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RISKREPORTER Egypt CountryRiskAssessment Egypt 24/11/16 ExportTransactions PoliticalRisk (1to7) Riskdriversandoutlook ShortTerm 1 7 SincePresidental-Sisitookoffice2yearsagothecountryhasenjoyedamoresecurepolitical order,althoughthishasnottranslatedintoimprovedeconomicfundamentals.Onthecontrary, hisrepression,terroristattacksandweakmacroeconomicpoliciesarehavingadramatic impactontourism–akeysourceofforeignexchangeearnings–andsevereconsequences forforeignexchangereserves,thecurrentaccountbalance,economicgrowthand unemployment.Inaddition,lavishmegaprojectshavebeendrivingupthefiscaldeficitand publicdebt,puttingpublicfinancesinadirestate.AlthoughtheGulfstatescametotherescue withaid,whenoilpricesfellGulfaiddriedupwhiletheeconomyfurtherdeteriorated,as illustratedbyshortagesofhardcurrenciesandbasiccommodities.Imminentreformsappeared necessary.Thesebodewellfortheeconomyinthelongtermbutarepainfulintheshortterm, possiblytriggeringwidespreaddiscontent.However,thewaningeconomyalsofuelledunrest. Egyptseemedtobestuckbetweenarockandahardplace.Multilateralorganisationscame onthescene.TosecurealoanfromtheIMF,though,decisionshadtobemade:theexchange rateoftheEgyptianpoundwasfloated,representinga50%devaluation,andfuelsubsidies werecut,leadingtoa47%priceincrease.Inthisdifficultcontext,therecentlysecuredIMFloan willsupportliquidityandrecentandanticipatedreformswillhelptheeconomytorecover. Nevertheless,politicalriskloomsinacountrywheretwopresidentshavebeenoustedinthe last5years.Forthesereasonsandasshort-termandMLTexternaldebtisontherise,Egypt’s politicalriskclassificationsareincategory5and6respectivelyforshort-termandlong-term politicalriskonascalefrom1(best)to7(worst). Commercialriskremainshighgivenadifficultbusinessenvironmentcharacterisedbyred tape,weakcreditsupply,poorinfrastructure,increasinglendingratesandadepreciating currencyanddouble-digitinflation.Asaconsequence,CredendoGroup’scategoryforthe commercialriskassessmentisC(theworst). Facts&figures Medium/LongTerm 1 7 SpecialTransactions 1 7 CommercialRisk(AtoC) B A C Directinvestments(1 to7) WarRisk 1 7 Riskofexpropriationand 1 governmentaction 7 Transferrisk 1 7 Pro's Relativelylowdebtserviceleveldespiterisingexternaldebt Rathergoodrelationswithexternaldonors Improvedmacroeconomicpolicies(albeitfromaweaklevel) Floatingexchangerate Cons Poorexternalliquidity Difficultbusinessenvironment Direfiscalfinances Heightenedriskofsocialunrest HeadofState PresidentAbdelFattahal-Sisi(since8June2014) Headofgovernment PrimeMinisterSherifIsmail(since12September2015) Descriptionofelectoralsystem Presidential:4-yearterm;lastelection:May2014 Legislative(forHouseofRepresentatives):5-yearterm;lastelection:16December 2015 Population 91.5m PercapitaIncome(USD) 3.340(2013) Incomegroup Lowermiddleincome Mainexportproducts Privatetransfers(36.4%ofcurrentaccountreceipts),tourism(13.5%),SuezCanal receipts(10.7%),oil(16.7%) Countryriskassessment Politicsasusual Duringthepast5years,Egypthasbeengoingthroughaperiodofdramaticchange.In2011 Egyptianprotestseruptedwhichweremotivatedbydomesticdiscontentandtheeventsin TunisiawherePresidentZineal-AbidineBenAliwasremoved.Following18daysofdeadly unrest,theauthoritarianPresidentMubarakhandedoverpowertothemilitaryafter30yearsin office.Thoughmassdemonstrationsstopped,significantprotestsagainstthenewmilitary rulerscontinued.Nonetheless,anewpoliticallandscapeemergedastheIslamistMuslim Brotherhoodformedapoliticalparty,theFreedomandJusticeParty,andin2012their candidate,MohammedMorsi,waselectedinthefirstpresidentialelectionsinhalfadecade. However,inthefollowingmonthsMorsiprovokedcontroversyandmanyEgyptiansbeganto