 6.8

France 4.9 France 5.8

6 Egypt


Quarterly indicators 2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrPrices Consumer prices (2000=100) 117.7 121.8 123.3 126.0 126.3 127.7 128.5 130.0Consumer prices (% change, year on year) 9.6 11.9 11.7 11.9 7.3 4.8 4.2 3.2Wholesale prices (2000=100) 139.3 144.8 142.9 148.8 148.0 151.9 151.7 154.4Financial indicators Exchange rate E£:US$ (end-period) 6.168 6.190 6.229 6.131 5.788 5.779 5.752 5.779Deposit rate (av; %) 7.8 7.7 7.7 7.7 7.6 7.6 7.2 6.5Discount rate (end-period; %) 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0Lending rate (av; %) 13.4 13.3 13.5 13.3 13.4 13.4 13.1 12.6M1 (end-period; E£ m) 95,955 100,620 104,129 108,498 111,397 115,446 124,823 125,466M1 (% change, year on year) 18.3 17.0 14.1 16.0 16.1 14.7 19.9 15.6M2 (end-period; E£ m) 412,299 428,205 444,748 461,887 473,340 488,202 507,401 514,223M2 (% change, year on year) 15.2 13.9 13.3 14.4 14.8 14.0 14.1 11.3HFI stockmarket index (end-period)a 14,216 14,466 19,828 23,893 34,077 41,772 48,169 55,360

Sectoral trends Crude oil production (m barrels/day) 0.73 0.71 0.71 0.70 0.70 0.69 0.69 0.70

Foreign trade (E£ bn) Exports fob 11.24 11.82 11.81 12.86 12.64 13.44 15.27 20.27Imports cif -16.25 -18.90 -21.51 -23.05 -26.30 -29.60 -29.68 -29.11Trade balance -5.01 -7.08 -9.71 -10.19 -13.66 -16.16 -14.41 -8.84Foreign reserves Reserves excl gold (end-period; US$ m) 13,176 13,576 13,526 14,273 16,876 18,043 19,792 20,609

a Hermes Financial Index.

Sources: IEA, Monthly Oil Market Report; IMF, International Financial Statistics; Oil Market Intelligence; Bloomberg.

Egypt 7


Outlook for 2006-07

Political outlook

The Egyptian government appears to have backtracked on its promise to deliver political reform, as evidenced by recent crackdowns on street protesters and a tightening of political control. Recent public protests in support of two judges facing disciplinary hearings for �damaging the image of the judiciary� after alleging that electoral fraud occurred in the 2005 parliamentary election have been violently quashed by riot police. There have also been mass arrests of supporters of opposition groups. The government�s actions appear to be only in part spurred by concerns arising from the bomb attacks in the resort town of Dahab on April 24th, although the tightening of the government�s control has intensified since then. The Economist Intelligence Unit believes that another reason is the strong performance of supporters of the illegal Muslim Brotherhood in the unusually liberal parliamentary election in November and December 2005. The group�s members, standing as independents, won 88 seats, more than half of those they had contested. The ruling National Democratic Party (NDP) secured around 70% of the seats, well down on the 87% it held in the outgoing parliament. Although the NDP�s majority is more than sufficient to ensure that the government will be able to pass the legislation it deems necessary, the strong showing of the Brotherhood appears to have made the president, Hosni Mubarak, who notoriously distrusts the organisation�s motives, more intent on not relinquishing control. Even so, it is now difficult for the authorities to deny that the Brotherhood commands widespread support.

The Brotherhood�s initial aim in parliament is likely to be to win official party status. If it achieves this by September 2006, it will be eligible to put forward a candidate for the 2011 presidential election; it will also feel able to field more candidates in the next parliamentary poll, allowing it to extend its influence through democratic channels. There is a small possibility that the regime may acquiesce, judging that to do so would defuse popular anger and expose the group�s absence of workable policies!the Brotherhood�s public proclamations lack detail, centring largely on its catch-all slogan �Islam is the solution�. To dilute the appeal of the Islamists, the government may also ease restrictions on the operations of the legal opposition parties, whose credibility has been badly damaged by years of failure to weaken the state�s grip. Far more likely, though, especially in light of the events of late April and early May, is that the regime will continue to resist granting the Brotherhood party status. This strategy carries risks for the government, however. Over the past year the group has demonstrated its ability to mobilise supporters, and its leaders may be tempted to harness this backing to pressurise the government.

Despite moves by Mr Mubarak during 2005 to liberalise the polity!primarily by holding Egypt�s first multi-candidate presidential election!the president�s faith in and commitment to the process is highly questionable. Moreover, he remains deeply mistrustful of the Brotherhood�s motives, having stated repeatedly that the Islamists support democracy only as a means to win power. The decision in late February to postpone for two years local council elections

Domestic politics

8 Egypt


(in which the Brotherhood was again expected to perform well), in addition to the recent tightening of political control, provides further evidence of the tough stance the government is preparing to take.

A key foreign policy concern for Egypt in the outlook period will be relations between Palestinians and Israelis, with the ultimate goal of restarting peace talks. Egypt attaches great importance to achieving a peaceful outcome to the dispute, which it sees as having the potential to spill over from the immediate conflict. At stake, too, is Egypt�s wider influence in the region, which has historically stemmed from its close ties to the US, in turn based largely on mutual efforts to bring peace between Arabs and Israelis. Ties with the US have deteriorated in recent years, after the involvement of Egyptians in the September 11th 2001 attacks prompted unaccustomed scrutiny in the US of Mr Mubarak�s rule. Equally, the Egyptian government has been alarmed by the ideological nature of policies espoused by members of the US administration. Egypt�s relations with Israel have improved over the past 18 months, with closer co-ordination over Israel�s withdrawal from the Gaza Strip and strengthening economic ties. However, the victory of Hamas in the Palestinian legislative election in January further complicates an already highly intractable dispute, increasing the possibility of a descent into a conflict that would raise suffering among the Palestinians to a degree that would elicit popular anger in Egypt.

Economic policy outlook

The sharp deterioration in Egyptians� living standards in the early part of this decade, which stemmed largely from poor economic management under the government of the previous prime minister, Atef Obeid, was an important factor in generating opposition to the government, and undoubtedly con-tributed to the success of the Muslim Brotherhood in the 2005 parliamentary election. Some younger, more dynamic figures within the ruling establishment argue that an effective way to counter the Islamists would be to accelerate the programme of economic reform embarked on by the cabinet of the prime minister, Ahmed Nazif, which took office in mid-2004. This, they contend, would achieve more rapid, sustainable economic growth, which would raise living standards and, over the longer term, blunt the appeal of the Islamists. However, this is unlikely to occur, largely because it would imply a degree of social dislocation that the president, whose caution is well-established, would be uncomfortable with, and that the Brotherhood could readily exploit. Indeed, there is some risk that concerns over further bolstering support for the Brotherhood may constrain the process of reform.

Even so, the government is likely to persist with a policy of measured reform, with the aim of raising the rate of economic growth and strengthening the capacity of the private sector to absorb the unemployed and so reduce pressure on the public finances. Measures introduced so far have included sharp cuts in income tax rates and customs duties. The cabinet has also reinvigorated privatisation, launched a process of consolidation in the troubled banking sector and begun to overhaul commercial legislation and tackle entrenched bureaucratic constraints. However, this approach carries risks. If commitment to

International relations

Policy trends

Egypt 9


reform flags, economic activity might not strengthen sufficiently!and privatisation might not accelerate enough!to offset some of the revenue shortfalls caused by tax reforms, even taking into account the widening of the tax-base, leaving the public finances in a more precarious state.

Official data show that the (central government) budget deficit widened markedly, to 9.3% of GDP, in fiscal year 2004/05 (July 1st 2004-June 30th 2005). Revenue was close to our estimates, but spending grew far more strongly than we had expected, driven by a surge in �other� outlays!those excluding wages, interest, defence or capital. It is not yet clear whether the revisions stem from changes in methodology or simply from closer examination of the accounts.

By raising the base line from which our forecasts are made, the revisions have necessarily had a marked impact on our projections. Moreover, taking into account data for the first seven months of 2005/06 that show strong growth in expenditure, owing to a sharp increase in subsidy costs, we now forecast that Egypt will register a fiscal deficit equivalent to 11.8% of GDP in 2005/06 (up from 10.2% in our previous report). Customs receipts are likely to grow strongly!following a sharp decline in 2004/05 brought about by tariff cuts!as import volumes rise robustly. Income tax receipts will contract somewhat, because of the sharp reduction in the rates of corporate and personal income tax, but probably by less than budgeted, as the tax base has widened and more individuals have filed tax returns. Spending growth is unlikely to slow by as much as we had previously expected, as high energy prices have prevented the government from rationalising its payments on its social safety net (principally on subsidies), even though private-sector activity has picked up. Overall, spending growth will be relatively strong, underpinned by a large increase in public-sector wages!driven by pledges made in the 2005 presidential and parliamentary elections. Spending will also be pushed up by higher interest payments on domestic debt, as the debt stock will increase to almost 112% of GDP by end-2005/06. The deficit is expected to narrow to 10.9% of GDP in 2006/07, owing to an acceleration of tax revenue growth as recent tax reforms bed down and the economy picks up. The upturn in private-sector activity will also ease government spending pressure.

The government�s historical caution over contracting foreign debt makes it likely that the authorities will finance the deficits through local borrowing. The domestic debt stock, which has increased sharply in recent years (reaching 104.7% of GDP at the end of 2004/05), will thus continue to rise as a percentage of GDP. However, privatisation will pick up, and part of the proceeds will be used to pay down domestic debt. Provided economic growth accelerates, the government should be able to meet its commitments and engineer an improvement in the public finances in the medium term to longer term.

After years of poorly focused monetary policy, the Central Bank of Egypt (CBE), under the governorship of Farouk al-Okdah!appointed in late 2003!has introduced more coherence into monetary management. In an attempt to bring greater sophistication (and therefore predictability) to monetary policy, and to move away from direct intervention, the CBE under Mr Okdah has introduced a range of new tools to influence monetary conditions and has begun to

Fiscal policy

Monetary policy

10 Egypt


anchor its monetary policy in targeting inflation. However, the measures are likely to take time to bed down. As well as properly developed instruments, this will require significantly more sophisticated skills on the part of CBE personnel.

