A general view of the Egyptian Stock Market in the capital Cairo on January 6, 2013. (KHALED DESOUKI/AFP via Getty Images)

When Private Isn’t Private: The Blurred Lines of Regime-Owned Enterprises in Egypt

10/09/2020 . By Timothy E. Kaldas

Once again, Egypt has received financing from the IMF, and once again the IMF has pledged that funding will contribute to a reform program designed to lead to inclusive private sector-led growth. However, due to the evolving sophistication of the regime’s political economy over the past decade, it’s likely that the IMF’s traditional areas of focus—such as privatization of state-owned enterprises (SOEs) and deficit reduction—will be inadequate to deliver the promised results. Despite nominal privatization, the regime will likely continue to dominate and expand its control over economic growth sectors while ensuring the private sector’s increased dependency in order to capture much of the growth in Egypt’s economy, as private sector companies will continue to regularly depend on subcontracts from and joint ventures with what I will refer to as “regime-owned enterprises” (ROEs).

A regime, by definition, is the coalition of ruling institutions and elites that exercise high levels of control and influence over the state, while neither defined by nor limited to the state. This control enables securing rents and exercising power over the country at large, but that power exists beyond the state’s instruments. Individuals outside of official state institutions, such as retired generals and regime-affiliated elites running entities classified as “private companies” can also be regime assets. The definition of regime stands in contrast to that of the state, which is the formal and limited set of institutions that are unambiguously owned by the public and includes its security apparatus, ministries, and other institutions.

In response to growing domestic and international concerns over the expansive growth of the military’s economic activities and “public” interventions in the market, President Abdel Fattah El-Sisi proposed listing military companies on the stock exchange as a purported economic opportunity for the private sector and the public more broadly. However, rather than reduce regime interventions in the market, it’s more likely to encourage further entrenchment and expansion of ROEs going forward.

The most active and powerful set of ROEs are military-owned companies. Their profits do not flow to state coffers and are not subject to taxes, customs, or most state oversight. Moreover the state may absorb their losses when their books run into the red. Beyond the substantial and expanding economic empire owned by the Egyptian Armed Forces is a large array of companies owned and run by retired officers working closely with the regime and are tied to its extra-state activities. ROEs, outside the state on paper, are often considered by international finance institutions (IFIs) to be private sector market actors and not the focus of privatization reforms under discussion.

During President Hosni Mubarak’s tenure, IFIs often focused on encouraging the government to privatize SOEs. Many of these enterprises were sold off to regime elites that were tied to the ruling National Democratic Party. While these SOEs ceased to exist as officially state-owned enterprises, they remained “regime-owned enterprises.” This allowed the regime to continue to draw rents from the companies and use profits to their own interests. Regime elites would then use a portion of this wealth to fund presidential initiatives and political campaigns in the name of the president and first lady, while distributing patronage to poor Egyptians to soften the blow from reduced government aid and rising poverty levels. Indeed, the transition from SOE to ROE removed companies from state supervision and ended any public claims to their profits, allowing regime figures to use wealth from privatized ROEs with even less scrutiny, removing their finances from public records and the state budget.

Rather than rein in ROEs to make more room for a competitive private sector, the regime seeks to have the private sector invest in and work with ROEs, which expands ROEs’ access to capital while increasing the private sector’s dependence on them.

While some hope military companies listing on the stock exchange may at least have to finally open up their books and become more financially transparent, this is far from certain, as legal exceptions are regularly crafted for ROEs, particularly those associated with the armed forces which are not subject to most taxes, customs, and regulatory controls applied to private sector entities. This has manifested in situations including Egypt’s new VAT law in 2016, which exempted all military-owned companies. Regardless of whether they open their books, these companies stand to retain their anti-competitive privileges after being listed on the stock market. Laws and regulations may also be selectively applied, allowing the regime to privilege parties that serve its own political or business interests regardless of formal legal equality.

Indeed, such IPOs are likely to transform the military’s National Service Projects Organization (NSPO) into a private equity firm of sorts that builds up companies and sells equity in them to raise capital without needing to place additional burden on the state banks it traditionally borrows from and without having to tap the profits or cash flow of its existing companies. Moreover, selling A and B class shares (with far more voting power reserved for B class shares) would allow for a majority of the company’s equity to be sold without ceding control. This would be the latest step in promoting regime-led growth on which the private sector is a dependent.