believethattheyhadexchangedoneauthoritarianrulerforanother.Inaddition,thelackof securityandthedeteriorationoftheeconomyfuelledunrest.Thedismayboiledoverintoa newwaveofprotests.OnlyafewdaysafteroverwhelmingdemonstrationsagainstMorsi’sfirst yearinoffice,hewasoustedbyEgypt’sarmy.AnewconstitutionwasadoptedinJanuary 2014,abolishingtheupperhouseofparliament.Instead,Egypt’slegislaturenowconsistsofa singleHouseofRepresentativeswhichwaselectedin2015fora5-yearterm.Inaddition,Mr al-Sisi,aformerleaderofthearmedforces,wonthepresidentialelectionsinJune2014with 97%ofthevote. Sinceal-Sisicametopower,Egypthasenjoyedamoresecurepoliticalorder,althoughthe countryhasslippedbackintoauthoritarianmilitaryrule.Indeed,themilitaryandsecurityforces retaintightcontroloverpolicymakingwhilestillcontrollingkeyareasoftheeconomy. Furthermore,sinceMorsi’soustingtherehasbeenacrackdownontheMuslimBrotherhood. TheMuslimBrotherhoodleadershipwasdetainedalongwiththousandsofitsmembers,a courtbannedallMuslimBrotherhoodinstitutionsandmorethan100presumedMuslim Brotherhoodsympathisers,includingformerPresidentMorsi,weregiventhedeathsentence. Anti-governmentprotestnumbershaveconsequentlydwindled,butatthesametime,terrorism incidentshaverisensharplygiventhelackofotherchannelsforpoliticalexpressionfor Islamistsincombinationwithspillovereffectsfromregionalsectarianconflicts.Terrorism incidentsarehavingadramaticimpactonthetourismsectorasillustratedbythedowningof theRussianaeroplaneinNovember2015byalocalgroupthatclaimedallegiancetoIslamic State,afterwhichtourismrevenuesplummeted.Inaddition,supportforthepopularal-Sisiis waningduetohisinabilitytorespondtotheongoingeconomiccrisis,inparticularpersisting unemploymentandhighinflation,aswellastodeterioratingpublicservices,increasingpolice brutality,rampantcorruption,andenergy,foodandwatershortages.Nevertheless,unrest seemslimitedfornowbuteconomicrecoverywillbecriticalforpoliticalstabilityinthecoming years. Complicatedfriendships EgypthastraditionallybeenanimportantallyintheArabworldasitiscrucialforregional stabilityandhometotheSuezCanal,animportantwaterwayforworldtrade.Egypthas benefitedfromastrongimprovementinrelationswiththeGulfcountries(notablySaudiArabia, theUnitedArabEmiratesandKuwait)sincePresidentMorsiwasremoved.Thisisexplained bytheiraversiontotheMuslimBrotherhood,whichisseenasanideologicalcompetitor (particularlybytheregimeinRiyadh).TheGulfstatesalsoprovidedthecountrywithfinancial aid,butaidhasbeendecliningandhasbeengivenintheformofsoftloanssince2016,which isattributedtothepersistentlowoilprices,disagreementaboutregionalpolitics(e.g.Syria) andfrustrationaboutthelackofimprovementinEgypt’seconomy.Inparticularrelationswith SaudiArabialookbumpyasillustratedbythehaltinsupplying700,000tonnesofpetroleum productspermonthongenerouscreditterms.Nevertheless,SaudiArabiaandotherGulf countrieslookcommittedtosupportingthecountryastheyrecentlycamethroughwith deposits,estimatedatUSD3billion. RelationswiththeIMFhavebeenimprovingbutalsoremaincomplex.InJanuary2015theIMF publisheditsfirstArticleIVin5years,whileduringthesummerEgyptstruckapreliminarydeal foraUSD12billionIMFloanprogramme,whichwillbedisbursedover3years.Ittookseveral monthsbeforetheloanwasapprovedbytheIMFboard.Afirstconditionforapprovalwas securingUSD5-6billioninbilateralfinancingforthefirstyear,whichrequiredseveralallies. Cutsinfuelsubsidiesandafurthercurrencydevaluationwerealsoessentialbeforeadeal wasstruckbutittookuntilthebeginningofNovembertofloatthecurrencyandcutthese subsidies.Thoughittooksometimetosecuretheloan,itisthefirsttimeEgyptreachedan agreement.TwopreviousagreementswiththeIMFindeedcollapsedinthepastfiveyearsdue toalackofpoliticalwilltoimplementreformsandfearofrisingsocialtensions. Wobblyeconomy