Economic forecast

International assumptions summary (% unless otherwise indicated)

2004 2005 2006 2007

Real GDP growth World 5.5 4.9 4.7 4.4

EU25 2.4 1.7 2.2 2.3

US 4.2 3.5 3.1 2.4

Exchange rates ¥:US$ 108.1 110.1 109.2 98.5

US$:� 1.244 1.245 1.296 1.390

SDR:US$ 0.675 0.677 0.665 0.635

Financial indicators ¥ 2-month private bill rate 0.00 0.00 0.25 0.58

US$ 3-month commercial paper rate 1.48 3.49 5.24 4.88

Commodity prices Oil (Brent; US$/b) 38.5 54.7 70.0 66.0

Cotton (US cents/lb) 62.0 55.2 60.1 62.5

Food, feedstuffs & beverages (% change in US$ terms) 8.5 -0.5 4.0 -4.2

Industrial raw materials (% change in US$ terms) 21.0 10.5 20.0 -17.9

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

We estimate that global growth (measured using purchasing power parity exchange rates) averaged 4.9% in 2005!a performance that stands slightly above the long-term average, but that marks a deceleration on the 5.5% recorded in 2004. We expect global growth to slow but remain strong in 2006, at 4.7%, and to ease further in 2007, to a still relatively buoyant 4.4%. The US dollar is expected to depreciate further against most currencies over the second half of this year and during most of 2007 (before beginning to strengthen again by year-end)!an important consideration given the prominent role that the Egyptian pound�s value against the US currency plays in Central Bank calculations. US interest rates, meanwhile, are expected to peak soon, before stabilising and then easing over the subsequent 18 months.

We have raised our forecast for the price of the benchmark dated Brent Blend, which is now expected to average around US$70/barrel in 2006!a 28% increase on last year�s previous record high. The continued exceptional strength of oil prices reflects the ongoing tightness of the market, with production still struggling to keep pace with growth in demand. With most producers operating at close to their maximum, the market has little spare capacity, ensuring not only that prices remain under upward pressure, but also that even minor developments that curb!or threaten to curb!output lead to sharp and sometimes sustained price spikes. The market should begin to loosen in 2007, as output growth picks up speed, but with surplus capacity remaining low and the regional political environment staying tense, prices will remain high at around US$66/b.

International assumptions

Egypt 11


We have recently revised our historical national accounts data in light of the rebasing of national accounts data carried out by the Ministry of Planning (which reports GDP data). Our revised figures suggest that GDP growth over the period was higher than previously estimated. Stronger growth impetus leading into 2005, along with data suggesting that the tourism sector recovered more quickly than anticipated from the 2005 attacks in Sharm el-Sheikh, has improved the outlook for real GDP expansion. As well as boosting export volumes, the stronger performance of the tourism sector has enhanced the prospects for private consumption and investment. Growth in these two areas will also continue to be boosted by the reduction of personal and corporate income tax rates in 2005/06. Our view has been confirmed by preliminary data indicating that real GDP growth accelerated to 6.1% year on year in the second quarter of 2005/06 (October-December 2005). However, the impact of the bomb attacks in Dahab in April is likely to lead to a modest slowdown in the rate of expansion in the final quarter of the fiscal year. We therefore believe that real GDP will grow by 5.7% in 2005/06. Going forward, we expect investment to be supported by increasing confidence, as the government presses on with legislative and administrative efforts to improve the business environment, and as privatisation gathers pace. A number of large-scale infrastructure projects will also boost investment, helped by strong, oil-driven liquidity in the Gulf, as investors turn to Egypt, as witnessed by the continuous appetite shown for Egyptian assets over recent months. However, growth will be constrained by buoyant import growth, spurred by consumer and investment demand. That said, the increase in purchases of capital goods bodes well for the future strength of the economy. We therefore expect economic growth to accelerate in 2006/07, to 5.9%, helped by strengthening business confidence and improved access to finance for firms, supporting a strong rise in investment and private consumption.

The strengthening of domestic demand, which has been stimulated by large cuts in income tax rates, is likely to lead to an increase in average consumer price inflation in calendar 2006, albeit only marginally, to 5.1%. Inflation should be generally constrained by the stability of the Egyptian pound against the US dollar (and other major currencies) as well as by a decline in average world non-oil commodity prices. In addition, the overhaul of the monetary frame-work should enable more effective control of liquidity. These factors should allow the authorities to bring down the average rate of inflation to 4.3% in calendar 2007.

As a result of strengthening foreign-currency inflows and major improvements in the policy framework, the Egyptian pound appreciated in late 2004 and in 2005 from an average of around E£6.2:US$1 in 2004 to under E£5.8:US$1 in 2005. Consequently, the CBE began to sell pounds on the market in a bid both to protect the competitiveness of Egypt�s non-oil exports and to maximise the opportunity to build its reserves. Although the authorities� intervention slowed the rate of appreciation, the pound�s average rate against the dollar still rose in 2005 by almost 7%, and by around 10% in real terms against the euro. We expect the pound to pick up marginally in 2006 to an average of around E£5.7:US$1,

Inflation

Economic growth

Exchange rates

12 Egypt


which will mark a further appreciation against the euro, although the competitiveness of Egyptian exports will not be much compromised, given the extent of the fall in the pound since the start of 2000. In 2007, with confidence in the currency robust, we expect the authorities to manage a depreciation against the US currency in order to support non-oil exports. However, with the dollar likely to weaken against the euro, the nominal decline will be modest, with the pound expected to average E£5.75:US$1.

After expanding in 2005, the trade deficit will remain wide in 2006-07, at an annual average of around US$11.7bn, as strong growth in import spending, bolstered by tariff cuts (introduced in late 2004), high oil prices, strengthening economic growth and a depreciation of the US dollar offset a rise in gas export earnings. The non-merchandise surplus will widen gradually, as growth in tourism and strengthening inflows of workers� remittances offset an increase in gas-related profit repatriation. The expansion in the invisibles surplus will outpace growth in the trade deficit, and the current-account surplus will thus widen over the outlook period, helped by rising energy prices, from US$2.2bn (2.3% of GDP) in 2005 to US$2.7bn (2.5% of GDP) in 2006 and US$3.3bn (2.8% of GDP) in 2007.

Forecast summary (% unless otherwise indicated)

2004 a 2005 a 2006b 2007b

Real GDP growth 4.2 4.9 5.7 5.9

Industrial production growth 1.6 5.0 5.1 5.2

Gross agricultural production growth 1.9 3.5 3.1 3.2

Consumer price inflation (av) 11.3 4.9 5.1 4.3

Lending rate 13.4 13.1 12.5 12.1

Government balance (% of GDP) -5.9 -9.3 -11.8 -10.9

Exports of goods fob (US$ bn) 12.3 16.1 21.3 24.2

Imports of goods fob (US$ bn) 21.6 27.2 32.8 36.1

Current-account balance (US$ bn) 3.2 2.2 2.7 3.3

Current-account balance (% of GDP)c 3.8 2.3 2.5 2.8

External debt (year-end; US$ bn) 34.2 d 37.7 d 38.6 40.1

Exchange rate E£:US$ (av) 6.20 5.78 5.70 5.75

Exchange rate E£:¥100 (av) 5.73 5.25 5.22 5.84

Exchange rate E£:� (av) 7.71 7.19 7.39 7.99

Exchange rate E£:SDR (av) 9.18 8.54 8.57 9.05

a Actual. b Economist Intelligence Unit forecasts. c Ratio based on calendar year GDP; national accounts use fiscal year. d Economist Intelligence Unit estimates.

External sector

Egypt 13


Egypt (a) Middle East & North Africa

Gross domestic product(% change, year on year)

Egypt Middle East & North Africa

Consumer price inflation(av; %)

(a) Fiscal years ending June 30th.

2

4

6

8

10

12

2001 02 03 04 05 06 07

0

1

2

3

4

5

6

7

2001 02 03 04 05 06 07

The political scene

There are signs that political reform in Egypt has stalled, in sharp contrast with the developments in 2005 when Egyptians voted in the first multi-candidate presidential election and also went to the polls in an unusually free parliamentary election in November and December, even though the last round of the elections was marred by political turmoil (February 2006, The political scene). The election led to the outlawed Muslim Brotherhood taking an unprecedented 88 seats, or around 20% of the total, in the People�s Assembly, despite running against the apparatus of the ruling National Democratic Party (NDP). The strong showing of the Brotherhood and its subsequently higher profile may be the real reasons behind the government�s recent tightening of control. On Thursday May 11th riot police in Cairo moved in to disperse public protests against the disciplinary hearing of two appeal court judges who were arrested after demanding an enquiry into alleged fraud during the 2005 parliamentary election. Their allegations include police assaults on opposition supporters and ballot rigging by pro-regime judicial election observers. (The judiciary monitors elections in Egypt.) The two judges from the Court of Cassation (the highest appeal court), Hisham Bastawisi and Mahmoud Mekki, together with eight other judges, are facing disciplinary action on charges of �damaging the image of the judiciary�, but their hearing had to be adjourned twice, owing to the amount of public protest surrounding the proceedings. (The two judges were subsequently acquitted on May 18th, but Mr Bastawisi was reprimanded and his next promotion withheld.) According to several news-papers, including the local Daily Star Egypt, as well as Time and the New York Times, on May 11th, when the second hearing was due, security forces and plain clothes police beat up and arrested local activists, including those from Kifaya (Enough), a secular grass-roots movement, and the Muslim Brotherhood, both of which have backed the judges. Journalists were denied access to the High Court, where the hearing was to be held, with thousands of armed riot police sealing off the nearby streets. Security forces reportedly particularly targeted journalists, and two cameramen working for al-Jazeera and Reuters were also attacked and severely beaten by riot police.

Political reform stalls amid crackdown on protesters

14 Egypt


The judiciary has become increasingly activist in recent years (May 2005, The political scene). Mr Bastawisi and Mr Mekki are the leading figures of a so-called Revolt of the Judges, which has gradually emerged from the influential Judges� Club!a professional body with a membership of some 7,000-8,000 judges. Indeed, the anti-government protests had begun as a sit-in at the Judges� Club, which has been calling for the government to endorse a proposed draft law drawn up by the Club aimed at safeguarding the independence of the judiciary. The draft proposes that the judiciary be controlled by a council elected by fellow judges, removing oversight of salaries, bonuses and promotions from the Ministry of Justice. However, the state-appointed Supreme Judicial Council (the official governing body, under the Ministry of Justice) claims that the Judges� Club does not represent the opinions of the majority of judges, and it is unlikely to meet the campaigning judges� demands for greater judicial independence to be enshrined in law.

The judiciary is highly respected in Egypt, and any protest against the regime led by the Judges� Club has the potential to galvanise other anti-regime groups. However, the president, Hosni Mubarak, has denied government involvement in the disciplinary hearings that the ten judges are facing, arguing that the dispute is between the Judges� Club and the Supreme Judicial Council. Even so, the level of violence used against the protesters, in addition to numerous other events in recent months, has led to a general feeling among local activists and international observes that promised political reforms have been put on the backburner.

The crackdown on protesters comes on the heels of a series of clampdowns on opposition movements in recent weeks (as the government has sought to tighten control), which took place even before the bombings in the Sinai resort town of Dahab in April (see below). In March the publication licence of Afaq Arabia, the newspaper published by the Muslim Brotherhood, was revoked. Detentions of Brotherhood activists have also been stepped up. In April five publishers, including the head of the Brotherhood�s media committee, who were preparing to publish an article criticising the emergency laws!in place since 1981 when the former president, Anwar Sadat, was assassinated!were arrested. The lawyer and the office manager of an independent MP affiliated to the Muslim Brotherhood were also arrested. There have also been several other arrests, including of Mohammed Rashad el-Bayoumi, a member of the Brotherhood�s Guidance Bureau, and of at least 40 university students accused of Brotherhood membership. In total, it is estimated that some 300-500 Brotherhood activists are currently being detained by the authorities without charge. The series of arrests is in stark contrast to the situation in 2005, when Brotherhood candidates were permitted to participate in the parliamentary election, and even to use the group�s controversial slogan, �Islam is the solution�, for the first time. As a result, the movement became the largest opposition bloc in the People�s Assembly, with 88 seats. However, the Brotherhood remains officially banned, on the grounds that the constitution requires all political parties to be secular. Arrests are therefore not abnormal, but they have become more frequent and widespread in the past two months.

