Business monthly March 05   EDITOR'S NOTE COVER STORY EXECUTIVE LIFE VIEWPOINT IN PERSON SUBSCRIPTION FORM IN BRIEF MARKET WATCH ADVERTISING RATES IN DEPTH CORPORATE CLINIC Search Business Monthly | Back Issues

COVER STORY

anchoring investors

egypt has long talked of luring more foreign direct investment (fdi), but the numbers have never matched expectations. the government’s haphazard policies and lack of long-term planning made it challenging to market to investors. what’s more, us investors – the ones with lots of capital, but also the most demanding in terms of returns – were slow to come by. business monthly speaks to american companies already investing in egypt to find out what it takes to lure investors, and – more importantly – what it takes to keep them.

by réhab el-bakry

expectations are high. last july’s cabinet shuffle, which infused fresh blood into the cabinet in the form of the dynamic ahmed nazif and several ministers drawn from the private sector, has given the business community a sense of optimism. unlike previous governments, which were long on promises but short on action, this one appears to be taking tangible steps towards economic reform by revising tax legislation, tackling customs reform and signing new trade agreements that increase the export potential of egyptian products.

the timing could not have been better. investors are looking at this part of the globe from a new perspective, viewing macroeconomic and political risks as less threatening and seeing greater profit opportunities and less risk in the region’s emerging markets. for the third consecutive year, world fdi has grown. the economist intelligence unit expects it to double within four years.
the world’s largest single investor, the us contributes roughly $40.7 bil- lion per year in fdi. it’s investments in egypt, however, are relatively small given the country’s political, economic and cultural importance in the region. egypt receives just 8.4 percent of us fdi in the middle east-africa region, behind israel, saudi arabia, south africa and qatar, respectively.

the us is the third largest investor in egypt, behind britain and holland. some 65 percent of its current $3.7 billion investment is channeled into the oil and gas sector. the remaining $1.29 billion is divided among 288 companies, including big names such as microsoft, pepsico and intel.

“although american investments in egypt may not be as big as those of other countries, they have always been successful,” says hisham fahmy, executive director of the american chamber of commerce in egypt (amcham). he points out that us companies that have entered the market over the past two or three decades have had tremendous success. for the most part, they have managed to secure enviable market shares and demonstrate long-term profits despite the local economy’s hiccups.

the chamber represents a successful investment of its own. established in 1982 as an independent, non-profit organization dedicated to enhancing trade and investment between egypt and the us, its membership has grown to 1,161 companies doing business with the us or interested in doing business with the us. given its large membership base, resource pool and unparalleled access to both egyptian and us decisionmakers, the chamber is often the first stop for potential us investors.

and lately it’s been very busy indeed. it seems that more companies are interested in the market these days. “the relationship with the us on the economic and trade front has always been good. there’s always better and there’s always worse. however, i believe that right now there’s a lot of interest among american companies, not only for trade but also for investment in different sectors,” says fahmy.

while he cautions that eight months is hardly long enough to judge the economic performance of a country, a number of major us firms look ready to enter the market. “many investors have been eyeing the egyptian market for a very long time. it’s just that people believe that the right government is in place to reform the economy and support the private sector when it comes to both export and investment.”

a senior us embassy official agrees, stressing that this is the first time where all the reformers in the government are managing all the right portfolios. previously, a handful of reformers were holding posts that prevented them from effecting change. but this time around, reformers are holding key posts and are led by a reform-minded prime minister.

with the right people in place, the government appears to now be taking steps to implement the very policies the local business community has been advocating for years. in doing so, it is not only improving the business climate, it is creating an environment suitable for investors. this is important, the official notes, because less than 10 percent of world fdi goes to developing countries. “this means that the entire developing world is competing for around 10 percent, and egypt is just one of these countries.”

egypt also faces stiff competition from other countries in the region, including jordan, lebanon and the united arab emirates, all of which have their own schemes for grabbing a share of the 10 percent. “egypt has somewhat lagged behind them,” he admits, explaining that earlier governments did not adequately respond to issues raised by investors.

concerns about concerns

investors have faced their fair share of problems concurs tarek kabil, pepsico president of egypt and north africa, but there are other factors that make it a highly lucrative market. “egypt has always been a mother country in the middle east on a lot of fronts,” he says. “if you want to be in this region, you have to be in egypt.”