TheEgyptianeconomyhasbeenflounderingsince2011.AnnualgrowthsincetheArab Springhasbeen2.7%onaveragein2011-2016,comparedtoanannualgrowthof5%in 2000-2010.Egypthasbeensufferingeconomicallyfromyearsofpoliticalturbulence,falling tourismrevenues–akeysectorandsourceofforeignexchangeearnings–andinvestments andforeignexchangerationing.Inaddition,growthhasbeenimpededbytheratherdifficult businessenvironment(Egyptranks122ndoutof190countriesintheWorldBank’sEaseof DoingBusiness2017ranking).Furthermore,slowgrowthhasresultedinhighunemployment, runningat14.5%in2015/2016,withyouthunemploymentestimatedatthreetimesthatrate. Inthelongertermthepicturelooksbrighter.Inlate2015a‘supergiant’gasfieldwas discovered,estimatedtobelargerthanOman’sreservesaccordingtoEIA.Egyptisthelargest non-OPECoilproducerandthesecondlargestdrynaturalgasproducerinAfricabutitisalso thecontinent’slargestoilandgasconsumer.Thatiswhyitisanetfuelimporterasof2012.If energycompanyEni’sestimatesareaccurate,thefieldwillincreaseEgypt’sgasreservesof 65.2trillioncubicfeetbyalmosthalf.ThegascanprovideforEgypt’sownenergyneedsand renewtheexporttrade.Inaddition,reformsrequestedbytheIMFcanalsoturnthingsaround inthelongtermasreformsarelikelytofostergrowthandcreatejobs. Stemmingunrestwithanovervaluedexchangerate Egypt’sliquiditysituationhasdeteriorateddrasticallysince2011.Theforeignexchangerate waskeptatanovervaluedratetokeepimportpriceslowasEgyptisahugeimporterofbasic goodssuchaswheat.Lowpricesofbasicgoodscouldstemunrestasinthepastbasicgoods appearedtobeanimportanttriggerfordiscontent.Inaddition,sourcesofforeignexchange revenueswereunderpressure(seebelow).Consequentially,foreignexchangereservesmore thanhalvedfrom5.8monthsofimportcoverintheJuly2009/June2010fiscalyearto2.3 monthsofimportcoverinJune2016.TheGulfcountriescametotherescueinApril2015with USD6billionindeposits,andagaininthesummerof2016withUSD3billionindeposits.The EgyptiangovernmentalsoconcludedanumberofloanswiththeWorldBank,theAfrican DevelopmentBankandalsoSaudiArabiaandChinatosupporttheEgyptianeconomyand increasethecountry’sliquidity.Nevertheless,theloansanddepositscouldonlytemporarilylift thereservesanddevaluationwasstillnecessaryasforeignexchangereservescontinuedto fall.Thedevaluationofthepoundby13%inMarch2016broughtnosolaceastheexchange ratewasstillovervalued.Indeed,therewasstillahugedifferencebetweentheofficialrate, whichstoodat8.88poundstothedollar,andtheblackmarketrate,whichstoodat18.25 poundstothedollaratitspeak.Theovervaluedexchangerateincombinationwithlowforeign exchangereservesledtowidespreadshortagesofimported(basic)goodssuchassugar, babymilkandrice.Asprotestsescalated,theEgyptianauthoritiesevenconfiscatedstocksof sugaratcompaniesmakingsoftdrinksandsweetstoselltheminoutletsretailingsubsidised food.Paymentdelaysinhardcurrencieswerealsobeingreportedasthesewererationed. Indeed,thepolicyofkeepingtheexchangerateovervaluedhadtheoppositeeffectofthat intendedbythegovernment.Asthepressureontheexchangeratewasmounting,atthe beginningofNovembertheCentralBankofEgyptannouncedafreefloatingofthepound, representingadevaluationofabout50%.Theflotationliftspressureonforeignexchange reserves.However,inflationisalsolikelytoincreaseasimportpriceswillincrease.Inflation wasalreadyatahigh15.5%yearonyearinAugust2016,thehighestlevelsince2009,dueto thedevaluationinMarchthisyear.TheflotationoftheEgyptianpoundislikelytofurther increaseinflation,whichexplainsthepasthesitationoftheCentralBanktofloatthecurrency. Inaddition,anticipatedsubsidycutsandtaxincreaseswillkeepinflationelevatedintheshort term.TheIMFexpectsayearlyinflationof16.5%inJuly2016/June2017,thoughitwouldnot beunrealisticforthesenumberstoprovehigher. Hitbymultipleshocks