Government tightens control

Egypt 15


There are other indications that political reform is stalling. In March the Political Parties Committee, a government body that regulates and licenses political parties, unexpectedly refused to grant a licence to allow candidates of the moderate, Islamist-leaning Wassat (Centre) Party, originally formed by a breakaway group of Muslim Brotherhood members, to stand in parliamentary elections. The government also announced that it was postponing for two years local council elections that were due to have taken place in April this year. Officially, the delay is necessary in order to prepare a new local administration law, intended to promote decentralisation. However, opposition groups have asserted that the move is designed to maintain the dominance of the NDP in the wake of its disappointing performance in the 2005 parliamentary election and that the government fears that the Muslim Brotherhood would become too dominant in local councils if a vote were allowed to take place now. The council elections are particularly significant because elected local politicians are among those eligible to provide the 250 signatures required for an independent candidate to stand in presidential elections.

Tension in the country was thus already mounting before three bombs exploded in the South Sinai resort town of Dahab on April 24th, killing 20 people (mostly Egyptians) and injuring 83. This was the third series of bomb attacks in the Sinai Peninsula, a popular destination for foreign and Egyptian tourists alike, within 18 months. In a similar pattern to the other two bombings, the Dahab attack took place on a secular, national holiday, which meant that the resort was particularly busy with Egyptian visitors. The bomb in Taba that killed 34 people in October 2004 was detonated on the day before the holiday to mark the start of the 1973 Arab-Israeli war. An explosion killed 64 people in Sharm el-Sheikh on July 23rd 2005, Egypt�s National Day. The bombs in Dahab exploded hours before Sinai Liberation Day and a day after Coptic Easter. The attack in Dahab was followed by two suicide attacks on UN peacekeepers in North Sinai two days later, in which only the bombers were killed. It is likely that the perpetrators of all of these attacks over the past year or so are Sinai Bedouin, members of a local extremist group, Tawhid wa al-Jihad (Unification and Holy War). The group is thought to be inspired by but not directly linked to Osama bin Laden�s al-Qaida network. Following the attacks in Dahab, the government moved quickly and carried out a series of arrests, mainly of Bedouin from North Sinai. On May 9th the police shot dead Nasser el-Khamis Melahy, who they claimed was the leader of the cell behind all the Sinai bombings over the past 18 months. Other suspects from the same group have given themselves up to the police. The Bedouin live in the impoverished northern part of the Sinai Peninsula and are thought to resent the recent rapid development of Sinai that has brought scores of foreign tourists to the region. They also appear to have targeted Egypt�s secular and Western-leaning society, by always attacking the popular holiday resorts on secular, national holidays, when many Egyptians are visiting. South Sinai in particular is held up by some local radical Islamists as being too �decadent� and Westernised, acting as a lure to unsuspecting young Egyptians and flying in the face of a vision of a more religious society wanted by the Islamist groups.

Bomb attacks add to mounting tension

16 Egypt


During his election campaign in the run-up to the presidential election in September 2005, Mr Mubarak�s had pledged that the emergency laws, which give the authorities sweeping powers of arrest and to restrict public demon-strations, would be repealed and replaced with US- and European-style �anti-terror� legislation. However, on April 30th the current emergency laws were extended for two more years, ostensibly to allow more time for the drafting of the promised new �anti-terror� legislation. Mr Mubarak argued that the Dahab bombings, in addition to the (unrelated) arrests of a ring of 22 alleged Islamist militants known as al-Taifa al-Mansoura (the Victorious Sect), based near Cairo, were ample proof that Egypt still needed emergency laws.

All told, it seems that the government�s message is clear: protest will no longer be tolerated. This may seem surprising, given the reforms that were implemented in 2005, but one of the reasons is no doubt that official pressure from the US to push forward with democratic reform in the region has largely ceased recently. With the worsening of the conflict in Iraq and the diplomatic crisis over Iran�s nuclear programme, the attention of the US government has been diverted elsewhere. Moreover, the victory of Hamas, a radical Islamist group, in the Palestinian legislative election, as well as other recent Islamist political successes in the region, makes Egypt�s position as a stable and pro-US regime in the Middle East even more important to the US, and the likelihood of the US government insisting on political reform in the short term is therefore very small.

The easing of US pressure for political liberalisation was already obvious before the US secretary of state, Condoleezza Rice, visited Egypt in February. There had been some speculation that the US would use her visit to press for political reform in Egypt, following strong criticism from the US Congress at the imprisonment of the opposition leader, Ayman Nour, in December 2005 on charges of forgery. Mr Nour is the leader of the liberal al-Ghad Party, and came a distant second to Mr Mubarak in last year�s presidential election, but lost his parliamentary seat in November. Mr Nour claims that his imprisonment is politically motivated. His efforts to make an international issue out of his imprisonment, describing his detention as �Egypt�s model of repression�, have met with some success. Mr Nour�s wife, Gameela Ismail, correspondent for Newsweek, has officially complained of police harassment. Mr Nour himself has been transferred from prison to hospital after going on hunger strike to protest against the conditions of his imprisonment. His cause has been taken up by Human Rights Watch as well as by various US congressmen.

During her visit, however, Ms Rice refrained from overtly criticising the Egyptian government, although she did express some �disappointment� at �setbacks� to reform. She emphasised in particular the good relations between the current US administration and the Egyptian government. After the secretary of state�s visit, Mr Mubarak quoted Ms Rice as agreeing with him that it would take a generation to develop democracy in the Arab world. One lever that the US government can use to apply pressure on the Egyptian government is the promise of a free-trade agreement (FTA) between the two countries. Ms Rice had declared prior to her visit that the time was not yet right for the US and

Emergency laws are extended

US avoids pressing directly for reform, but cuts aid by 10%

Egypt 17


Egypt to begin negotiations on an FTA, and recent events are likely to put negotiations on hold indefinitely, or at the very least until the US administration believes that it can secure congressional approval. This does not seem to be an immediate prospect, as the annual US$1.8bn financial assistance package from the US to Egypt is being called into question by some members of Congress who have raised questions over human rights issues in Egypt. Indeed, in early May the US Senate voted to reduce by 10% the annual US assistance to Egypt, citing the country�s failure to introduce democratic reform as the reason behind the decision.

Although the gradual liberalisation introduced in 2005 appears to have been reversed, it has led to some changes in the political climate. The government has faced unusually vocal public criticism over its response to the various domestic crises that have arisen in 2006. Two uncommonly frank reports on the sinking of the Al Salam Boccaccio �98, a ferry, in the Red Sea in February, published in April by the Shura Council (the upper house) and the People�s Assembly, blamed the government for negligent oversight and responding too slowly to the disaster, in which more than 1,000 people died, most of them Egyptian expatriate workers. The Shura Council report blamed the authorities for failing to offer support to the families of victims, noting that no cabinet ministers visited Safaga, the port where the boat was due to arrive, following the disaster. The People�s Assembly report condemned officials at the Egyptian Authority for Maritime Safety for colluding with the company to allow the ferry to sail with inadequate safety equipment. It reserved most of its blame, however, for the ferry owner, Mamdouh Ismail, the chairman of the NDP�s Heliopolis office and a presidential appointee to the Shura Council. Rumours have spread that government officials had subsequently helped Mr Ismail flee the country, and that the prosecutor-general and the People�s Assembly froze his assets and the Central Bank of Egypt froze his family�s bank accounts. Mr Ismail, who is currently in London, served on the Red Sea Port Authority and is the owner of Al Salam Maritime Transport (the company that owned the ferry), as well as Al Salam hotels in Cairo and in Sharm el-Sheikh. Mr Ismail has now been stripped of his parliamentary immunity.

The ferry disaster has come to epitomise Egypt�s antiquated infrastructure, as well as the aloofness of Egyptian bureaucracy. Families of victims were left stranded for days in Safaga, with no help or support from government officials. Violent protests subsequently broke out at the port, which led to riot police being called in. The new transport minister, Mohammed Mansour eventually raised E£42m (US$7.4bn) in donations from private businesses, and families of the victims will receive E£30,000 (US$5,300) and survivors E£15,000 through a government disaster relief fund.

The series of government clampdowns, its poor handling of the Safaga ferry disaster and the outbreaks of bird flu that have all but closed down the country�s vital poultry sector (see The domestic economy: Manufacturing) have contributed to a general feeling of despondency among Egyptians. The government�s recent gestures and public pronouncements, such as the announcement by Gamal Mubarak, the president�s son and a leading official in the NDP, of plans to reform the electoral system, are now seen as largely

The government faces public criticism

18 Egypt


symbolic. These reversals have led many Egyptians to express increased pessimism regarding prospects for peaceful political change.

Economic policy

The Egyptian budget for fiscal year 2006/07 (July 1st 2006-June 30th 2007) was approved by the People�s Assembly at the beginning of May. No formal data have been released yet, but according to local press reports fiscal revenue is projected to increase by 24.6% to E£162bn (US$28bn) in 2006/07, compared with the previous year�s budget, partly as a result of recent tax reforms that have widened the tax base (November 2004, Economic policy). General government expenditure is also projected to rise, by 15.4% to E£217bn. The finance minister, Youssef Boutros-Ghali, announced that a major goal in this year�s budget was to contain the fiscal deficit, although it is projected to diminish only slightly to E£58bn. At a forecast 9.2% of GDP, this remains a substantial shortfall, although healthy economic growth and rising foreign direct investment (FDI) mean that macroeconomic stability is not at risk in the near term. Government officials have emphasised their intention to reduce the deficit in the coming years, aiming for a deficit of 3% of GDP by 2009-10, but this will depend upon the government finding a solution to the problem of domestic subsidies, which, at E£58bn in 2006/07, are budgeted to account for 27% of total current (operational) expenditure.

Fiscal projections (E£ bn unless otherwise indicated)

2004/05 2004/05 2005/06 2006/07

Budget Outturn a Budget Budget

Government revenue 117 109 130 162

Operational expenditure 160 158 188 217

Wages 43 41 46 51

Subsidies 32 30 51 58

Other 85 87 91 108

Balance -44 -50 -59 -58

% GDP 8.2 9.3 9.5 9.2

a Preliminary.

Sources: Ministry of Finance; Central Bank of Egypt; local press reports.

