Egypt outlook

Quarterly update

By Nenad PacekFebruary 2011

Contents

• Political risks and outlook and bottom line for companies• Economic fundamentals• Growth trends and drivers• Household consumption trends• Gross fixed investment trends• Government spending trends• Currency outlook• Interest rates and inflation rate outlook• Forecast table

Political risks and outlook

• After the removal of ex-president Mubarak, the Supreme Military council is in charge of steering the country towards new elections

• The military council is headed by Field Marshall Tantawi, a long-standing friend of ex-president Mubarak

• The military played the role of a “good, neutral guy” during the revolution and has so far been able to protect its standing in the population

• But this relatively good standing can quickly evaporate if the opposition parties and protesters see that the military council is really going to “steal the revolution”

• The military has dissolved parliament and it made a promise to allow free elections in about six months

• A newly formed committee (which also includes a representative of the Muslim Brotherhood) is now rearranging a few clauses in the constitution that should allow free elections

Political risks and outlook II

• A full set of constitutional changes will be left for after the elections• The current changes are just aimed at amendments that would allow free

elections in six months and allow independent candidates and new political parties to participate

• The key constitutional articles 76, 77, 88, 93, 179 and 189 are particularly being looked at because amendments would remove rules such as “you have to have 250 signatures from elected parliament members if you want to run for president” (obviously, no one could meet such criteria in the past)

• The details of the amendments will be known soon but we do not expect surprises – amendments will allow interested parties and individuals to participate in the electoral process

• Any suspicion by the opposition that the military council will try to fudge the rules will be met by more protests

Political risks and outlook III

• Egypt has a temporary government now appointed by the military council whose make-up has already caused “foul” cries from opposition leaders

• The ministers of justice, foreign affairs, interior and defence are unchanged

• There are 10 new ministers, some from opposition but not in key roles• While this is annoying to the opposition, as long as constitutional

amendments are acceptable, we are unlikely to see massive protests and elections should go forward as planned

• The military council will not want to risk upsetting an agitated population • The military establishment also does not want chaos in the future – many

high ranking military officials own, co-own or participate in a number of business ventures and will want to protect their business interests

• Ultimately they want Egypt that will prosper (and in which rules of the game will be favouring domestic firms) so that they can make more money

Political risk and outlook IV

• The military is also happy that Gamal Mubarak-driven, pro-business government is now out of the picture (which is bad for Egypt over the medium term – see our first alert from a few weeks ago)

• Even before the political crisis there was growing power struggle for influence over business deals between the military-statist establishment and the technocratic government

• It is now clear which option will get more business deals and have a bigger influence on behind-the-scenes policy decision making

• In our previous updates we were consistently bullish about Egypt prospects under the recently removed pro-business government – companies were reporting record sales growth and Egypt was among the biggest emerging market corporate priorities

• Our medium term fear is that whatever the outcome of elections, the future economic policy will be more statist and worse for multinationals

Political risk and outlook V

• Executives with long experience in Egypt will remember the statist years between 2001 and mid-2004 when Egypt was literally falling apart, when it ran out of foreign exchange reserves, when it had constant black market exchange rate and when businesses were pulling out of the country

• The worst case scenario for companies is that some form of a statist government is elected after new elections (in the background co-ordinated by military business interests) and that we go through a number of difficult economic years with more protectionism of the domestic business interests

• We are quite certain that Egypt, after the upcoming elections, will not have a pro-business, high-calibre technocratic government it had prior to the protests -- operational environment could get more difficult and companies should be more cautious with their 3-5 year sales/business plans for Egypt

Political risks and outlook VI

• Although it is too early to make strong predictions, we think the base case political scenario is the following:

• Elections take place in six months and major political protests until then are avoided

• The elections are, in the words of one our clients, “somewhat managed” by the military intelligence in order to try to secure a secular party or group of parties in the government (or in worst case with the minimal influence of moderate Islamists)

• A new government is then formed but it has to cope with massive economic problems, low growth, booming budget deficit and weaker pound

