Contracting GDP

The Egyptian economy contracted by 0.3% in the fourth quarter ending a politically-momentous but economically-forgettable year for the country.

“Though private spending jumped 5.1%year-on-year in 3Q11 up from 3.5% a quarter earlier; the drastic fall in investments by 23%YoY kept GDP growth at a low level of 0.3% – below 2Q11 of 0.4%. Investments in 4Q11 is expected to see even higher year-on-year drop of 38% – triggered by the escalated tension during this quarter,” says CI Capital research in a note.

While the USD3.2 billion loan from the International Monetary Fund is going to boost sentiment, the country has a long way to go to reach stability.

“Egypt’s economic situation remains challenging. Growth has stalled and this is hurting the Egyptian economy and the Egyptian people,” said Gerry Rice, Director of External Relations at the Fund. “In addition, foreign exchange reserves have dropped substantially, reducing the authorities’ margin to maintain macroeconomic stability.”

The country’s foreign reserves have dropped 53% year-on-year in January to USD16.4-billion, as capital fled the economy last year.

In addition, foreign direct investment remains depressed.

“Social and political unrest in Egypt is still weighing on FDI inflows. In 3Q11, FDIs retreated to USD0.4bn vs. USD1.6bn a year earlier,” notes CI. “This came above our expectations of USD0.2bn. Moreover, huge foreign selling in equities and bonds shifted portfolio investments to a net outflow of USD1.7bn, vs. a net inflow of USD5.9bn in 3Q10.”

The Institute of International Finance (IIF) expects countries such as Egypt, Tunisia and Libya – all of whom saw the end of their dictators’ rules in 2011 – to continue to see weak growth over the next 12-18 months.

It is clear that in Egypt economic policymaking will remain subservient to political issues. There is definite lack of clarity surrounding the economic policy framework and great difficulty in forging political consensus due to the diversity and multiplicity of political parties in the new governing coalition.

As a result, the IIF expects the economy to perform only modestly in the coming 2-3 years.

“Egypt… could be heading towards an economic crisis if growth rates do not take off unemployment that does not begin to show meaningful declines,” the IIF said

Indeed, the political situation looks messy at the moment with many disgruntled stakeholders.

The Muslim Brotherhood’s Freedom and Justice Party won 47.2% of the parliament seats with the Salafist Al Nour party winning nearly 25%, leaving the liberals way behind.

This political turnaround has left many liberal Egyptians, who led the Tahrir Square revolution last year, feeling disillusioned as the country takes a more religious turn in its political and social life.

“Real and honest moderate Egyptian Islam has receded in the face of Wahhabi Islam coming from Saudi Arabia and the Gulf countries,” wrote Alaa Al Aswany, a best-selling Egyptian author and columnist in a recent blog.

“For thirty years masses of oil money has been used to drown Egypt in Wahhabi ideas. The purpose of this support for the Wahhabi school of thought is basically political, in that the Saudi system of government depends on an alliance between the ruling family and the Wahhabi sheikhs. Hence spreading the Wahhabi ideology reinforces the political system in that country,” Mr Al Aswany wrote in his blog.

Analysts have accused the majority Freedom & Justice Party for colluding with the Salafists and the army to ensure the ‘status quo’ of miltiary dominance remains; any changes, they feel, are merely cosmetic in nature.

The final piece of the political puzzle will be put in place in the next few months when nominations for presidential elections start on March 10 to April 8.

The spoardic clashes between the army and protestors and the football stadium tragedy which saw 70 people killed, shows the situation remains volatile in the country.

Meanwhile, Egypt’s relations with the United States and its client state Israel are also worrisome.

“The current US-Egypt military relationship could become a casualty of rising nationalism in Egypt, the prosecution of democracy workers in the country, and the likely marginalisation of the armed forces. A breaking point this spring could come amid economic crisis in Egypt, with destabilising results,” said a note from Oxford Analytica.

The Muslim Brotherhood has also warned that it could review relations with Israel if the U.S. reduced military aid to Egypt.

“U.S.-Egyptian ties have withstood serious tensions in the past. Yet in the present political context in both countries, a bilateral crisis is possible — with broader ramifications for Egypt’s stability,” noted Oxford Analytica.

This may be an exaggeration given that Egypt will likely forge closer ties with its Sunni neighbours the rich Gulf states, who could step in financially if the U.S. aid stops.

But the 80-odd million Egyptians are finding a way to keep the economy moving. CI Capital outlines some of the major economic deveopments over the past few weeks:

  • The Central Bank of Egypt set a 100bps raise in deposit rate and 50bps increase in lending rate – putting its support for the local currency ahead of backing investments.
  • The IMF USD3.2bn loan is to be signed in March 2012 bearing an interest of 1.2%. The loan will be received this loan over three phases; by which one third of the loan will be received upon signature, while the second tranche will be received after 3-month period; and the last tranche after six months from signing the loan.
  • Apache Corporation has agreed with the Government of Egypt (GoE) to invest USD1bn in oil and gas explorations in Egypt in 2013.
  • The World Bank approved an USD240mn loan to develop the Giza North power project as part of an USD600mn loan approved in 2011.
  • Egypt signed a soft loan with the World Bank worth USD200mn with an interest rate of 1.2%. The loan is to finance the second phase of the waste water project with an investment cost of USD310mn.
  • The government decided to offer PPP projects in the infrastructure and sewage projects worth EGP11bn.
  • The PM allocated EGP175mn for the development of slum areas throughout Egypt – scheduled to start immediately. The budget includes EGP100mn from the Slum Development Fund and EGP75 mn from the general budget.
  • Egypt signed gas export agreement with Jordan over the new prices to be applied retroactively as of January 2011and is due to be revised mid 2013 and every two years after.
  • Japan granted Egypt USD12mn to support the agriculture sector through applying maintenance to the irrigation and potable water networks.

Meanwhile, the Egyptian stock exchange which was rocked last year by the political unrest and saw a 47% decline, has surged 41% in the first six weeks of the New Year, making it the best performing market in the region.

Market data shows that emerging markets funds are taking another look at the Cairo market, given its low PE valuations and the long-term prospects of the country.

This growth is even more commendable given that Standard & Poor’s recent lowered the country’s credit rating to B with a negative outlook.

The Egyptian Central Bank interventions–to support the Egyptian pound in the face of significant capital outflows and double-digit annual inflation–have resulted in a sharp decline in net international reserves. These were USD16-billion at end-January 2012, down from USD36-billion at the start of 2011, the ratings agency said in its review.

“Historically, our assessment of Egypt’s external score has been a relative strength to the rating; this is now being eroded. We estimate that net international reserves, excluding gold, now cover less than three months of goods and services imports compared with more than six months at the start of 2011,” said the agency.

In addition, S&P warned that if the government fails to stem the decline in reserves, or an uncertain policy environment and weak institutions emerge from the ongoing political transition, the rating could be lowered further.

“The political transition process could be undermined over the coming year as the constitution is redrafted and a new president is elected–currently expected by June 2012–after which a new government would be formed,” said the agency.

“In our view, the transition to more-participatory political institutions in Egypt could falter, leading to weaker political institutions and rising domestic conflict.”