Substantial fiscal deficits are not a new phenomenon in Egypt. Official figures for the first seven months of 2005/06 (July 2005-January 2006) show an already substantial budget deficit of E£23.2bn!an increase of 11.3% compared with the same period of 2004/5. In April the chairman of the Central Auditing Agency, Gawdat al-Malat, announced that the deficit on the general govern-ment budget for the full fiscal year could reach as much as E£55.4bn (12.3% of GDP), significantly above the government�s own projection of a shortfall of 9.5% of GDP. Successive years of budget deficits have led to very high levels of public debt, and with the shortfall set to overshoot its target in 2005/06, public debt is likely to increase even further. The IMF�s Article IV consultation mission, which visited Egypt in April, warned that public debt and the budget deficit �cannot be sustained at current levels without compromising Egypt�s economic

New budget seeks to address deficit on public finances

High budget deficit and public debt remain key problems

Egypt 19


potential�. The Egyptian government therefore needs to embark on structural reform to reduce expenditure, even if tax reforms implemented in 2004 are slowly widening the tax base, which should help Egypt increase revenue collection over the longer term.

Data for the first seven months of 2005/06 show a 17.8% year-on-year increase in revenue, which is well on course to meet the target of a 27% year-on-year rise, given that budgetary income is traditionally stronger in the second half of the fiscal year. However, this was offset by a 14.9% increase in expenditure, which looks set to overshoot its full-year target of a year-on-year rise of 17.4%.

By end-January tax receipts had increased by 9.6% compared with the same period of 2004/05, with taxes on goods and services rising by 8.6%, a reflection of buoyant economic growth in the first two quarters of the fiscal year (see The domestic economy: Economic trends). However, income tax revenue, which is budgeted to rise by 17.3% over the full fiscal year, improved by only 9.7% year-on-year in the seven-month period, and will need to pick up sharply in the fourth quarter (April-June 2006) if this target is to be met. Some positive signs, though, have come from the income tax declarations submitted by end-March under the new income tax law, which was intended to increase revenue by simplifying procedures and removing incentives for tax evasion.

More than 2m people filed their tax returns by the closing date of April 1st 2006, up from 1.1m in the previous year, according to the Ministry of Finance. The Income Tax Authority says it has collected around E£1bn, up from last year�s E£400m in personal income tax. This is an impressive rise, albeit from a very low base, and can largely be credited to the new income tax law (No.91/2005) that reduced the maximum tax rate for individuals from 40% to 20% with effect from the start of 2005/06, a measure that has increased the number of people willing to declare their earnings. Individuals now pay tax of 10% on income between E£5,000-20,000 a year, 15% on income between E£20,000-40,000 and 20% on any income above E£40,000. The new tax code is not viewed as final, as several laws have also been announced to improve the process for resolving tax disputes and enforcement. Despite the increase in the number of filings, the vast majority of Egyptians do not pay income tax and belong to the so-called informal sector.

The deadline for filing corporation tax returns was April 30th 2006 and the results were not available for this report. However, the new tax law also reduced corporation tax rates, and most experts expect this to lead to an increase in tax receipts from this source too. Under the old tax system, industrial and export firms paid 22% and most other companies paid 40%. The maximum rate for most companies is now a flat rate of 20% on profits.

Wage and salary payments continue to rise strongly, with an 11.2% year-on-year increase in the first seven months of the fiscal year boosting total expenditure growth. The greatest concern, however, is the 43% rise in subsidy costs, which reached E£24.2bn in the first seven months. The increase stems largely from high global energy prices, which have forced the government to increase total subsidy outlays. This trend is set to continue both in the remainder of this fiscal year and in the next, as international oil prices continue to rise.

20 Egypt


State finances, Jul-Jan (E£ m unless otherwise indicated)

Actual Projected

2004/05 2005/06 % change % changea

Total revenue 52,395 61,719 17.8 27.0

Taxes 35,714 39,154 9.6 14.6

Income tax 14,510 15,915 9.7 17.3

Property tax 463 595 28.5 -5.0

Taxes on goods & services 15,903 17,273 8.6 6.8

Taxes on international trade 4,461 4,676 4.8 4.8

Other taxes 350 695 98.6 53.5

Grants 192 855 345.3 -1.4

Other revenue 16,489 21,711 31.7 61.2

Returns on financial assets 11,484 17,469 52.1 90.5

Proceeds on sales of goods & services 2,428 2,643 8.9 -9.3

Other 2,577 1,599 -38 25.8

Total expenditure 73,214 84,136 14.9 17.4

Wages & salaries 22,021 24,495 11.2 11.8

Purchases of goods & services 4,961 4,998 0.7 33.2

Interest payments 12,002 12,992 8.2 10.9

Subsidies, grants & social benefits 16,971 24,218 42.7 72.4

Other expenditures 10,626 10,681 0.5 -13.6

Purchases of non-financial assets 6,634 6,752 1.8 -14.1

Net acquisition of financial assets -14 740 n/a -5.2

Budget balance -20,806 -23,157 11.3 18.6

a For full fiscal year according to 2005/06 budget.

Source: Ministry of Finance.

Despite widening the tax base, which should eventually help stem the growth of the fiscal deficit, the government also needs to improve its control of expenditure growth, especially energy subsidies. However, this is also a politically sensitive question, as both consumers and companies benefit from artificially low energy prices. In February the government had to raise energy subsidies for the current fiscal year from E£22bn to E£40bn to offset the steady increase in international oil prices. Energy subsidies are to remain at this level in the 2006/07 budget, bringing total subsidies (which also include food products, among others) up to E£58.4bn, or a considerable 27% of overall government expenditure. Moreover, given that oil prices have continued to increase and are projected to stay at record levels for much of 2006/07, the cost to the Treasury of energy subsidies is likely to be revised upward again in the course of the fiscal year. The government has emphasised that this situation is unsustainable in the long term, and it appears to have embarked upon a campaign to gradually prepare public opinion for an eventual reduction in the subsidies in the longer term. Emphasising that �two-thirds of gasoline subsidies go to the rich while only one-third trickles down to the poor�, the prime minister, Ahmed Nazif, has declared that eventually it will have to be up to the Egyptian people, represented by the People�s Assembly, to decide if subsidies are to remain at this level, given that only E£36bn is allocated to health and education. At the moment, however, it seems unlikely that any major changes to Egypt�s subsidy policy are forthcoming.

Subsidy reform remains politically sensitive

Egypt 21


Although political reform may have faltered (see The political scene), the government continues to emphasise its commitment to carrying on with economic reform in order to promote economic growth and job creation. Greater private-sector involvement in the economy, including privatisation, is one of the key elements of this policy, which was also highlighted by the IMF delegation during its recent visit to Cairo. Figures from the finance ministry show that the proceeds from privatisation reached E£13.3bn in the first seven months of the current fiscal year, more than double the E£5.6bn for the whole of 2004/05, itself a tenfold increase on 2003/04. Further privatisation initiatives have been announced in recent months, as well as plans to promote public-private partnerships in sectors such as infrastructure, power, communications, health, education, housing and transport. At the biannual EuroMoney con-ference, held in London, government representatives said that they envisaged inviting private investors to develop housing and infrastructure projects, such as sanitation, and then lease them back to the government in order to generate a profit. Although these ideas look interesting in principle, and the government lacks the resources without private-sector participation to alleviate the current acute housing shortages, it remains to be seen whether the authorities will be able to attract sufficient investor interest to get these projects off the ground.

The privatisation of the Bank of Alexandria, the first state-owned bank to be put up for sale in Egypt, moved forward in late March, after suffering a series of delays (February 2006, Economic policy). Strategic investors were invited to submit non-binding purchase offers for a 75-80% stake in the bank. The remaining 15-20% stake will be floated on the Cairo and Alexandria Stock Exchange, with 5% reserved for employees. The sale is now scheduled to close in August this year. Possible contenders include Deutsche Bank of Germany and BNP Paribas of France, which would lead to a much-needed presence of foreign capital in Egypt�s banking sector. However, there is speculation that the local Commercial International Bank may be the most likely buyer.

The government has mentioned other future part-privatisations, including of the 100,000-barrel/day (b/d) Middle East Oil Refinery and the Alexandria Mineral Oils Company, but details of these divestments have yet to be published.

The government is keen to take advantage of high international energy prices to expand its domestic energy sector. The prime minister, Mr Nazif, announced in March that Egypt is seeking to attract US$20bn in foreign investment into the country�s oil and gas sectors over the next five years, including for 20 new petrochemical plants. According to official sources, the oil sector already accounts for 80% of total foreign direct and indirect investment in Egypt. The petroleum minister, Sameh Fahmy, has announced plans for new liquefied natural gas projects, additional gas export pipelines and gas-to-liquids schemes. However, proposed developments depend on Egypt being able to increase its proven gas reserves by at least 200%, to 120trn cu ft, through further exploration activity (see The domestic economy: Oil and gas).

The Ministry of Petroleum is working on ambitious plans to build a US$9.5bn, 350,000-b/d combined refinery and petrochemicals complex at Kafr el-Sheikh

Privatisation plans move ahead

Cabinet focuses on attracting new FDI

22 Egypt


in the Delta on the Mediterranean coast, 30% of which would be funded by private investors. It remains doubtful however whether the project will be realised in full owing to the numerous obstacles the government would need to clear to make the project economically viable. Egypt has never previously carried out a project of this scale and would need not only to attract private strategic investors to partner the project, but also to rely on imported crude. It will face tough competition to attract investors from similar projects in Saudi Arabia and the rest of the Gulf.

The Egyptian government is continuing its efforts to improve the domestic business environment, following up on reforms already introduced in areas such as customs and taxation. The government has announced that a new US$142.5m grant from the US Agency for International Development will be used to strengthen the supervisory powers of the Central Bank of Egypt and to promote other reforms. Consequently, a new National Committee for Upgrading Economic Legislation was set up in April, with the mandate of fostering a more investment-friendly environment. Its first priority, according to the justice minister, Mahmoud Abu Leil, will be the passing of a new law creating specialised courts for the settlement of business disputes, which is due to be presented to the People�s Assembly during its current session.

Other efforts are aimed at alleviating the problem of the continued scarcity of affordable land for both residential and industrial developments, with the government recently approving two draft property laws. The first aims to simplify and speed up the laborious and expensive real estate registration process, which has meant that much property remains unregistered, creating a grey zone for land disputes. The law will establish a fixed fee of around US$150-300 for property registration, rather than the existing proportional stamp duty tax. The second draft law will significantly reduce property tax from 47% to 10%, while simultaneously expanding its scope. There are also plans for a draft law on freedom of information exchange, intended to improve investors� access to land data.

Despite a reduction in interest rates in January, the Egyptian pound has remained strong, owing to continued robust capital inflows, principally FDI. As of mid-May the interbank exchange rate was E£5.77:US$1, only marginally weaker than the December 2005 average of E£5.73:US$1. The relative stability of the currency is likely to have been one of the factors supporting the Central Bank�s decision to cut rates again on April 6th, for the second time this year. The bank�s Monetary Policy Committee (MPC) decided to reduce its overnight deposit and lending rates by 25 basis points each, to 8% and 10% respectively with effect from April 7th. The decision was made despite accelerating economic growth, with real GDP growth reaching 6.1% year on year in the second quarter of 2005/06 (October-December). The MPC justified its decision on the basis of �moderate� inflation!consumer price growth averaged 4.9% in 2005, which the Central Bank attributed to the existence of unutilised capacity in several economic sectors.

