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Egypt’s Economy: Neither Collapsing nor Thriving

The reality is that Egypt’s economy is neither on track to collapse nor is it likely to “boom.” The truth is decidedly less extreme yet remains troubling. Egypt’s economy won’t collapse because its international partners won’t allow it to. Egypt is too big to fail and the government knows it.

Earlier this summer, a pair of articles in Foreign Policy were published offering seemingly diametrically opposed views on Egypt’s economy. Yehia Hamed, investment minister under the late president Muhammad Morsi, argued the economy was on the verge of “collapsing.” In response, Ahmed Shams El Din, head of research at EFG Hermes offered a rebuttal that suggested the economy was “thriving.” The idea that Egypt’s economy is thriving will certainly be news to the millions of Egyptians who the government has just reported have fallen below the poverty line since the last poverty survey conducted in 2015, with the poverty rate officially having risen from 27.8 percent to 32.5 percent.

The reality is that Egypt’s economy is neither on track to collapse nor is it likely to “boom.” The truth is decidedly less extreme yet remains troubling. Egypt’s economy won’t collapse because its international partners won’t allow it to. Egypt is too big to fail and the government knows it. Critics of Egypt’s economic policy, including Hamed, warn that its effects could spark a wave of mass migration. In his article, Hamed insists that “when a country begins to fail, it is only a matter of time before the people take matters into their own hands or start to look for somewhere else to call home.” While economic underperformance and limited opportunities encourage people to migrate, those realities have been a feature of life in Egypt for decades, not years, and the idea that there will be a sudden explosion of Egyptians crossing the Mediterranean is unrealistic, however much it may resonate with a European Union that is increasingly paranoid about an uptick in migration.

The criticism of Egypt being too heavily dependent on debt is valid. External and internal debt have risen substantially in recent years and the cost of servicing this debt eats up a substantial proportion of state revenue, and some economists fear that Egypt will be unable to service its external debt in the long term given Egypt’s small and shrinking export base. While Shams El Din indicates that debt levels remain manageable as a percentage of gross domestic product (GDP), the issue is, to date, the state has failed to adequately increase revenue and will continue to depend on debt financed growth to sustain itself and its ambitions. Although some of this this debt is low interest and owed to the countries of the Gulf and to the International Monetary Fund (IMF), much of the new debt raised from the private sector is at much higher interest rates, more than triple the rate of GDP growth. Borrowing at these rates is unsustainable, and high interest rates domestically stifle growth, as borrowing costs deter businesses from expanding.

Egypt has yet to succeed at overcoming some of the key structural challenges that have hampered its growth and caused its economy to hobble from bailout to bailout and crisis to crisis for decades. Its already high trade deficit is actually growing despite the collapse in the value of the pound and a variety of increases in customs paid on imported goods. Manufacturing also remains heavily dependent upon imported materials and machinery. Moreover, bureaucratic hurdles at customs complicate Egypt’s ability to better integrate into modern supply chain production. Exports are actually declining despite the competitive advantage the float of the pound was meant to offer.

Those such as Shams El Din who claiming that billions of dollars invested in Egyptian debt represents confidence in Egypt’s economic prospects are making an untenable argument. Fixed income fund managers have been focused on buying short term Egyptian debt, much of it limited to 6-12 months. What does this tell us? Investors are happy to cash in on very high interest rates at a time with minimal risk of default (when Egypt is in the middle of an IMF bailout) but are far more worried about committing to holding large amounts of Egyptian debt in the long or even medium term. Over half of Egypt’s external debt is short term at the moment. If investors were confident in Egypt’s long term economic prospects, they would be more open to taking longer term positions with their fixed income investments. A far more realistic reading of their aversion to doing so is that it demonstrates a lack of confidence in Egypt’s long term economic health.

