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Egypt Rising

In the face of revolution, Egypt stands bloodied but unbowed.

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Over the past two years, Egypt has undergone a significant transformation, not only politically but also economically. The protests in Cairo’s downtown Tahrir Square, in January 2011, have had a wide-ranging impact not only on the country’s political composition, but also on its short- and medium-term economic performance. While the ups and downs since the revolution have been palpable, the downs obviously more so; the long-term fundamentals of Egypt remain just as appealing as they were in the years leading up to former President Mubarak’s ousting. Provided investors are willing to ride out the immediate uncertainty, the prospects for growth are encouraging.

In the pre-crisis days of 2007 and 2008, Egypt was racking up GDP growth in excess of 7% and services like telecommunications were growing by double digits annually; tourism jumped up by as much as 21% in one year. The country’s stock market, one of the continent’s largest both in terms of listed firms and capitalization, attracted significant inflows from foreign institutional investors, while the banking sector—leaner and meaner after several years of consolidation and robust regulation—saw a drop in non-performing loans and an increase in profitability.

But the combination of falling global demand, together with revolutionary instability, meant that GDP growth last year fell to 1.8%. Growth in 2012  was only slightly better, at 2%, while forecasts for 2013 are at a solid but lower-than-needed 3%. Foreign Direct Investment (FDI) fell by more than $10 billion in 2011 and key sectors, like tourism, have slumped, contracting by nearly 6% over the most recent fiscal year. Industrial action has depressed manufacturing output in labor-intensive sectors even as official unemployment has risen to 12%, not counting the vast ranks of the underemployed.

Egypt faces problems that have been exacerbated by the revolution—including some very pressing long-term political questions, ranging from the creation of a new constitution to improving institutional trust—but among the more urgent challenges is the lack of inclusive growth. The subsidy debate highlights this most acutely. Government grants and social benefits made up roughly one-third of total expenditure in the 2011/12 fiscal year, which runs from June to June, according to the ministry of finance. Reducing the burden is a priority for President Mohamed Morsi’s new government, yet reforming subsidies carries not only significant political risk but also fails to alleviate the pressure on the most vulnerable portions of the population. As a result, steps have been tentative at best. The focus has been primarily on energy subsidies and the most recent version of the 2012/13 budget from May 2012 sought a reduction in fuel subsidies by some 27%, with consumption-intensive industries seeing the most significant increase in costs. Food subsidies have been left untouched.

The country is also grappling with an increasingly hollow labor structure, which exacerbates income inequality. Figures from Egypt’s Central Agency for Public Mobilization and Statistics (CAPMAS) show that unemployment among university graduates reached 18.9% in 2010 and a similar study in 2012 revealed that demand for high- and low-skilled workers is outstripping that for middle-skilled employees, dampening social mobility and constraining opportunities for the middle class.

However, for a short period there was a steady stream of more encouraging news, which while not exactly pointing to a full-fledged recovery, hinted at a more hopeful outlook. Growth forecasts for 2013 were pegged at 3%, still far lower than what is needed but nonetheless comparatively robust. Headline inflation, which reached as high as 18% in the pre-crisis years, dropped to a far more manageable 5.4% in August. Similarly, yields on a number of Egyptian bonds had eased to some of their lowest levels in nearly a year in September when the country hawked its first floating-rate bonds. Around roughly the same time, Moody’s reaffirmed its B2 rating for Egyptian sovereign bonds, due in part to an improving political outlook, along with a more stable external payments position, stronger macroeconomic conditions and a restart of International Monterary Fund (IMF) negotiations—all of which spelled good news for the government.

By the end of the year, however, things began to look rocky again, with the pound dropping precipitously, from 6.05 to the dollar to 6.30 to the dollar. Deficit estimates from the current     fiscal year, ending in June, may hit up to 10% of GDP. Combined with continuing political instability in the wake of protests over the constitutional referendum, the spate of worsening indicators is far from encouraging for Egypt’s policymakers.

The IMF loan, which could be worth up to $4.8 billion, is particularly important in terms of strengthening investor confidence, which has been hit hard not only by the broader uncertainty but also by regulatory hiccups and governance scandals, particularly in sectors such as real estate and construction. However, with one of the most attractive price-earnings ratios in the region, Egypt’s firms remain extremely attractive on a value basis and the country’s stock market has rebounded by more than 37% in recent months.

There is still potential for a turnaround for the country’s economy, but if this momentum is to be sustained in the years to come, Egypt will need to better leverage its competitive advantages. Crucially, Egypt benefits from both strong export ties and a vast consumer population, which provides firms with access to large domestic and foreign markets. In spite of rising subsidies and wages, the country is nonetheless extremely competitive as a manufacturing destination. Furthermore, significant upstream gas reserves have the ability to provide feedstock not only for Africa’s largest refining sector but also for the rapidly-growing electricity segment, which is racing to keep up with annual demand growth of 7%.

It is difficult to understate the impact of Egypt’s 2011 revolution, given the economic ramifications of the massive political changes the country has undergone. The past two years have been turbulent but if the country can better exploit its healthy long-term fundamentals, a return to robust growth is virtually assured.

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