Laws on dispute settlements and land registration passed

Central Bank continues to lower interest rates

Egypt 23


The domestic economy

Economic trends

Having reached a robust, albeit unspectacular, 4.9% in fiscal year 2004/05 (July 1st 2004-June 30th 2005), up from 4.1% in 2003/04, real GDP growth continued to accelerate in the first half of 2005/06, according to information from the Ministry of Planning. Economic expansion reached 6.1% year on year in the second quarter (October-December), up from 5.3% year on year in the first quarter. Domestic demand continued to drive economic growth, with the strongest driver being investment, which increased by 10.8% year on year in the second quarter, after expanding even more robustly in the first quarter, by 12.4% year on year. This compares with full-year fixed investment growth of 9.8% in 2004/05 and 6.2% in 2003/04. The rise in investment demand comes on the back of the government�s continued push to improve Egypt�s business environment and to facilitate both foreign and domestic investment. Household consumption picked up strongly in the second quarter, expanding by a hefty 7% year on year, following growth of 6% in the first quarter. Both investment and private consumption demand have been buoyed by better credit facilities, reflected by an increase in lending to the private sector (see below).

GDP by expenditure, quarterly data (E£ bn unless otherwise indicated; at constant fiscal 2002 prices; fiscal years finish Jun 30th)

2004/05 2005/06 2005/06 2004/05 1 Qtr 1 Qtr % change 2 Qtr 2 Qtr % change Domestic demand 138.9 148.6 7.0 149.2 137.5 8.5 Final consumption 97.5 103.3 5.9 98.5 92.3 6.7 Household consumption 84.0 89.0 6.0 87.0 81.3 7.0 Public consumption 13.5 14.3 5.9 11.5 11.0 4.5 Gross capital formation 14.5 16.3 12.4 16.4 14.8 10.8 Investment 14.5 16.3 12.4 16.4 14.8 10.8 Change in stocks 0.0 0.0 0.0 0.0 0.0 0.0Net exports 0.1 -1.6 - -3.2 -1.8 -

Exports of goods & services 26.9 29.0 7.8 34.3 30.4 12.8Imports of goods & services 26.8 30.6 14.2 37.5 32.2 16.5

GDP at market prices 112.1 118.0 5.3 111.7 105.3 6.1

Sources: Ministry of Planning; Economist Intelligence Unit.

Exports of goods and services continued to expand robustly in the first half of 2005/06, although the growth rate (averaging 10.3% in the first six months) was well down on the 26.4% recorded in 2004/05. Import expansion continued to outpace export growth, however, leading to negative net exports in both quarters, which acted as a drag on overall growth. Although no breakdown was given of goods and services, export expansion in the period July-December 2005 was lifted by the launch of liquefied natural gas (LNG) exports, after two trains came on stream at the Egyptian Liquefied Natural Gas Company�s sites at Idku in May and September respectively. Growth in services exports was also driven by tourism, which recovered quickly after the bomb attacks in Sharm el-Sheikh in July 2005. However, with further attacks in South and North Sinai in April 2006 (see The political scene), the services component of total exports is

Economic growth accelerates in first half of 2005/06

24 Egypt


likely to decline in the last quarter of 2005/06. Strong household and investment demand pushed up import growth, a trend that the Economist Intelligence Unit expects to continue for the remainder of the year.

The positive trend in GDP data for the first half of 2005/06 is also reflected in the latest biannual Business Barometer, a survey of 165 manufacturing firms, 35 construction companies and ten tourism firms, carried out by the Egyptian Center for Economic Studies (ECES). Most companies (79%) surveyed by ECES reported a stronger or a stable performance between July and December 2005, compared with 75% in the previous six months, with only 21% recording lower growth. Measures of production output, domestic sales, exports and investment were all slightly higher than in the previous six months, confirming the buoyant GDP data. The survey shows investment remaining robust, with 30% of firms increasing investment in the six-month period (down from 37% in the previous survey) and 61% maintaining investment levels (up from 53%). Only 9% of respondents had reduced investment between July and December, and most of those were in the construction sector.

Less positively, the survey also pointed to strong growth in wages and prices, with a full 99% of respondents reporting higher or stable wage growth between July and December 2005 and 70% reporting higher input prices. Some 30% of respondents passed on the price increases and raised their final product prices. Employment trends, however, still point to some underlying fragility in the economic recovery. More companies reported a reduction in employment than an upturn: 25% reported a net decline in staff numbers, 57% no change and 19% a net increase. This was, however, a marginal improvement on the previous survey, in which 29% had reported a reduction in staff numbers and only 17% an increase.

The survey suggests that firms are strongly optimism about the January-June 2006 period, with the majority of the companies surveyed expecting higher or stable levels of economic activity and export growth: 72% of respondents expected to increase production in the period and only 10% to see output fall. In the survey group, 74% of firms believed export volumes would rise, with only 4% anticipating a decline. However, a more modest 66% of firms expected to see an increase in domestic sales, compared with a more modest 75% in the previous period. Tourism firms remained the most bullish of those surveyed, with 90% expecting improved (80%) or stable (10%) activity in January-June. However, the survey was conducted some time before the bombings in Dahab, and it is unclear at present to what degree the tourism sector will be affected by the attacks.

In the latest ECES survey, �access to finance� remained one of the most important constraints on growth cited by the surveyed firms, although �limited demand� had moved to the top of the list of �constraints to operations� (the survey does not quantify its constraints). The other obstacles given by firms were access to imports and a lack of skilled workers. Data on domestic credit from the planning ministry suggest that access to finance improved in the last months of 2005, with credit growth to the private sector rising sharply to 17.1% in the final quarter of 2005. However, between January and March 2006, credit

Survey for July-December reflects buoyant mood

Financing improves only marginally

Egypt 25


growth to the private sector decelerated dramatically, to just 0.4%. Growth in total domestic credit picked up again in the first quarter of 2006, having contracted in the fourth quarter of 2005. The end-2005 contraction was due to a sharp reduction in credit to non-financial public enterprises and, to a lesser extent, to central government. The private sector absorbed almost 60% of total domestic credit in the fourth quarter, a continuation of the positive trend of private-sector borrowing gradually outstripping credit to the public sector. Even so, central government borrowing still accounted for 35.4% of total credit at end-December 2005. Even more worrying, the share of total credit to central government rose, to 36.2%, in the first three months of 2006. The low proportion of total domestic credit to the private sector is a reflection of the high risk averseness of domestic banks, which is only gradually improving on the back of government�s attempts to reform the sector by increasing minimum capital requirements for banks (November 2005, The domestic economy: Economic trends). Moreover, the high level of government debt arising from the gaping fiscal deficit offers a relatively reliable channel for investment for risk averse banks and tends to crowd out private-sector financing.

Domestic credit (E£ m unless otherwise indicated)

2001 2002 2003 2004 2005 2006 Dec Dec Dec Dec Mar Jun Sep Dec MarTotal domestic credit 342,342 387,126 438,479 481,998 485,934 496,812 499,702 480,220 490,343 % change, quarter on quarter - - - 3.2 0.8 2.2 0.6 -3.9 2.1 % change, year on year 10.8 13.1 13.3 9.9 8.0 9.3 7.0 -0.4 0.9To private sector 197,038 207,089 225,023 233,685 231,774 236,999 242,136 283,601 284,750 % change, quarter on quarter - - - 1.9 -0.8 2.3 2.2 17.1 0.4 % change, year on year 11.5 5.1 8.7 3.8 2.0 3.1 5.6 21.4 22.9 % of total 57.6 53.5 51.3 48.5 47.7 47.7 48.5 59.1 58.1To central government 94,091 127,216 157,489 185,964 193,414 195,307 189,760 169,841 177,728 % change, quarter on quarter - - - 3.9 4.0 1.0 -2.8 -10.5 4.6 % change, year on year 8.5 35.2 23.8 18.1 16.1 16.9 6.0 -8.7 -8.1 % of total 27.5 32.9 35.9 38.6 39.8 39.3 38.0 35.4 36.2To non-financial public enterprises 43,393 44,316 47,999 54,806 53,772 58,273 59,839 34,578 34,678 % change, quarter on quarter - - - 7.5 -1.9 8.4 2.7 -42.2 0.3 % change, year on year 10.4 2.1 8.3 14.2 10.5 16.1 17.3 -36.9 -35.5 % of total 12.7 11.4 10.9 11.4 11.1 11.7 12.0 7.2 7.1

Source: Ministry of Planning.

Buoyant economic growth is starting to have an impact on prices in Egypt. According to data from the Central Agency for Public Mobilisation and Statistics, consumer price inflation, measured by the consumer price index, started rising again in the first quarter of 2006, to 3.7% year on year in March and averaging 3.7% for the quarter, after falling to 3.1% in December 2005. Inflation had fallen for most of 2005 on the back of a better managed monetary policy that targets price stability. The wholesale price index recorded only very moderate inflation in the first months of 2006, with year-on-year price growth averaging 1.3% in the first quarter. However, wholesale inflation picked up in March, to 2.5% year on year.

Inflation picks up again in the first quarter

26 Egypt


Inflation 2005 2006 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb MarConsumer price index (100=2001/02) 134.8 135.3 135.0 135.5 135.8 136.4 137.3 137.5 137.6 138.3 138.5 138.8Consumer price index (% change, year on year) 4.7 5.1 4.7 4.3 4.7 3.8 3.0 3.2 3.1 3.4 4.0 3.7

Consumer price index (% change, month on month) 0.7 0.4 -0.2 0.4 0.2 0.4 0.7 0.1 0.1 0.5 0.1 0.2Wholesale price index (% change, year on year) 3.1 4.2 5.1 5.1 n/a 7.7 6.5 3.8 1.0 0.0 1.3 2.5

Source: Central Agency for Public Mobilisation and Statistics.

The existence of inflationary pressures is also confirmed by money supply data. According to the IMF�s International Financial Statistics, growth in both M1 and M2 remained strong in the final quarter of 2005. Although both decelerated in year-on-year terms, money supply growth nonetheless remained buoyant. This is confirmed by Egyptian pound liquidity, which is derived by subtracting the value of foreign-currency deposits (a proxy for dollarisation) from the value of M2. At 24.8% year on year, Egyptian pound liquidity growth only slowed moderately in the final quarter of 2005, from 29% in the third quarter. The share of foreign-currency deposits in total money supply has continued to fall, accounting for 27.7% of total money supply at the end of the final quarter of 2005, down from just over 37% at the end of the first quarter of 2004. This points to stronger consumption growth (as confirmed by our GDP data) and greater confidence in the local economy, as many Egyptians held foreign currency as a savings instrument at the peak of the currency crisis in 2003-04.