• Bottom line for companies: count on significantly weaker sales in the short-term (12-18 months) and over the medium-term lower sales growth than usual (coupled with more complicated business environment)

Political risks and outlook VII

• Another quite plausible scenario is that moderate Islamist party or parties win the majority in elections (although Muslim Brotherhood has so far said it is not going to have a presidential candidate – we will see)

• In such a scenario it could be that the moderate Islamists indeed prove to be similar to Erdogan’s AKP in Turkey and that Egypt (like Turkey) is run in an uneasy co-existence between the secular army and the religious (but not extremist government)

• Companies, based on the current information, should not be alarmed about this scenario – if the new government indeed resembles Erdogan’s in Turkey, business could be steadily improving from a shattered base

• But in such scenario, the military would stand by and monitor closely if the government would go towards Sharia law or Islamist state of some kind – this would not allowed and could lead to a military coup down the road

Economic fundamentals – from good to shaky in the next few years

• Egypt vastly improved its economic fundamentals since 2004, but debt levels, reserves and deficits will get worse in 2011

• Population is 87m people, expected to grow by at least 1.5m people every year

• External debt is now less than 15% of GDP, one of the lowest percentages of any country in the world, but it will accelerate fast as current account deficit rises in the next few years

• Foreign exchange reserves dropped a little to $35bn (8 months of imports) but they will decline in 2011 and in the worst case could get uncomfortably low if the central bank is forced into frequent currency interventions

• Public debt has been reduced from a staggering 130% of GDP in 2005 to less than 80% (still high, but slightly lower than European Union avg.)

• Public debt was on a good, downward trajectory but will increase sharply as budget deficit goes into double digits and off

Growth trends and drivers – severe slowdown

• Traditional drivers of growth (tourism, FDI, remittances, exports), except Suez Canal, will be affected in the next at least 12 months but possibly longer

• Corporate enthusiasm for Egypt has largely evaporated• Growth will slow down substantially during 2011• In our recent regional paper we have already downgraded Egypt growth

for 2011 • We expect 2.5-3.5% growth in the base case scenario of relative political

calm until and after elections, largely driven by a series of fiscal stimulus packages financed with expensive short-term borrowed money

• In the worst case scenario, there is a real possibility of recession and executives should count on that and communicate this scenario upwards within their companies

Growth trends and drivers II

• A number of factors will slow corporate sales and economic growth in the next 12-18 months– Production disruptions due to increased number of strikes and lack of domestic demand– Capital outflow (so far 8-10bn dollars left the country in the last few weeks only)– Lack of FDI– Lack of investment by local conglomerates – A significant decline in tourism revenues (hotel occupancy is now around 10%)– Weaker export markets in the area and in the EU– Lower remittances due to problems in key “money sending” markets, but also fears that

money sent might be stuck somewhere in the local banking system– Currency depreciation which will increase inflation and make imports more expensive

(reducing domestic spending of imported goods)– Lack of government spending on infrastructure and large projects (as borrowed cash is

diverted into higher subsidies and maintenance of social peace in the short-term)– Lower tax/customs revenues, booming budget deficit will reduce ability to invest also in

the next few years and high premiums on borrowing will reduce ability to spend overall

Growth trends and drivers III

• To try and control the economic damage, the interim government will surely continue with sizeable stimulus and subsidy packages

• The government will have to borrow substantially to be able to increase spending – at the moment it can sell T-bills but at almost 11% premium but in the worst case scenario it could face increasingly prohibitive rates

• IMF might step in to help temporarily but such borrowing will come with strings attached (less spending, higher interest rates) – a scenario which is also bad for corporate sales in the short term

• Budget deficit will skyrocket to between 10 and 13% already in 2011 and stay high also in 2012

• Although the military council has banned industrial strikes, they will continue sporadically and continue to negatively impact production and industrial output (and exports)

Household consumption

• Household spending was growing 5% per year until a few weeks ago• The outlook for consumer goods firms is weak although companies that

manufacture cheaper brands locally will do better than those relying on imported products

• We expect no growth in household spending in 2011 and in the next two quarters there is a strong possibility of sales decline year-on-year