This structure of relations between the private sector and ROEs can already be seen clearly in contracting, where the latter often receive noncompetitive tenders from the state and subcontract them out to private firms, ensuring that private sector profits come through a system of dependency on ROEs, rather than direct competitive access to government tenders. While most foreign direct investment (FDI) goes to the state-controlled oil and gas sector, the regime is also adept at capturing FDI shares in other areas as well. Large foreign companies that do business in Egypt often enter the country by partnering with ROEs, as was the case when Mercedes resumed manufacturing in Egypt last year, following a meeting with President Sisi himself.

While Egypt’s GDP growth has accelerated since the 2016 IMF bailout (pre-coronavirus), much of that growth has been captured by the regime through investments in the gas sector and sizable government stimulus in the form of infrastructure spending that often passed through ROEs in the contracting sector. ROEs are even active in the tourism sector, with the military building seaside resorts. In the booming real estate sector, the military has established its own property development companies while controlling the sale of state lands ensuring it takes in revenue from its competitors in the industry. Indeed, while Egypt’s economy has grown since the 2016 bailout, the non-oil and gas private sector contracted nearly every single month while poverty continued to rise.

Since the overthrow of Mubarak, the military has sought to marginalize the core civilian business elite that thrived during his tenure. Prominent businessmen close to the regime had cases brought against them, and some, like Ahmed Ezz, were sent to prison. Since 2013, the civilian business elite’s political role has been visibly circumscribed with far greater emphasis on assigning prominent roles to current and former officers.

During this consolidation, there has been a clear eye to control economic power and avoid the risk of the reemergence of the politically powerful civilian elite of the Mubarak-era. Even harsh economic reforms, such as cuts to energy subsidies, can look quite different when this political economy lens is applied, as cuts to energy subsidies were central to the business models that buoyed companies in the cement sector, in which private sector companies compete with ROEs. Moreover, as the government’s contractor of choice, the military can guarantee the sale of its cement production to the state while private companies struggle to survive in an oversaturated market (exacerbated by new military investments); adding to the list of anti-competitive advantages ROEs enjoy while further weakening the private sector.

Traditional fixation on the state and its enterprises as the locus of political intervention in the market to the detriment of private sector activity has been outdated for some time, as the regime has found ways to exercise control over companies that are no longer formally part of the public sector while continuing to deter independent private sector activity thus hampering growth and economic development. As the regime continues to blur the line between public and private enterprise, these challenges will grow.

The aggressive expansion of ROEs and their interventions in the market over the past seven years make these challenges all the more apparent and require new approaches when considering genuine reforms capable of achieving the inclusive private sector-led growth that is being advocated by IFIs and Egypt’s international partners. The current approach allows the regime to extract growing rents and raise capital, all while securing the praise and financial support of international partners who fail to acknowledge the extent to which reforms have helped expand and consolidate the regime’s power over the market, while failing to set Egypt on a sustainable path forward and improve overall living standards. Furthermore, increasingly aggressive interventions in the economy by ROEs will continue to deter independent domestic and foreign investment in Egypt’s economy, significantly hampering potential for growth and poverty alleviation. Future economic reform efforts must be framed by a more sophisticated political economy perspective to avoid simply deepening the entrenchment of ROEs at the expense of an independent and competitive private sector that is able to deliver the growth and jobs needed to accommodate Egypt in the future.

A starting point for reform that would at least weaken the anti-competitive powers of ROEs and SOEs is ensuring that all enterprises, regardless of their status or institutional affiliations, are subject to the same taxes, customs, and regulatory frameworks. Transparent independent monitoring of licensing issuances could help ensure that legal regulatory equality would not be a façade for unequal implementation, as is often the case and should be built into monitoring for future financing. Ultimately, the challenge rests in the fact that the regime seeks to limit, as much as possible, any sharing of power and money is power. Refusal to decentralize economic control demonstrates a prioritization of this control over the health of the economy and the public interests it serves more broadly.