with over 70 million citizens – the largest population of any arab country – egypt is an essential market for any company investing in the region. but beyond the sheer size of its consumer base, egypt is also influential in the region owing to its media and culture.

pepsi recognized these strengths early. in 1947, the soft drink giant entered into a joint venture with a local company to produce and bottle pepsi-cola in egypt. to date, the company has invested $900 million in egypt, adding about $15 million a year. the company currently produces a variety of soft drinks, including pepsi, mirinda and mountain dew, as well as several snack brands such as lays, cheetos and chipsy. it employs around 8,000 local workers at its 11 factories.

kabil emphasizes that his company’s profits are derived almost entirely from domestic sales. “pepsi is not a product that is exportable because of the high costs associated with shipping, [which is why] we have manufacturing plants in every country where pepsi is available,” he explains. “on the snacks side of the business, we do export from egypt to surrounding markets but for the most part, the domestic market is much more important to us in terms of revenue.”

similarly, procter & gamble can attest to the advantages of egypt’s market size. the us firm’s direct investment in egypt has seen it grow from one small factory in cairo in 1986 into the biggest producer of consumer goods in egypt and one of the largest in the region. “we started with less than £e 12 million invested. we’ve now invested close to £e 1 billion over a period of 20 years with almost £e 600 million invested over the past four years alone,” says country general manager mohamed samir.

p&g’s local factory in sixth of october city produces a full line of consumer products for both the domestic and regional markets. almost one-quarter of all products are exported, generating £e 300 million in export sales in 2004. new trade agreements, including the eu association agreement signed in june 2001, have given the company even greater confidence in its egyptian investment.

“we have huge interest in egypt because it’s a huge domestic market and also because we needed a base for surrounding countries,” says samir. “when you see the movement towards free trade agreements – whether with arab or african countries, and in the future with europe and the us – then egypt is the right place in terms of cost and availability of human resources. so when you think about it logically, egypt makes sense.”

tackling the egyptian market

the egyptian market may be lucrative, but the key to success is finding an investment model that works for a company’s specific business model, corporate strategy and sector of investment. dan mccarthy, chairman and managing director of general motors egypt, says having the flexibility to switch between investment models is one of egypt’s strengths. “the fact is you can be a 100-percent invested company, which is an attraction because it allows you to make your decisions without consulting with anyone. on the other hand, the option of having egyptian shareholders who know the market, consumer patterns and the government can be an attraction.”

the attraction was strong enough to lure the american automotive giant back into egypt after a long hiatus. while gm previously had a factory in alexandria in the 1930s, it had pulled out of egypt following the nationalization trend of the 1950s. when egypt adopted an open market economy and more flexible investment options in the late 1970s, the company once again looked to the nile. in 1983, it re-entered the market through a joint venture with egyptian, japanese and saudi arabian partners.

“it’s been a very good partnership,” explains mccarthy. “general motors holds a contract to manage the company on behalf of the shareholders. the shareholders take a very active role in board meetings, but they let gm do what they’re supposed to do and carry out the management contract. all in all, we’ve been here for 22 years and we’re still going strong.”

pepsi, meanwhile, found that after years of operating in egypt with an egyptian partner, it had the experience necessary to navigate the local market on its own. in 1994, pepsi bought out its egyptian partners’ share and took full control of its factories and distribution networks.

“the direct investment model works better for us because we have the chance to operate the business the way we want,” says kabil. “we have the skill, the human resources and the knowledge required to operate in a country like egypt. at the same time, we prefer to make all decisions regarding our expansion and investment ourselves.”

telecommunications heavyweight motorola has also toyed with both investment models at various times during the past 30 years. “we had a lot of success with both models,” affirms osman abou el-nasr, general manager and regional account director for motorola egypt’s global telecom solutions sector. he says the company found a market niche in the 1970s while completing a contract to build a walkie-talkie network for the government. in 1998, motorola invested in 18 percent of mobinil, helping the nascent mobile phone operator to expand its gsm network and providing mobile handsets. “when we had the opportunity to expand into the mobile market here in egypt, we were more than happy to take it because this was an [untapped] market.”

however, as motorola international restructured, so did its egyptian subsidiary. in 2000, motorola sold its shares in mobinil and returned once more to the 100-percent investment model. abou el-nasr says the switch went smoothly. “this is clearly illustrated by the fact that orascom telecom [motorola’s previous partner in mobinil] is still a client of ours and we’ve cooperated with them on several of their other international ventures.”

pounding headache

investing in egypt has proven successful for many us firms, but that’s not to say it comes without challenges. one problem all investors in egypt face is the government’s tendency to make sudden decisions. while the decisions may herald good news, they can throw off a company’s long-term plans and jeopardize investments, as p&g’s samir points out.

