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TAKING STOCK OF THE ECONOMY
Excerpts from “Egypt on Track... But the Devil is in the Details”
Published by Beltone Financial, February 2008
Analysis by GEOFFREY CRAIG
With stellar headline numbers and prestigious accolades won, it would seem that Egypt’s economy is on track for sustained growth. Or, could there be a snake lying in the weeds? Last month, Cairo-based regional investment bank Beltone Financial issued a research note entitled “Egypt on Track... But the Devil is in the Details.” The report analyzes the health of the country’s economy, summarizes recent developments and forecasts economic indicators for 2008.
Bolstered by strong domestic demand, the economy expanded rapidly over the last four years following a slowdown from 1998 to 2002. High regional liquidity and economic reforms resulted in real GDP growth from an anemic 3.2 percent earlier this decade to 7.1 percent for FY 2006-07. Real GDP should continue to grow in the range of 7.2 percent to 7.8 percent until FY 2009-10, the report says.
“We believe that growth will continue at relatively high levels in the medium term as local and external demands remain high and reforms continue. We do believe, however, that this higher growth in the medium term hinges on a number of factors, including: i) maintaining the pace of reforms, ii) expanding the reforms to the micro level, iii) sustained economic growth in the GCC region, and iv) preventing social and political pressures from delaying implementation of sensitive economic reforms.”
A key challenge going forward is spreading the economic gains to people in lower income brackets. Thus far, growth has not translated into higher purchasing power or lower unemployment for everyone. Part of this lag is due to rigidities in the labor market and an educational system that does not adequately train young workers, the report concludes. The jobs generated for low-skills workers have mostly come from the informal labor market and large labor-intensive construction projects.
The appointment of the Nazif government in July 2004 marked a new phase in Egypt’s fiscal policy management. The government implemented measures that boosted revenue, and chipped away at the long-standing budget deficit that had ballooned to 9.2 percent of GDP in FY 2005-06. The report states that the government will be able to achieve its goal of cutting the budget deficit to 3 to 4 percent of GDP, but later than the government’s target date of FY 2010-11. They forecast a budget deficit of 5.5 percent of GDP in FY 2009-10.
Various reforms will help government revenues, which are projected to grow at 15 percent per annum until the end of the decade, reaching LE 287 billion in FY 2009-10. Specifically, the privatization of some government assets in 2008 and reforms related to the implementation of new property and value added taxes and the pension system should result in higher revenue as early as FY 2008-09.
“Overall, we believe the dynamics of the government finances will continue to develop, as the impact of the structural and regulatory changes of the different fiscal tools runs its course, and reflects positively on the budget deficit, significantly reducing it over time. We believe, however, that the pace with which the budget deficit will drop will be a function of the government’s commitment to implementing scheduled economic reforms and the extent to which the government will go in its protection of the low-income population, by either delaying implementation of reforms or increasing social spending to hedge this group against the negative externalities.”
The country’s external position should also remain strong, the report stated. In FY 2006-07, the current account recorded a sixth consecutive surplus. Rising external receipts should sustain the surplus for the present fiscal year. But the report predicts that the current account will then turn negative as a by-product of healthy economic growth. That is, greater imports will push the current account into negative territory. The report predicts a current account deficit of $2.9 billion in FY 2008-09 and $9.3 billion in FY 2009-10.
“As the growth in hydrocarbon exports slows over time, with the decline in oil exports and stability in exports of natural gas, we expect the growth in imports, both oil and non-oil products, will outpace that of total exports, sustaining higher merchandise trade deficits over time. Consequently, with the current account becoming increasingly sensitive to the widening of the merchandise trade deficit, counterbalancing the strong growth in external receipts, we expect the current account to register a surplus, for the last time in this cycle, of $859 million in FY 2007-08.”
As for inflation, the Central Bank of Egypt (CBE) was unsuccessful in its attempts to slow prices by raising interest rates twice in late 2006. The transmission of monetary policy-related mechanisms and tools is still weak, the report found. Therefore, the CBE will not officially start implementing an inflation-targeting policy in the short term, and will instead manage the absorption of liquidity.
“In our opinion, we believe inflation will remain relatively high in the medium term, ranging between 6-8 percent, in the absence of shocks, and rising to 11 percent, at least, in the event of further fiscal restructuring and higher economic growth. We do not expect the CBE to be aggressive in interest rate changes, however, considering the shortcomings in monetary policy tools and inflation indices.”
A copy of this report is available upon request from Beltone Financial, www.beltonefinancial.com
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