Download Strategic Framework for Transformation of the Egyptian Economy

Policy Reform for Egypt:
2004-2008
Policy Reform for Egypt: 2004-2008
I.
Transition Towards Global Competitiveness: Strategic Framework for
Transformation of the Egyptian Economy
A.
Background
The Egyptian economy has introduced a multitude of reforms in recent years to increase
levels of competitiveness, accommodate job creation needs, improve human development
needs, and sustain GDP growth under stable conditions. In spite of positive developments
and improvements within a number of sectors, a number of factors have increased
frustration in the efforts to achieve more ambitious targets of economic growth, and more
broadly distributed increases in purchasing power. Some have been external, owing to
political instability in the region and around the globe, financial crises that have reduced
investor interest in most emerging markets, and a more general slowdown in the global
economy. However, other factors have been internal, and relate to policy and structural
issues in the economy that need to be remedied for faster growth, rising incomes,
enhanced physical and social infrastructure, and an overall improvement in living
conditions.
As Egypt confronts the challenges of the 21st century, it must confront a number of longstanding weaknesses and development obstacles so as to overcome economic,
institutional, scientific, technological and digital gaps. In response to this, the proposed
note focuses Egypt’s needed structural reform efforts within a strategic movement to
develop a globally competitive and knowledge-based economy.
Movement in this direction does not preclude continued patterns of work and
employment in many traditional areas, such as agriculture in rural areas, and
manufacturing and services in urban areas. Instead, it recognizes the need to implement
sound policies and reform measures to support economic development, and gain
increased access to the benefits which are more readily available as a result of the
revolution in information systems and telecommunications in recent years; with a focus
on how to apply such benefits to the local economy and institutions.
The strategy for transformation identifies the building blocks needed for the transition of
the Egyptian economy towards greater global competitiveness. This includes key reforms
in the areas of financial sector, private sector, knowledge economy and tax policy. These
interventions are designed to accommodate a more competitive, modern economy
capable of improving Egypt’s level of economic, institutional, and infrastructure
development. The elements of the strategy are all integrated with one another, and work
together to help Egypt achieve its broad strategic objectives.
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Policy Reform for Egypt: 2004-2008
II.
Financial Sector Reform
A.
Overview
While Egypt’s financial sector has made progress in many areas in recent years, several
areas remain where further progress is needed; in some cases on an accelerated basis. In
the banking sector, key priorities include (i) finalizing state bank privatization, (ii)
strengthening financial intermediation, (iii) enhancing financial stability, (iv) more fully
developing regulatory and supervisory capacity at the CBE, (v) improving corporate
governance, and (vi) increasing transparency and accountability. All of these reforms are
to run parallel with other areas in which Government of Egypt (GoE) has already made
formal commitments, such as movement to RTGS in the payment system.
In the non-bank sector, attention should be focused on a combination of activities in the
securities markets, insurance and pensions, as well as venture capital, leasing, warehouse
receipts, housing finance, and municipal finance. In the securities markets, key objectives
include (i) increasing equity market participation, and (ii) developing debt markets—
Government and private. In the insurance sector, priorities include (i) strengthening the
legal framework and actuarial profession, (ii) bolstering regulatory and supervisory
capacity, and (iii) promoting an environment that is conducive to strengthening the
market and financial condition of the insurance sector. With regard to pensions, efforts
should to be made to introduce a sound second pillar, as government finances and the
existing single-pillar scheme are insufficient and are guaranteed to be under-funded, as
elsewhere throughout the globe. Venture capital (VC) is considered vital for development
of a globally competitive economy. However, for VC to develop, information flows must
be open, and exit mechanisms are required for VC firms to sell their shares. As of now,
the markets in Egypt do not demonstrate the underlying conditions for vibrant venture
capital. Leasing activity needs to accelerate in Egypt, particularly to assist SMEs with
new financing vehicles for fixed assets. Linked to all of these areas is the
underdevelopment of financial infrastructure for agricultural finance, housing finance,
and municipal finance.
B.
The Banking Sector
Egypt’s banking sector is the bulwark of the Egyptian financial system. The financial
system is bank-based, and its 571 licensed institutions are responsible for most lending
and investment in the economy. Moreover, many of the banks and specialized institutions
play a role in “development” needs of the economy, albeit not without cost. However, as
elsewhere (e.g. Turkey, transition Europe), experience over the years has shown that
directed lending and subsidized credit schemes usually carry painful economic costs. In
the banking sector, these are often manifested by eventual recognition of non-performing
loans and the need for provisioning, ultimately reducing earnings and capital. For banks
serving as agents for governments, the costs are ultimately borne from fiscal and/or
monetary sources. As many of the banks are state-owned, the flows are circular, yet the
costs ultimately weaken the economy and reduce financial stability. For these reasons, it
1
A recent presentation by the Governor of the CBE noted there were 55 banks.
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Policy Reform for Egypt: 2004-2008
is imperative for Egypt’s banking sector to embark on a reform effort so as to enable its
banks to operate professionally and commercially, while adhering to sound regulations
and supervisory requirements to ensure underlying stability. The following reforms are
proposed to achieve these objectives.
