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Egypt- Coping with 9/11 and the Global Slowdown

By Scott B. MacDonald

With the events of 9/11 and the U.S. assault on Afghanistan, business throughout the Middle East and North Africa has suffered. Egypt, in particular, is racing to deal with a slumping tourist industry, falling exports to the West and creaky public finances. The Egyptian economy is strongly linked to the West, through trade and tourism as well as worker remittances. Consequently, the global economic slowdown has a sting, which although painful, is manageable.

Egypt has come a long way since it started down the road of an IMF-sponsored economic reform and stabilization program in 1991. This program focused on trade liberalization, land reform, exchange rate unification and devaluation, the privatizations of parastatal enterprises, and the reduction of food and other subsidies. All of these programs created a foundation for a more efficient economy. Private sector participation in the economy increased significantly over the past decade as a consequence of these changes and stimulated a quicker pace of economic expansion. In addition, the planned development of the country's significant natural gas resources is promising for future export expansion. This would go a long way to reduce the traditional heavy dependence on tourism, workers' remittances, and Suez Canal fees for foreign exchange earnings.

While considerable progress has been made, the reform process has slowed in 2000 and 2001. The privatization of parastatals has slowed and public sector debt remains high. Growth is expected to slow to 3% in 2001 and the government is struggling to contain large fiscal expenditures. The budget deficit is expected to be a substantial 5.4% of GDP by year-end. The rating agencies, which give the country Ba1/BBB- credit ratings, are also growing increasingly bearish, especially Standard & Poor's which has a negative outlook. With a slowdown in global economic growth, Egypt is clearly feeling the pressure. Consequently, the market increasingly expects a further devaluation of the Egyptian pound before year-end. According to a recent Reuters poll, analysts expect the pound to weaken against the dollar to 4.33 by end-2001 and 4.75 by end-2002, from 4.25 at present. The currency has been trading at the weaker end of the band since its 6% devaluation in August 2001 (it is allowed to trade +/- 3% around a central rate of 4.15).

We expect that tourism revenues are likely to decline by around 25% year-on-year over the next 12 months (a decline in FX revenues of about US$ 1bn). Two other key sources of foreign exchange for Egypt are also likely to fall due to the slowdown in the international economy - remittances from workers abroad (about US$ 3.0-4.0bn per annum) and Suez Canal revenues (US$ 2bn per annum). The Central Bank of Egypt is reportedly once again restricting the supply of hard currency to local companies and banks, to artificially support the currency and maintain FX reserves. This is a practice that has been criticized in the past as it could lead to the re-appearance of a black market for hard currency. Despite the delicate nature of such maneuverings, Egypt still maintains $14 billion in foreign exchange reserves. This is equal to three times the level of Egypt's short-term public external debt.

The most recent IMF Article IV report (released November 5, 2001) commended Egypt for the "progress made in strengthening the economy over the past decade by substantially reducing the fiscal deficit, bringing inflation to low levels, improving debt service indicators, and advancing structural reforms." It also noted that the "key challenge in the period ahead is to restore strong economic growth and robust job creation, while maintaining macroeconomic stability." A renewed emphasis on structural and financial reforms, including the long-discussed privatization of a number of banks, was advocated. In the medium term, the IMF also recommended a reduction in public sector debt (including foreign debt), equal to 64% of GDP.

It is important to underscore that Egypt is advancing the reform process, despite a somewhat slower pace. Parliament approved in June 2001 a law promoting the development of a mortgage market. This includes provisions for strengthening the potential claim of lenders over property collateral. In addition, a draft money laundering law has been prepared to criminalize this activity, reinforce penalties, and create a central authority to supervise and coordinate detection and enforcement efforts. On the privatization front, a number of smaller companies were privatized last year as was a large cement company in September 2001.

Like most Middle Eastern countries, Egypt faces a challenging economic future in which it must balance public opinion and economic realities. Although a large part of the Egyptian public is opposed or lukewarm to the U.S. war on terrorism (especially the military action against Afghanistan) and is often ambiguous about its relations with the West, the economy is strongly linked to Europe and the United States. The country receives around $2 billion a year from the United States and is regarded as a key ally in the region. The likelihood of a new conflict with Israel is remote. Moreover, the connection with Europe is improving. In June, 2001, the Egyptian government signed an Association Agreement with the European Union which, once ratified, will provide for a phased, multi-year reduction on tariffs on EU imports. This is expected to help boost Egyptian exports to key European markets.

The fundamental challenge for the Mubarak administration is to balance managing the economy with an eye toward those strong economic links to the West and the need to be supportive of international trade and commerce with a public that is not thrilled by the seemingly pro-Israeli tilt of Washington. Moreover, radical Islamists though defeated, have not been entirely crushed and have the potential for creating greater problems (especially vis-à-vis the tourist industry). One of the ironies of the terrorist attacks on America is the consequential economic pain to one of Islam's largest countries in the form of an economic slowdown. Considering the geo-strategic importance of Egypt to the West and the Mubarak government's own interest in seeing Islamic radicals defeated, one of the battlefields in the war on terrorism is the Egyptian economy. This could mean a higher level of U.S. economic support and clearly, if needed, more active assistance from multilateral agencies such as the World Bank and International Monetary Fund.

Egypt has made considerable progress on the economic front since the 1980s when there was deep concern that the country might default on its external debt. Now that threat is far removed, but many of the challenges remain in what is now a more difficult international environment. Much will depend on the government's ability to balance the needs of its population with tough geo-political realities.