Money supply (E£ m unless otherwise indicated)

2003 2004 2005 Dec Mar Jun Sep Dec Mar Jun Sep DecM1 93,520 95,955 100,620 104,129 108,498 111,397 115,446 124,823 125,466 % change, year on year 23.4 18.3 17.0 14.1 16.0 16.1 14.7 19.9 15.6M2 403,634 412,299 428,205 444,748 461,887 473,340 488,202 507,401 514,223 % change, year on year 21.3 15.2 13.9 13.3 14.4 14.8 14.0 14.1 11.3

Foreign-currency deposits 148,652 152,973 157,469 161,453 163,841 151,523 146,194 141,893 142,258 % of total 36.8 37.1 36.8 36.3 35.5 32.0 29.9 28.0 27.7

Egyptian pound liquidity 254,982 259,326 270,736 283,295 298,046 321,817 342,008 365,508 371,965 % change, year on year 8.9 13.3 13.8 14.5 16.9 24.1 26.3 29.0 24.8

Source: IMF, International Financial Statistics.

Financial and other services

A large-scale media scandal broke out in April after information was leaked that the entire 150-year-old state-owned department store Omar Effendi was to be sold to a private investor at a lower than expected price. The Holding Company for Trade (HCT) negotiated the sale to Anwal Group, a Saudi retailer, for E£504m (US$88m) for the retail chain�s 82 branches. According to the chairman of HCT, Hadi Fahmy, the initial committee valuating Omar Effendi had complied with the Privatisation Act (Law 203 of 1991) and an independent auditor had submitted a valuation for the store of E£400m-500m. The process was complicated, however, by a request from the National Bank of Egypt that an estimate be made for the property value of each separate branch in order to

Egyptian pound liquidity remains high

Setback for Omar Effendi privatisation

Egypt 27


increase prospective buyers� options. A second committee then valued the aggregate assets of Omar Effendi at E£1.14bn (US$200m).

It was then rumoured in the press that Mr Fahmy was under pressure to submit a low figure for the valuation to expedite the sale, underselling the state-asset, which led to a formal request to the State Prosecutor�s Office to investigate both Mr Fahmy and the investment minister, Mahmoud Mohieddin, for fraud. The investigation has since been suspended, with the state prosecutor, Maher Abdel Wahed, citing a lack of evidence to support the claims. The E£1.14bn valuation is likely to not have taken into account Omar Effendi�s considerable tax liabilities, back-office bureaucracy, over-staffing and necessary repairs. The department store owes more than E£50m in back taxes and employs nearly 6,000 workers. It registered a profit in 2005 for the first time in five years. Considering that Anwal Group has announced that it plans to spend E£300m post-acquisition on renovations, as well as fund early retirement packages to reduce the workforce, the true value of the successful bid approaches E£1bn. As a result of pressure from the public and the media, however, which has accused the government of favouring big business and undervaluing the �family jewels�, Anwal Group has said that it will raise its offer by a possible E£200m in exchange for 90% control of Omar Effendi, with an option to buy out the remaining 10%.

The Omar Effendi sale highlights the increasing public scepticism towards privatisation deals, which stems partly from Egypt�s traditional problems of rampant corruption in the government and bureaucracy. In an interview with Al Ahram, a pro-government newspaper, in April, the prime minister, Ahmed Nazif, in an attempt to assuage public concerns, affirmed that the government would not sell companies at just any price, adding that the privatisation programme was giving top priority to the protection of workers� rights. This shift of emphasis, which included a new commitment to trade union involvement in divestments, if it is implemented by the government, may, however, have negative implications for future state sell-offs.

Suez Canal 2006 2000 2001 2002 2003 2004 2005 Jan-Mar Vessels (no.) 14,141 13,986 13,447 15,667 16,850 18,176 4,422

Tonnage (m) 439 458 445 567 621 671 173Receipts (US$ m)a 1,942 1,911 1,964 2,606 3,085 3,458 853

a Includes Navigation Services.

Source: Suez Canal Authority.

Full-year results for the Suez Canal were slightly lower than the preliminary figures announced by the chairman of the Suez Canal Authority, Ahmed Fadel, in December 2005 (February 2006, The domestic economy: Financial and other services), but were still well up on those for 2004. A total of 18,176 vessels, carrying 671m tonnes of cargo used the canal in 2005, bringing in US$3.5bn, a 12.1% increase in revenue compared with 2004. In the first three months of 2006, Suez usage remained high, albeit perhaps slightly below the 2005 turnout, if the three-month figures are annualised. High prices on shipping fuel and strong demand for raw materials have made it more cost effective to transit

Suez Canal receipts reached US$3.5bn in 2005

28 Egypt


through the Suez Canal to reach markets in Europe and the US, but the recent drop in commodity prices could lead to slightly fewer vessels using the canal in 2006 than in 2005.

As part of the government�s efforts to overhaul the banking sector, and to achieve the long-term goal of increasing capitalisation and reducing the number of non-performing loans, several financial institutions will be consolidated. Officials from the Central Bank of Egypt said that the small state-owned or part-state-owned banks!Al Watany Bank of Egypt, the Islamic International Bank for Investment and Development (part-owned by the state-owned Bank Misr, which has a 20% stake), Alexandria Commercial and Maritime Bank, and the Arab Investment Bank!will be merged or taken over by financial investors. The Egyptian Workers Bank is to be merged into the Industrial Development Bank (another state-owned bank). So far no timetable for the mergers has been forthcoming.

A Lebanese bank, Bank Audi, won the bid in January for a complete buyout of the Cairo Far East Bank (CFEB), according to Al Akhbar, a local daily. Bank Audi paid a total of US$94m at US$35 a share. Earlier in the month, EFG-Hermes Group, Egypt�s largest investment bank, announced that it would acquire 20% of Bank Audi. To finance the deal, EFG-Hermes agreed to increase its capital by E£3.2bn through new share issues. The deal has expanded the scope of EFG-Hermes�s portfolio from management deals, securities brokering and investment management to include banking financial services. As Bank Audi will soon control CFEB, this will enable EFG-Hermes to enter Gulf markets, according to Asharq al-Awsat, a pan-Arab daily newspaper, published in London.

Amid upheaval in regional stockmarkets, especially in the Gulf, Egypt�s, benchmark Hermes Financial Index (HFI) held up fairly well in the first four months of 2006. Although the HFI slipped by 2.1% month on month in April, to 56,786, the HFI rose by 2.6% between January 1st and May 9th. The net value of transactions in April was E£13.7bn, a drop of 30% compared with March. However, average net daily value traded in April was only down by 9% on March, falling from E£892m to E£809m, according to EFG-Hermes. The market was held up by the strong performance of firms in the construction and housing sector, no doubt buoyed by the government�s plans to upgrade Egypt�s infrastructure. Shares in SODIC (6th of October for Development & Investment, a construction company) rose by 25.3% month on month in April, after the firm announced a net full-year profit of E£41.3m in 2005. Egypt Telecom performed the worst, with its share value declining by 11.1% month on month and by 25% in the year-to-date.

During April the Cairo and Alexandria Stock Exchange (CASE) launched a new blue-chip index, the Dow Jones CASE Egypt Titans 20 Index. According to EFG-Hermes, this index will measure the performance of the Egyptian exchange using the same methodology as the Dow Jones Global Titans 50 Index, and should contribute to improving the image of CASE and thereby, it is hoped, make the market more attractive to foreign investors.

Consolidation in the banking sector continues

The Egyptian exchange holds up well

Egypt 29


20,000

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

65,000

70,000

75,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May

Hermes Financial Index

Source: Bloomberg.

2005 06

Manufacturing

Avian flu arrived in Egypt in late 2005. The epidemic has spread rapidly, resulting in 13 human cases at the time of writing, with five fatal so far, and in financial devastation in the poultry sector, which supports up to 3m Egyptians, according to official data. The Egyptian government�s response to the problem has been to eliminate as many birds as possible, with anecdotal evidence of local farmers tossing chickens in the Nile and others hiding their livestock on rooftops to prevent the authorities from confiscating their sole source of income and sustenance. According to official estimates, nearly 80% of poultry farms have closed, at a loss to the sector of E£10m (US$1.8m) a day. Poultry exports, worth US$28m in 2005, have been suspended, and the country may have to begin importing chicken. The government has closed down all 870,000 shops selling live poultry, ordering them to trade in frozen products instead and offering soft loans to facilitate purchases of freezers, as well as planning the establishment of modern slaughterhouses, which previously accounted for only 25% of birds killed. The government has also promised compensation for poultry producers.

The Ministry of Health has claimed that a total of 1,500,000 birds have been destroyed. This compulsory cull has forced livestock vendors to choose between buying authorised frozen chicken or facing fines of up to E£10,000 (US$1,750) if they fail to comply. Wadi Holdings, one of the two largest poultry producers with E£30m worth of livestock, said that sales had dropped by 50% and the remaining half had been sold at 50% of the normal market value by mid-April. An export ban has prevented Wadi from selling off its livestock to its international clients in Libya, Jordan, Yemen, Iraq, and several African countries. The epidemic has led to sharp falls in sales volumes and prices of poultry products, including eggs, whereas meat and fish prices have risen. Another leading poultry producer, Cairo Poultry Company, the sole distributor to US fast-food restaurants such as McDonald�s and KFC in Egypt, quickly converted much of its products to frozen commodities and invested capital in glucose and starch operations to make up for losses. The company�s general manager, Magdy el-Sebaie, said that he expects poultry sales to rebound in June after the

Avian flu strikes Egypt

30 Egypt


end of the flu season, according to Business Today, a local monthly magazine. KFC has held an aggressive marketing campaign to alleviate fears of contracting the virus. Even so, shares in Cairo Poultry Company had dropped by nearly 20% on the Egyptian stockmarket by end-March.

In response to the human cases, the health ministry has essentially declared a state of emergency and stockpiled 80,000 courses of Tamiflu (an antiviral drug) to respond to a potential wider outbreak of the H5N1 virus among humans. Worldwide, 206 cases and 114 deaths have occurred, according to Reuters.

To date 471 Egyptian textile companies have joined the Qualified Industrial Zone (QIZ) scheme between Egypt, Israel and the US. The scheme was introduced at the end of 2004, just before the expiration of the Multi-Fibre Arrangement (MFA), which had set national quotas on the textile trade for three decades. The QIZs are located around Cairo, Alexandria and the Suez Canal. Goods from these areas can be exported duty free to the US. However, the agreement also stipulates that there must be at least 35% local value-added in production, 11.7% of which must come from Israel, in order to forgo tariffs that usually range from 10% to 35% and can exceed 50% in some cases. So far only a few of the 471 textile firms have been able to take full advantage of the QIZs and export to the US, however, mainly because of the deficiencies in the quality of the textiles produced, or an inability to export. Although any industry is allow to take advantage of the QIZ deal, textiles have dominated and represent 77% of exports under the scheme. Israel has also benefited from the agreement. According to the Jerusalem Post, an Israeli English-language daily, the value of exports to Arab countries in 2005, excluding diamonds, rose by 29%. Exports to Egypt saw the largest increase, rising by 214% in 2005. Israel has had a similar QIZ agreement with Jordan for several years. Although Egyptian textile manufacturers have complained about the inability of Israeli companies to meet Egyptian demand for Israeli goods, the Egyptian Ministry of Foreign Trade and Industry said that Israeli content has been around 13% recently, exceeding the minimum 11.7%.