• Lack of confidence, lower tourism revenues, lower remittances, sporadic protests and strikes will all keep domestic household consumption significantly below levels that companies are used to in the last few years

• Rising inflation rate will reduce disposable incomes and spending on bare necessities will be the core mode of consumption

• Move to cheap brands will accelerate• Spending on consumer durables will fall more than on food and beverages

Household consumption II – corporate opinion

• “We just got the approval in December from our board to increase local presence in Egypt and to build a factory. I know many other companies were planning to do the same. Now, everything is on hold. We are not sure where all of this is going. Sales have virtually stopped for a few weeks but the last few days we are seeing some return to normality. I hope the country does not explode again before summer elections. Or after elections. I will be surprised if we manage any sales growth this year.” Regional director, Food and beverages multinational

• “2011 will be catastrophic for business. We will have to cut staff and other costs. I don’t expect much spending on new TVs in the current environment”. Regional director, consumer electronics manufacturer

• “We have just gone through a quick re-forecasting exercise and expect sales to decline up to 15% until the summer.” Regional director, consumer goods firm

Gross fixed investment

• Corporate purchases as a whole were down almost 10% in 2009, worst in years and in sharp contrast to over 15% annual growth between 2005 and 2008

• Gross fixed investment recovered in 2010 to 7.5% • Just as corporate spending was supposed to grow again in double digits

the severe disruption has changed B2B prospects for 2011 and 2012• FDI will drop sharply until there is full clarity related to politics and many

investors will delay investments much longer• Domestic conglomerates’ enthusiasm to invest in the domestic market has

dropped sharply and many will either sit on their cash and will try to move it abroad

• We expect corporate spending to shrink at least 10-15% in 2011, but in some segments it might get much worse

• 2012 will stay weak (base case flat vs. a weak 2011)

Gross fixed investment II

• A number of planned major industrial and infrastructure projects (such as Upper Egypt, Suez, Port Said, West Alexandria....) will be now put on hold and the previous opportunity for companies to join some of those projects under Public Private Partnership arrangements is unlikely in the short-term

• The plan to spend $20bn every year in the next decade on various infrastructure projects (water plants, wastewater plants, highways, hospitals, schools, power generation etc.) will not happen in 2011 and 2012 as money is channelled into subsidies and current spending rather than investment spending

• All of the above plans were supposed to have a tremendously strong impact on corporate spending, but companies will have to wait at least two years before, maybe, some of this is put in motion (provided that all goes reasonably well after the elections and that the government does not resemble the one between 2001 and mid-2004)

Gross fixed investment – corporate opinion

• “Our major customers are coping with workers’ unrest and survival. All business is on hold and will be for a while. I am monitoring our costs and we will have to cut them very quickly. What a reversal of our corporate plan which was all about growth, growth!” Regional director, industrial company

• “I have been working for multinationals here for 22 years. 2011 will probably be the worst year ever. And we had some bad years in the past. All our orders have been cancelled, except one. I am asking my middle managers to take a collective pay cut and we have stopped all promotional activities.” Country director, industrial company

• “What is clear at this stage is that our sales will go from double digit growth to double digit fall. Only our customer servicing contracts will keep us alive until the summer.” Regional director, IT company

Government spending trends

• After substantial cuts in public debt over the last 7 years, we now expect the public debt to rise to close to 100% of GDP again in the next two years

• This increase will be fuelled by sharp increase in budget deficits in the next two to three years, particularly in 2011 when it will go into double digits

• However, companies will not benefit much from higher budget deficit since most of it will be a result of lower tax intake, rather than more spending

• In fact most new spending will go to placate the population’s anger with high food prices and rising costs of new borrowing

• All of this is bad news for companies which were counting on new investment spending by the government

• It remains to be seen how elections will go and what the priorities will be, but in 2011 and 2012 budget allocations will be more about fire-fighting

Currency outlook

• The Egyptian pound has been broadly stable nominally in the last five years

• Due to improving fundamentals and inflows of long-term FDI capital, the pound was a fundamentally solid currency