Aside from interest in Egypt’s debt, foreign direct investment (FDI) in Egypt remains stubbornly low, consistently missing the government’s target of $10 billion. The overwhelming majority of FDI is in the oil and gas sector, which attracts investment regardless of economic outlook. Non-oil FDI in the first quarter of 2019 dropped nearly 45% compared to the first quarter of 2018 to a mere $400 million. Even Egypt’s domestic business community has not been bullish. The purchasing managers’ index (PMI) over the past few years has mostly been below 50 (negative and indicating a decline in purchasing by manufacturers) and when it does rarely break 50, it barely does so, suggesting very modest and brief increases in purchasing in the manufacturing sector. The EGX30, an index of Egypt’s stock market, is also down 4.3 percent year on year as well and fell 7.4 percent in the last quarter. These figures certainly do not suggest that Egypt’s economy is “thriving.”

The IMF program has been centered on cuts to Egypt’s expenses in an effort to bring the deficit under control and while it’s true that the subsidy cuts have helped on that front, this fad diet lacks a sustainable improvement in muscle mass and metabolism, that is to say revenue and growth. Egypt’s tax-to-GDP ratio remains a mere 15 percent. While the government has offered tax holidays hoping to change that by encouraging more businesses to register themselves, we’ve yet to see sufficient progress. While the government is celebrating growth rates of 5 percent, the reality is that in order to begin to pull itself out of poverty the government will need growth rates closer to at least 7-8 percent, especially given the rate of population growth Egypt is witnessing. The pressure to grow is exacerbated by the recent increase in the country’s birthrate.

The elephant in the room that the IMF avoids tackling directly, military- and other security sector-owned enterprises, are a formidable hindrance to Egypt’s economic transformation. The military and security sector’s aggressive expansion in Egypt’s economy has scared away potential investors and squeezed existing ones. This is notable in the cement sector, where Egypt’s manufacturing capacity was already oversaturated before the military decided to build a billion-dollar cement plant, placing further pressure on the sector and forcing layoffs among private sector producers. One German-owned cement factory has halted production and is reportedly considering liquidation. Moreover, given that the government is among the largest single purchasers of cement, the military’s unique access will likely will shield it from the consequences of exacerbating this glut in capacity.

Aside from deterring investment, the military’s enterprises do not share a comparable tax burden to private sector peers. Ultimately this means that every bit of market share the military takes from the private sector is a loss for potential tax revenue that could have been paid by a civilian alternative. This exacerbates the state’s revenue challenges because military enterprises as semi-public enterprises present the worst of all worlds in this respect. It shares many of the inefficiencies of public enterprises without even the promise that profits would feed back to state coffers, as the military keeps its accounts separate and a constitutionally protected secret.

Finally, the military receives an array of no bid contracts from the government, particularly in infrastructure. It then often proceeds to take its cut before farming out the work to subcontractors. This system means that the government is paying a markup on a large portion of its vital infrastructure work so that the president can continue to distribute patronage to the institution upon which he depends most to remain in power. Given the government’s already squeezed resources, this is a costly source of waste amid high poverty levels, with many Egyptians in poverty having no means-tested cash transfers to assist them to cope with the austerity measures they are enduring.

As has happened repeatedly in the past, when this unsustainable cocktail of waste, mismanagement, inefficiency, corruption and debt comes to a head, Egypt’s debt will be restructured and a bailout will be available if need be. That said its economy will not “boom,” because in an opaque investment environment where investors lack access to reliable data, and the military continues to expand its non-competitive grip on the market, FDI will not be forthcoming at a sufficient rate. Egypt will continue to hobble along, underperforming compared to most of its emerging market peers, and the Egyptian people will continue to be trapped in growing levels of poverty as a result of a government more interested in serving itself than it is in serving them.

What adds to the tragedy of all this, is that Egyptians have been asked to sacrifice so much in terms of subsidies and purchasing power with the promise that there will eventually be an economic reward, but given the track Egypt is on, they’re likely only to experience the sacrifice side of this arrangement.


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