The Egyptian textile industry is marred by obsolete structures and poor quality in the upstream spinning and weaving sector, which makes it difficult for Egypt to compete globally with other textile manufacturers such as China, despite the reputation of its raw cotton. The spinning and weaving sector is still dominated by Nasser-era state-controlled operations that suffer from a lack of government investment and that have accrued debts of E£9bn (US$1.6bn). As a result, many Egyptian textile companies import inexpensive, subsidised, but poor-quality fabric for its clothing manufacturing. The government�s attempt to generate brand awareness for high-quality Egyptian cotton, has so far been limited to designing a label. The attractiveness of Egyptian cotton is also held down by the fact that the long fibres are only useful for niche products such as bath towels and bed sheets rather than for mass-market items like clothing.

At the beginning of the year, the Bavarian Auto Group, the local subsidiary of BMW (Germany), expanded its locally manufactured car line (the 3 Series and the 5 Series) with the introduction of the X3, a sports utility vehicle (SUV), which should be ready for sale by June 2006. Ssangyong Musso, a Korean

QIZ agreement benefits textile industry

High duties encourage the local manufacture of cars

Egypt 31


manufacturer, began making SUVs in Egypt in February. High tariff duties prevent cars with engines larger than 1.6 litres from entering the Egyptian market at competitive prices, so international auto manufacturers are increasingly assembling completely built up vehicles in Egypt to circumvent high duties. Imports of the X3 were subject to a 235% tariff, which means that the locally manufactured version is one-third cheaper. A reduction in tariffs on imported vehicles from 104% to 40%, which came into effect from January 2005, led to growth of sales of imported cars of more than 90% year on year last year. Overall, the new passenger car market expanded by 70% to 94,322 units at end-2005, according to Egypt�s Automotive Marketing Information Council.

Oil and gas

In April the Egyptian president, Hosni Mubarak, formally opened the second liquefied natural gas (LNG) complex operated by Egyptian Liquefied Natural Gas Company (ELNG)!a consortium of BG Group (UK), Petronas (Malaysia), the Egyptian Government Petroleum Company and the Egyptian Natural Gas Holding Company (EGAS), two Egyptian state-owned companies!at the ELNG�s sites at Idku on the Mediterranean coast. The first LNG complex, Train 1, came on stream in May 2005, and Train 2 began production in September 2005, some nine months ahead of schedule. Both trains rely on natural gas from fields operated by BG. The Idku site can accommodate up to four more trains. BG has stated that it is currently working on developing a third train and aggregating gas from a variety of sources, including from fields off the coast of Gaza, which it is developing in conjunction with the Palestinian Authority.

High international gas prices and buoyant global demand have led to growing foreign interest in Egypt�s gas sector. Egypt has proven gas reserves of 67trn cu ft (some 75% of the country�s total proven hydrocarbons reserves), but a minimum of 120trn cu ft is necessary for the government to be able to realise its ambitious plans for the natural gas sector, which include LNG projects, gas export pipelines, gas-to-liquids (GTL) schemes and petrochemical expansions. In order to reach its goal of doubling its proven gas reserves, on February 20th the government launched its largest gas licensing round to date. EGAS invited international oil companies to bid for 12 concession blocks covering a total area of 37,000 sq km, situated in the Nile Delta, North Sinai (onshore) and in the Mediterranean Sea basin, according to the Middle East Business Weekly. Another licensing round was launched at the same time by Ganoub el-Wadi Petroleum Company, which invited bids for a total of eight blocks in the Red Sea, the Eastern and Western Desert and in the Gulf of Suez. The deadline for all 20 bids is July 16th. The government is hoping that an increase in Egypt�s proven gas reserves will enable it to diversify its gas offer and take advantage of new technology. It also intends to use more natural gas for domestic consumption, with a plan to extend natural gas to 6m households over the next five years. EGAS has announced that it intends to extend its gas distribution network, which currently has 500,000 customers, by 800,000 customers in 2006.

Second LNG complex is formally opened

Gas licensing round launched

32 Egypt


The Royal Dutch/Shell Group has been active both onshore and offshore in Egypt. In March it signed a so-called farm-in agreement with Centurion Energy (Canada), allowing it to take 50% of two onshore blocks in the Nile Delta (West el-Manzala and West el-Qantara) for an initial payment of US$15m, followed by another payment of US$20m if Shell remains a concession owner after an initial five-well exploration scheme. Under the agreement, Shell also agreed to pay premiums of up to US$225m, related to the volumes discovered. The deal includes a provision for co-operation between Shell and Centurion in the development of �LNG opportunities�, according to the Cyprus-based Middle East Economic Survey, an oil and gas industry publication. Drilling of the first well began in February. The concessions have three-year exploration terms with an option to extend for two additional three-year terms. The West el-Manzala and the West el-Qantary blocks are surrounded by the El Wastani and South el-Manzala Development Leases, both 100% owned by Centurion, which produce a total of 200m cu ft/day of gas and 6,500 barrels/day of liquids. Shell has also started drilling in two offshore concessions in the Mediterranean Sea. Drilling began at the end of April in the Northwest Damietta concession in shallow waters. Shell is the operator, with a 55% share. Kuwait Foreign Petroleum Exploration Company has 25% and Gaz de France the remaining 20%. Drilling at Shell�s second concession, the North East Mediterranean Deepwater (Nemed), is expected to begin in July. Nemed is jointly operated with Petronas and covers an area of 41,500 sq km. The Nemed concession is more challenging as the project requires drilling to a depth of up to 2,800 metres.

Infrastructure

Bidding for Egypt�s third mobile-phone licence has been competitive, with 21 companies showing sufficient interest to purchase the tender documents for US$25,000 and 11 consortia submitting applications by the extended deadline of May 4th. As in other recent similar sales, bidders from the Gulf states are making a strong showing, with Etisalat (UAE), MTC (Kuwait) and MTN Group (South Africa) considered the frontrunners. A surprise last-minute partnership between STC (Saudi Arabia), TMI (Malaysia) and a new Egyptian firm, BICO Telecom, also attracted media attention. Etisalat has entered into a partnership with a newly established Egyptian company, Mashreq Telecom, and MTN has teamed up with Investcom, a regional telecommunications company, Raya Holdings, a local firm, and the Saudi-based Golden Pyramids Plaza. MTC has agreed to raise US$4bn in financing for the licence. All the three frontrunners have previous experience in regional mobile-phone markets. In 2005 Etisalat paid US$3.3bn for Saudi Arabia�s second mobile-phone licence and US$2.56bn for a 26% stake in the state-owned Pakistan Telecommunications. MTC paid US$3.4bn for Celtel, a mobile operator in 14 Sub-Saharan African countries. MTN paid US$380.7m for a 49% stake in IranCell. Egypt�s monopoly fixed-line operator, Telecom Egypt, has also stated that it will bid for the mobile phone-licence in majority partnership with Telecom Italia. If successful, it would have to sell its existing 25.5% stake in Vodafone Egypt.

Third mobile-phone licence attracts many bidders

Shell expands its activities in Egypt

Egypt 33


A commission including representatives from the Egyptian National Telecommunications Regulatory Authority (NTRA) and the ministries of investment and finance will now select those bidders that meet more than 70% of the technical requirements, inviting them to resubmit proposals in a face-to-face financial auction in June or July, when the licence will go to the highest bidder. The NTRA requires the successful bidder to make an upfront payment of E£2.5bn (US$440m), in addition to a 3% share of annual revenue. Moreover, bidders must have a minimum turnover of US$1bn and a subscriber base of 5m. Implementation should begin next year, with the successful firm allocated the 1800 MHz frequency. Although the new operator will also be able to take advantage of national roaming and number portability to access the two existing mobile-phone companies� 900 MHz networks, its market share is forecast to be around 20%.

In late February an Egyptian service provider, Xceed Contact Center, became the first company in the Middle East and Africa to receive the �COPC-2000 standard� accreditation from the US-based Customer Operations Performance Center (COPC), a benchmark for outsourcing firms. Xceed completed certification in just nine months. Xceed employs 1,200 workers, who use web-enabled multi-channel workstations and take calls in nine languages, including Arabic, English, French, German, Spanish and Italian. Egypt has access to several established cables that link it to the rest of the African continent, Europe, Asia and the Americas and provide large bandwidth, helping to ensure good-quality telephone reception and rapid data transmission. The Egyptian government recently upgraded the system by replacing copper wires with fibre optic cables, which could help Egypt become one of the world�s major outsourcing locations. Although India has traditionally been the major outsourcing hub, especially in technology, it has focused primarily on IT services such as software development, systems integration and application implementation. Xceed provides IT-enabled services, such as call centres, business processes and data entry. The managing director of Xceed, Adel Danish, believes that demand growth for IT-enabled services will be strong. Xceed currently has an established relationship with clients such as Microsoft (US), Oracle (US), Carrefour (a French retailer) and General Motors (US), and also takes customer service calls for companies such as Telecom Egypt. According to Datamonitor, the number of service centre jobs in Egypt is expected to rise by more than 50% a year until 2009. Datamonitor puts the cost of services as the key driver to growth in outsourcing, and the only country with lower prices than Egypt is India, although labour costs in India have started to climb. A.T. Kearney, a management consultancy, has released its 2005 Global Services Location Index, which ranks the world�s top 40 countries for offshore outsourcing. Egypt, which made the list for the first time, was 12th, above any other African and Middle Eastern country.

Tourism

The April bombings in the small resort town of Dahab in South Sinai (see The political scene) have again put the future potential of Egyptian tourism in

Outsourcing could become a new growth industry

Sinai bombings are expected to hit tourism hard

34 Egypt


question. A series of bombings in various locations on the Sinai Peninsula over the past 18 months have demonstrated that the popular international tourist destination has become a specific target for Islamist militants. Local businesses in Dahab expect a decline in visitor numbers, but nonetheless believe that regular repeat visitors will continue to travel to the area. A week after the most recent attacks, the tourism minister, Zoheir Garana, said that 1-2% of hotel bookings had been cancelled since the bombings, and that average occupancy rate for hotels in the Sinai Peninsula was 81.3%. However, this was down from more than 95% in the week before the attacks, but in line with the 82% rate in the same period of 2005. The Egyptian government has blamed the peninsula�s Bedouin for both attacks and has waged an aggressive campaign to capture those thought to be responsible in order to reassure tourists (see The political scene).

Despite the reassurances from the tourism minister, with the high season about to begin in Sinai, there are concerns that the tourism sector, one of Egypt�s most important in terms of jobs and foreign-exchange earnings, will suffer a setback. The sector had recovered surprisingly quickly following the previous attacks. Although arrivals fell immediately after the Sharm el-Sheikh bombings in July 2005, by November they had recovered strongly to 738,000 (a year-on-year increase of 8.8%). Moreover, the total number of tourist arrivals rose by 6.2% year on year in 2005, to a record 8.7m. The Egyptian government is prioritising the expansion of the tourism sector, which is a key component of the government�s comprehensive plan for economic growth and job creation. However, recovery may be slower on this occasion, if fears grow of an endemic problem in Sinai.