Since2008,Egypthashadstructuralcurrentaccountdeficitswhichhavebeenwideningto elevatedlevelsovertheyears.Thoughthelowfoodandoilpricesofrecentyearsshouldhave benefitedEgyptasitisanimporter,thecountry’sexportrevenueshavewanedinrecentyears. Indeed,pressureonthekeysourcesofforeignexchangeearningshasledtoincreasing structuralcurrentaccountdeficits.Firstly,tourismhitadecadelowthisyear.Thesectorwas alreadysufferingfromtheupheavalsof2011and2013,buthastakenanotherhitdueto securityconcernsfollowingtheterroristattackstargetingtourisminthepast2years.Secondly, remittances–themostimportantsourceofcurrentaccountreceipts–arefallingsharplydueto weakerGDPgrowthintheGulfcountrieswhichdependheavilyonoil.Thirdly,therevenuesof theSuezCanal,whichwasrecentlyexpanded,havedecreasedasglobaltradeslowsonthe heelsoftheworldwidedownturn.Asaresult,thecurrentaccountdeficitisexpectedtoreacha highlevelofmorethan50%ofcurrentaccountreceiptsinJuly2016/June2017,anarrowing comparedtothehugedeficitofmorethan70%postedlastyear.Ontopofthat,officialtransfers areindecline,reflectingthedryingupofgrantsfromtheGulfstates.Onthepositiveside,the currentaccountbalanceisexpectedtonarrowinthecomingyearsastheflotationofthe overvaluedEgyptianpoundwillstrengthencompetitivenessandhencebolsterexports. Tourismrevenuesarealsoexpectedtoincreaseastheeffectoftheterroristattackswanes,but onlyifpoliticalstabilityremains.Inaddition,remittancesarelikelytorecoverinthecoming yearsinlinewiththeexpectedmodestrecoveryofoilprices.Moreover,astheIMFprogramme isapproved,itwillbecomeeasierforEgypttofinanceitscurrentaccountdeficit. Egyptfacessubstantialexternaldebtrepaymentsasshort-termexternaldebthasincreased substantiallyinthepastyeartomorethan25%ofcurrentaccountreceiptsin2015/16.The totalexternaldebthasalsobeenincreasing,especiallyinthelast2years,duetobilateraland multilateralloans.InthecomingyearsdebtislikelytoincreasefurtherasrecentlyanIMFloan wasconcludedwhileadditionalbilateralfinancinghasbeensecured.Ontopofthat,Egyptis alsointheprocessoffinalisingitsUSD3-5billionsaleofEurobonds.Asaresult,Egypt’stotal nominalexternaldebtisexpectedtoincreaserapidlyby32%in2016/2017toahighofmore than180%ofcurrentaccountreceiptsandtoleveloffatlessthan200%ofcurrentaccount receiptsin2018/19. Weakpublicfinances Publicfinancesareinadirestate.Egypthashadstructuraldeficitsfordecadesandthoughthe fiscaldeficithasbeendecreasingsinceitspeakof13.4%ofGDPinJuly2012/June2013,the expectedfiscaldeficitofJuly2016/June2017remainshighat9.7%ofGDP.Egyptisspending alargepartofitsbudgetmaintainingcostlyfoodsubsidiesandabloatedcivilservice,and interestpaymentsareveryhighwhiletaxrevenuesarelow.Inaddition,thegovernmentis investinginhugeconstructionprojectssuchasthenewSuezCanalandanewcitynearCairo. TheflotationoftheEgyptianpoundislikelytoworsenthefiscalbalanceintheshorttermas thestateisthemainimporteroffoodandfuel.Inaddition,thefiscaldeficitshavebeen financedbyaccumulatingdebtwhichisexpectedtostandatmorethan90%ofGDPinJune 2016/July2017.Sofar,Egypt’spublicdebthaslargelybeenfinancedbythedomestic financialsystem,whichhasimpededthecapacityofthebankingsectortofinancetheprivate sector,andrecentlybybudgetfinancingwiththesupportoftheGulfcountries.However, EgyptianbanksarealreadyhighlyexposedtothepublicsectorandthewillingnessoftheGulf countriestocontinuetheirsupportiswaning.Therefore,fiscalreformstocutthefiscaldeficit willbeofcriticalimportance.Egypthasalreadyhikedelectricitypricesby20-40%andfuel pricesby47%andapprovedaVATof13%asofSeptember.Nevertheless,morereformsare necessary.Fiscalconsolidationislikelytobepainfulwithfurthersubsidycutsonthecards, whichcouldexacerbatepopulardiscontent. 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