• The pound is now on a somewhat shaky ground and it has already weakened to 5.9 vs. $ and to 8.11 vs. the euro

• The central bank is trying to prevent the local population to sell off the pound in a panic – it has put the limits on how much foreign currency can be withdrawn by savers

• It is also trying to prevent bank panic by providing enough cash (pounds and foreign currency) to the commercial banking system

• The central bank has enough reserves to intervene against currency weakness for a while

Currency outlook II

• Weaker inflows of capital and weaker tourism and exports will create a more unstable environment for the pound

• We expect the pound to weaken further and to average 6.3 against the dollar and 8.4 against the euro in 2011

• It is likely to stay at similar levels also in 2012 – all provided that there is a favourable outcome of the elections and that there are no further major disruptions until elections

• However, companies should put a footnote in their plans for Egypt related to the possibility of a more severe currency depreciation in the short-term

• Over the medium-term, if the more statist elements of the political scene (see Political outlook earlier) gain an upper hand after the elections, we could again see several years of currency mismanagement, sharp depreciation, lack of reserves and the return of sizeable currency black market

Interest rates and inflation outlook

• Overnight interbank interest rates have gone up somewhat to 9.14% and overnight lending rate is now 9.75%

• Inflation rate year-on-year is currently 10.8% (food inflation over 20%) which means that real interest rates are still negative

• The central bank might be forced into increasing rates in case of any pound related panic – if that happens it will further reduce growth in the short-term

• In recent past, the central bank allowed negative real interest rates to support growth but now it might be forced into defending stability with higher interest rates which would hurt growth and corporate sales in the short term

• Inflation rate is likely to stay high – based on sharp price rises of food we expect inflation rate of 13% in 2011 (base case) – the government will try to control price increases through higher subsidies

Forecast table – selected indicators – base case

  2009 2010 2011 2012 2013

Real GDP growth, % 4.6 5.3 3.0 3.5 4.0

Household consumption, % 4.5 5.0 0 2.0 3.0

Gross fixed investment, % -9.3 7.5 -11.0 0 4.0

Government spending, % 8.1 7.5 8.5 7.0 5.5

Exchange rate vs. $ (average) 5.45 5.65 6.3 6.2 6.0

Inflation rate, % (average) 13 12.0 13.0 12.0 11.0

Budget balance, % of GDP -7.1 -8.2 -11.5 -10.0 -8.5

Current-account balance, % of GDP

-1.6 -1.5 -3.9 -3.0 -2.8

For more insight or data, please do not hesitate to contact us

• CEEMEA Business Group corporate service currently assists regional directors of 210 major multinational companies with economic assumptions on global economy, CEEMEA markets economic and business outlooks as well as key business trends. Executives also have regular opportunities to network in a series of private club meetings taking place in Europe and the Middle East.

• Nenad Pacek is an international economist, business strategist, professor and sought-after public speaker. He is the acclaimed lead author of „Emerging Markets: Lessons for business success and outlooks for different markets“ which is currently in its second edition.  Nenad advises global and regional directors in business and economic issues in emerging markets.

• Nenad is also founder and president of Global Success Advisors, a boutique advisory firm assisting global and regional directors of multinational companies with understanding and implementation of ever-evolving and best business practices in emerging markets as well as regular updates about virtually all countries around the world.

• Email: nenad.pacek@GlobalSuccessAdvisors.eu• Mobile: +43 676 646 0607

Disclaimer, sources, copyright

• Source: GSA Global Success Advisors GmbH research• Copyright GSA Global Success Advisors GmbH 2011

• Disclaimer: This material is provided for information purposes only and it has been researched to the best of author‘s and company‘s ability. It is not a recommendation or advice for an investment or commercial activity whatsoever. GSA Global Success Advisors GmbH accepts no liability for any commercial losses incurred by any party acting on information in these materials.

• Basic data sources come from central banks, own intelligence network, governments and public sources. Interpretation, views, forecasts, corporate interviews and business outlooks by GSA Global Success Advisors GmbH.