Tourism 2004 2005 2006 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr JanNo. of visitors (�000) 1,911 2,390 1,912 2,101 2,160 2,125 2,265 706

Receipts (US$ m) 1,321 2,111 1,401 1,450 1,468 2,322 1,611 n/aReceipts/tourist (US$) 691 883 733 690 680 1,093 711 n/a

Source: Central Agency for Public Mobilisation and Statistics; Central Bank of Egypt.

A key determinant of whether Egypt will be able to meet the government�s official target of 16m tourists a year by 2015 is the degree to which the authorities are prepared to allow the dominance of EgyptAir, the state-owned carrier, to be challenged. The World Travel and Tourism Council says that to meet the target of 16m by 2015, an additional 285 international flights to Cairo, 425 international flights to other Egyptian airports and 530 domestic flights are required per year. The study says that EgyptAir cannot achieve this with its current fleet of 38 commercial planes. The company has announced that it will buy up to 12 of the new Boeing 737-800 aircraft for US$850m. Each plane carries 159 passengers and is to be used on EgyptAir�s European and Middle Eastern routes. A recent press report revealed that EgyptAir intends to raise capital through a 20% initial public offering (IPO) on CASE to help pay for the expansion of the fleet to 52 planes by 2009, and possibly to 64 by 2010. The Ministry of Civil Aviation is commissioning two studies, to be completed by the end of 2006, to prepare for the IPO in 2007. EgyptAir has long been considered

EgyptAir intends to go public to raise new capital

Egypt 35


one of the most inefficient carriers in the world. As recently as 2001/02 the company reported losses of E£1bn (US$175m). According to Business Today, EgyptAir finally turned things around in 2004/05, posting a profit of E£431m (US$76m) on turnover of E£6bn. In 2005 EgyptAir invested E£45m in training its 24,000 employees, but has not followed recommendations from consulting firms to reduce its workforce.

One of the main constraints on the airline industry has not only been EgyptAir�s inefficiency, but also its outright domination of domestic flights. A handful of local and regional charter companies have recently begun operations, most notably Orascom Hotel Development�s SunAir and Tunisia�s Kharthago Airlines, which both began operating in Egypt in April. Cairo Airport is also undergoing expansion and upgrading in order to accommodate more passengers. A new terminal, Terminal 3, is being built by a Turkish company TAV Hol, for US$350m, of which the World Bank has provided US$280m in loans, and is due to be completed by July 2007. Cairo�s other two existing terminals have been undergoing renovations to improve capacity and aesthetics.

Foreign trade and payments

According to balance-of-payments data from the Central Bank of Egypt, the trade account recorded a deficit of US$2.7bn in the fourth quarter of calendar 2005. The trade deficit narrowed in quarter-on-quarter terms, from US$3.2bn in the third quarter, and also in year-on-year terms, from US$2.8bn in the fourth quarter of 2004. Total export earnings climbed by 41% year on year to US$4.5bn in the fourth quarter, while the import bill rose by 19% to US$7.2bn over the same period. However, in a six-month comparison, the trade deficit widened to US$5.9bn in July-December 2005 from US$5.1bn in the same period of 2004, on the back of a 26.3% surge in import spending, to US$14.4bn. Export earnings in the same period also rose strongly, by 35.5% to US$8.6bn, but not by enough to offset the growth in the import bill.

The surplus on the oil merchandise account widened to US$985m in July-December 2005 from US$680.1m in the same period of 2004, owing to a surge in crude oil and natural gas earnings. Natural gas earnings rose by a massive 1,935%, from US$19m to US$386.7m, as gas from the Train 2 at the Egyptian Liquefied Natural Gas Company�s sites in Idku came on stream in September 2005, boosting gas output. High international oil prices lifted crude oil export earnings to US$759.7m in July-December 2005 from US$475.9m in the same period of 2004. However, high oil prices meant that the crude oil import bill also rose, to US$816.1m in the second half of 2005 from US$153.5m in the same period of 2004.

The foodstuffs and cereals merchandise accounts both recorded deficits, as did those of electric appliances and equipment, base metals and products, and vehicles, passenger cars and other transportation goods. With the exception of the oil merchandise account, only the cotton and textiles account recorded a surplus in the second half of 2005. Egypt suffers from a structural deficit on its foodstuffs account, with an import bill of US$430.1m in the second half of 2005 substantially offsetting export earnings of just US$64.3m. The largest categories

Trade deficit narrows slightly in the fourth quarter

36 Egypt


of food imports are animal fats and oils, meat, raw sugar and fish. Tobacco is another big item on the import bill. Not including hydrocarbons, Egypt�s largest export earners are iron ore, steel and steel products, aluminium and its derivatives, chemicals, textiles and air conditioners.

Quarterly current account (US$ m)

2004 2005 Apr-Jun Jul-Sep Oct-Dec Jan-Mar Apr-Jun Jul-Sep Oct-DecTrade balancea -2,301 -2,255 -2,838 -2,128 -3,139 -3,198 -2,662 Export receipts 3,049 3,109 3,226 3,446 4,051 4,031 4,545 Oil 1,060 1,219 1,304 1,300 1,476 2,138 2,595 Non-oil 1,989 1,890 1,923 2,146 2,575 1,893 1,950 Import payments -5,350 -5,365 -6,064 -5,574 -7,190 -7,229 -7,207 Oil -805 -539 -1,048 -662 -1,726 -1,153 -1,406 Non-oil -4,545 -4,826 -5,016 -4,912 -5,464 -6,076 -5,801Services & income balance 1,939 2,662 1,839 1,530 1,812 2,170 2,074 Services & income receipts 3,352 4,182 3,520 3,646 3,683 4,623 4,117 Suez Canal dues 748 775 827 847 858 871 891 Travel 1,321 2,111 1,401 1,450 1,468 2,322 1,611 Services & income payments -1,413 -1,521 -1,681 -2,116 -1,871 -2,453 -2,043Transfers balance 1,212 1,076 1,349 1,593 1,411 1,355 1,390 Official net 392 265 351 342 99 90 211 Private net 820 811 998 1,251 1,312 1,265 1,179Current-account balancea 850 1,482 350 995 84 327 802

a May not sum because of rounding.

Source: Central Bank of Egypt.

Egypt�s services and income account recorded a surplus of US$4.2bn in the second half of 2005, compared with a surplus of US$4.5bn in the same period of 2004. The narrowing of the surplus was due to an increase in payments, from US$3.2bn to US$4.5bn, as both investment dividends and government payments abroad increased, although interest payments fell. Services and income receipts also increased, from US$7.7bn in July-December 2004 to US$8.7bn in the same period of 2005, owing to large increases in services receipts from transportation (including from the Suez Canal), �travelling� (including tourism revenue) and investment income. Net transfers also increased, by 13.2% year on year, to US$2.7bn in the second half of 2005, mainly because of workers� remittances from abroad, which rose to US$2.47bn in the last six months of 2005 from US$1.78bn in the same period of 2004. The largest share of remittances came from Egyptians in the US, but significant inflows also came from Kuwait, Saudi Arabia and the UAE. However, the increase in the transfers surplus did not fully offset the contraction in the services and income surplus and the widening of the merchandise deficit, resulting in a narrowing of the current-account surplus in the second half of 2005, to US$1.13bn, from US$1.83bn in the last six months of 2004. For the full calendar year of 2005, the current-account surplus was US$2.2bn, down from US$3.2bn in 2004.

According to the Central Bank, the capital and financial account recorded total net inflows of US$2.8bn in the second half of 2005, compared with a net outflow of US$360m in the same period of 2004. This was mainly because of a

The current-account surplus narrows in calendar 2005

FDI and portfolio investment boost the capital account

Egypt 37


strong rise in net inflows of foreign direct investment (FDI), which reached US$3.3bn, including US$1.9bn of investment in the petroleum sector and some US$520m in privatisation proceeds, in the second half of 2005. Net portfolio investments in Egypt also rose strongly in year-on-year terms in the second half of 2005, reaching US$2.8bn, up from US$121m in the same period of 2004. This was helped by the strong performance of the Cairo and Alexander Stock Exchange, which rose by 132% in 2005 (February 2006, The domestic economy: Financial and other services).

Quarterly capital account (US$ m)

2004/05 2005/06 Jul-Sep Oct-Dec Jan-Mar Apr-Jun Jul-Sep Oct-DecDirect investment abroad -5.0 -6.9 -6.2 -20.9 -18.6 -46.3

Net direct inward investment 774.5 1,064.9 1,220.1 842.3 1,947.0 1,366.2Portfolio investment abroad 72.9 179.9 304.1 -16.3 78.5 -426.2

Net inward portfolio investment 38.6 82.5 461.1 248.9 2,579.2 238.9Net borrowing (incl bonds) 76.6 707.5 11.5 205.0 -39.5 770.9

Other assets -2,093.2 -1,165.1 113.0 -34.7 -2,293.8 -1,030.4 Central Bank -0.8 -19.7 19.1 24.4 5.6 -48.9 Banks -899.6 -927.3 -324.3 -20.4 -1,550.1 -870.6 Other -1,192.8 -218.1 418.2 -38.7 -749.3 -110.9Other liabilities -275.2 190.3 -37.4 444.9 -443.5 161.9Capital-account balancea -1,410.8 1,053.1 2,066.2 1,669.2 1,809.3 1,035.0Net errors & omissions -174.3 -585.7 -523.2 -527.4 -324.1 -1,056.1Overall balance of payments -103.1 817.1 2,538.0 1,225.7 1,811.9 740.0Change in reserve assets 103.0 -817.1 -2,628.0 -1,225.7 -1,811.9 -740.0

a May not sum because of rounding.

Source: Central Bank of Egypt.

Although the current-account surplus narrowed in year-on-year terms in the last six months of 2005, the fact that Egypt has continued to record strong surpluses, and attract robust capital inflows, has enabled the country to continue to accumulate foreign reserves. According to the IMF�s International Financial Statistics, foreign reserves, excluding gold, rose to US$20.6bn by end-December 2005, up from US$14.3bn at end-December 2004. However, given strong growth in import demand, the rise in foreign reserves in terms of import cover was more modest. Import cover stood at 9.1 months at end-December 2005 (using calendar year balance-of-payment import data), compared with 8.9 months at end-June 2005 and 8.6 months in calendar 2003. New data from the Central Bank put Egypt�s foreign reserves at US$22.5bn at end-March 2006.

Foreign reserves (US$ m)

2003 2004 2005 Dec Dec 1 Qtr 2 Qtr 3 Qtr 4 QtrTotal reserves excl gold 13,589 14,273 16,876 18,043 19,792 20,609

Source: IMF, International Financial Statistics.

Foreign reserves strengthen in 2005

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