“for us, if the decision is good news, then i don’t see it as an issue. if it’s bad, then it’s an issue. but in all cases, it’s a lost opportunity because knowing the government’s plans helps us plan better. in most cases, it’s good for the investors to know things not only in advance but even a few years in advance so we can better project the developments in the market,” he says.

a case in point was the central bank of egypt (cbe)’s decision to float the pound, which was announced in early 2003 and enforced overnight. under the new exchange model, the bank dollar rate shot up from £e 4.65 to £e 6.15 within a year. the cbe’s sudden policy shift caused an unprecedented dollar shortage as speculators hoarded dollars and banks refused to sell them.

while samir applauds the decision, he says it was not the kind of financial policy shift investors want to read about in the morning paper after it’s already happened. “floating the pound was good for the economy and investment in the long term,” he says. “but the immediate effect was a heavy shortage in hard currency, which was problematic because we needed it to import our raw material and also to export. there was a period when we couldn’t get any hard currency.”

all investments depend to some extent on the ability to import raw materials, which is usually done in hard currency. for pepsi, which imports nearly 60 percent of its raw materials, the liquidity shortage caused headaches. “we try to find local alternatives and we’ve worked with local suppliers to help bring their production up to international standards, but even with that, almost everything has a component that is imported, which raises costs,” says kabil. “in a market as price-sensitive as egypt’s, you can’t simply increase the price for the consumer.”

while things got tough, the size of pepsi’s investment helped it weather the changes. kabil notes that large companies such as pepsi are better equipped to deal with a difficult year, but small and medium-sized businesses may not be able to handle the fluctuation as easily. for them, the only option was to resort to black market dollar trading, incurring huge losses.

in late 2004, the cbe launched an interbank market that allows banks to borrow and lend dollars without limitations. the new market helped to bring the bank and black market dollar rates to equilibrium and contributed to improving the pound exchange rate. more importantly, investors believe it will prevent a recurrence of hard currency shortages.

slash and learn

another “good” decision that had negative consequences for some investors was the nazif government’s sudden announcement in september 2004 that it would slash customs tariffs, starting with the automotive sector. while analysts hailed the move as the most significant economic reform of the year, it posed an additional challenge for local auto assemblers.

according to gm’s mccarthy, one of the major obstacles to developing egypt’s automotive market had been the oppressive customs regime. high import tariffs – up to 40 percent on imported cars and ranging from 14 to 27 percent on certain imported components – kept private vehicle ownership well beyond the reach of most egyptians. the scheme was intended to protect the local automobile assembly industry, which the government had encouraged in the 1990s by lowering tariffs on complete knock-down kits. the lower tariffs encouraged car assembly, while a requirement that 45 percent of parts for passenger cars be locally manufactured created a spare parts industry.

as far as local assemblers such as gm are concerned, the new customs scheme gives with one hand while taking with the other. by reducing duties on imported vehicles as well as components used to assemble cars locally, the new customs system reduced the gap between the two categories. this made imported cars more affordable, but at the same time threatened to undermine the local assembly industry.

mccarthy says adjusting the duty differential is a delicate game: too much and the local assembly industry loses its competitive edge; too low and the industry is crushed by import sales. “lowering prices is good for the consumer, but it has put more pressure on the local assembly industry to be competitive and we can only go so far,” he says. “if you completely wipe out the duty differential, there will be no local assembly.”

already, the local assembly industry faces a challenge in economies-of-scale. egypt’s market stands at under 70,000 vehicles a year divided among a dozen companies, while competing imports are produced overseas by factories each outputting up to 250,000 units per year. it’s this sort of competitive edge that prompted the government to protect its local producers in the first place, but now these companies will have to find other ways to compete. producing vehicles for export to other countries in the region is just one option being considered by local automakers.

in hindsight, the egyptian automobile industry needed a bit more vision when it was first started, but the sector’s growing pains are to be expected. mccarthy is confident that recent steps taken by the government – including improved access to finance and tariff reductions on automobile parts – will lead to rapid growth, a challenge he says his company is ready to meet.

banking on the masses

the banking sector has experienced its own growing pains, but the future is bright, says michel accad, division head of citibank for the middle east and north africa. he explains that with almost 30 banks, egypt is inarguably over-banked. but this shouldn’t be seen as a bad thing. “when you open up the market, regardless of whether the public sector banks or the private sector banks dominate the sector, it’s a good thing for the economy and the consumer. competition is good and choice is good. this will bring prices down and service levels up,” he says. “if competition continues and policies remain along the same reform path, then you will see some banks disappear or merge.”
for citibank, the goal has been to focus on clients often overlooked by their competitors. while most banks in egypt target the middle and upper middle class, citibank saw great potential in providing value-added services for lower-income clients, who represent the bulk of egypt’s 70 million citizens.

citibank has unrivaled success in this arena, says accad, noting that citizens of limited means are just as eager to purchase cars and homes, though they may require a little extra attention on the bank’s part to help them realize their dreams.

but competition is expected to heat up. accad projects that within five to 10 years, some 20 or 30 banks will merge and three or four of the significant international players will enter the market. for the time being, however, no new banks will be entering the market as the cbe is not issuing new licenses. instead, existing banks will compete for customers by offering value-added services that will help their clients expand their spending power and allow them to make larger purchases such as real estate or cars.

stamps and approvals

doing business in egypt requires getting used to a certain degree of bureaucracy. for those who’ve experienced it, it can be one of the biggest hindrances to investment. “we have a few employees whose sole job is to chase down signatures and approvals from the bureaucracy,” chuckles mccarthy.

every investor business monthly spoke to confirmed that bureaucracy was their worst nightmare, whether seeking approval for new projects or clearing items through customs. “there’s too much paperwork and bureaucracy to deal with whether... importing or exporting,” says samir. “there needs to be a much more efficient operating system for the bureaucracy. while the government has recently taken some decisions to make things a bit simpler, they need to work on ensuring that the actual employee understands their vision and works on implementing it.”

dealing with bureaucracy is not simply chasing approval stamps; it’s dealing with the disposition of government officials, some of whom can be unpleasant, to say the least. the nazif government is hoping to streamline the process with unified regulations that not only list the details of all approval procedures, but also limit the discretionary powers of civil servants. while it’s a promise heard before, this time legislation is actually being put in place.

a case in point is the proposed tax law, which is currently being debated in parliament. the draft legislation not only unifies the tax rate, it also works to minimize run-ins with the taxman. the law, which requires companies to file a statement of their taxable income, applies a flat corporate tax rate. tax experts say it’s a vast improvement over the existing system, under which the taxation authority determines a company’s revenues and imposes an arbitrary tax.

should the law pass, it will address another major hurdle for the egyptian private sector. “right now, we’re paying an effective tax rate of 15 to 30 percent on vehicles, which is too much,” explains mccarthy. “this [tax law] might give us the final push we need to export to other countries in the region, because this is one way for us to expand our revenues on locally assembled cars.”

the prospect that the tax code will pass may be one reason why mccarthy is optimistic that the government will be able to strike a balance between luring new investors while keeping existing ones happy. others base their confidence on previous experiences with “nazif efficiency.”

motorola’s abou el-nasr says prime minister nazif left an indelible mark on the ministry of communication & it (mcit) during his tenure as minister. the youthful ministry – just five years old – was spared much of the bureaucracy that plagues other ministries. still, dealing with government bodies can be a challenge. “we’ve been fairly lucky in the sense that ever since our sector was set up, we have been sheltered from dealing with the [ancient] bureaucracies that people in other sectors have had to deal with,” he says. “however, we run into this problem whenever dealing with another agency outside the telecommunication sector.”

the hope now is that nazif can bring some of this efficiency to the government and create the right environment for luring investors. efforts are being made on several fronts: reforming customs, smartening monetary policy, revising the tax code and signing trade deals to secure commercial markets. while tackling these longstanding issues is making egypt more attractive than ever to cautious investors, nobody is expecting a panacea.

after all, investing is always a leap of faith. the nazif government is taking measures to make the gap smaller, but in doing so it is making its own leap of faith. once the government commits itself to going down the road of reform, it is very difficult to go back. for us investors already in egypt, it’s an exciting time to be in the country and, given egypt’s relatively cheap, skilled labor force and the country’s status as the largest consumer market in the middle east – the payoff may well be worth the extra effort.

submit your comment

top