►Reform #1: State Bank Privatization
Egypt has four state-owned commercial banks, two specialized state-owned financial
institutions, and 11 joint venture banks with state participation. State banks have recently
been recapitalized, and new management/board members have been installed. The
program from 2004-08 should be for the state to exit banking, backed by more efficient
CBE regulatory/supervisory oversight, plus implementation of effective risk-based
supervision that is founded on sound internal systems, ongoing reporting, and risk
management capacity at private banks. This will require a diverse strategy encompassing
(i) privatization tenders and sales; (ii) mergers and acquisitions; (iii) consolidation and/or
resolution via purchase and assumption; and (iv) flotations on the local exchange. Key
needs for the Government include the need to map out a strategy and appropriate options
for each of the 17 banks, and then to map out requirements that are internal as well as
those that would be outsourced. These tasks should be done in FY 2004 and implemented
in 2005-06. Thereafter, 2007-08 should be dedicated to the clean-up of any residuals
from the privatization program, such as any bad debt collection resulting from the
transfer of bad assets prior to privatization transactions.
►Reform #2: Strengthen Financial Intermediation
Deposits in banks and specialized institutions approximated $66 billion at end 2002, or
nearly $1,000 per capita. Broad money to GDP approximated 86 percent, which is
reasonably high by international standards. With real GDP forecast to grow at
approximately 3 percent in subsequent years, a simple increase of that amount
compounded for five years would translate into deposits increasing to $79 billion by end
2008. Government strategy should be to strengthen the banking environment to ensure
the public has confidence in the economy, the currency and the banks to reach this target.
This, in turn, will help to increase the flow of funds for commercially viable enterprises
and projects, while also bringing down borrowing costs for households and enterprises.
Meanwhile, any decline in the broad money-to-GDP ratio should be offset by increases
in savings mobilization with insurance companies or pension funds.
►Reform #3: Strengthen Financial Stability
Banking system capital in Egypt at end-2002 was $13.5 billion, or $238 million on
average.2 Proposed changes are for domestic banks to have LE 500 million in minimum
capital by end-2006 (about $75-100 million-equivalent, depending on exchange rates3),
Figures derived from “Other Items (Net)” from International Financial Statistics (IMF) for deposit
money banks and specialized banks. This figure is spread across 57 banks and specialized institutions.
3
With the exchange rate at 6.13 per $1 as of October 30, 2003, this would be equivalent to $81.5 million on
that date.
2
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Policy Reform for Egypt: 2004-2008
and foreign bank branches to have $50 million in minimum capital. Such minimum
capital requirements would be substantial by international standards. However, based on
comparative “financial strength” measures, the changes appear to be warranted,
considering that Egypt’s scores are relatively low by global standards.4 Assuming a
simple 3 percent year-on-year growth figure, average capital should grow from nearly
$238 million in 2002 to about $285 million by 2008. This figure may change if there is
significant consolidation via mergers and acquisition, and purchase and assumption.
However, based on the existing number of 57 institutions, a $285 million capital target
per licensed bank is reasonable.5
Such capital figures will need to be tested for risk, putting the onus on CBE and banks to
ensure proper identification of risks so that these can be managed without adverse effects
on financial stability. In this regard, it is recommended that the government increase
minimum capital adequacy ratios to 12 percent no later than 2007 to account for market
risk premia that countries like Egypt face.
When there are early warnings of risks, these should be managed and administered with
the intention to getting bank CARs to, and above, the minimum required in the shortest
possible time. This calls for an explicit prompt corrective action policy to be articulated
and effectively implemented based on explicit triggers. This may include asset sales from
weaker to stronger banks, highlighting the importance of the need for more developed
secondary markets in the Egyptian financial system, as well as a more active syndicated
loan market in Egypt. Other measures include the termination of dividend payments (as
already exercised by CBE), freezing of salaries and benefits, limits on lending authority,
etc.
Credit risk is largely related to inadequate or incorrect information, poor credit risk
evaluation capacity, financing deals run through affiliates and connected parties, lack of
financial discipline, past reliance on subsidies and refinancing, and allocation of credit on
non-commercial grounds. Some of the risk associated with inadequate recognition of
non-performing loans relates to taxes applied against provisions. There is currently a 10
percent tax exemption applied to general provisions. While there is always concern about
For instance, Moody’s Financial Strength Index puts Egypt at 22.9 (on a scale of 100) as of May 2003,
placing it 43rd among 60 countries on a weighted average basis. (See “Global Financial Stability Report”,
IMF, September 2003.)
5
Assuming average assets of $114.7 billion-equivalent, this would require roughly a 1.5 percent annual
RoAA. Such earnings would approximate an RoAE of 11.2 percent. These returns are fairly consistent with
more advanced economies. For instance, in 2002, US banks’ ROA was 1.3 percent, and ROE was 14.5
percent. In Europe, after-tax ROA was 0.3 percent, and after-tax ROE was 8.2 percent. They are also
roughly on target for Egyptian ROE measures, which have declined y-o-y since 2001, but were 12.4
percent in 2001 and 11.1 percent in 2002. However, the RoAA figure is considerably higher than the norm
for Egypt, as its ROA has declined from 0.8-0.9 percent in 1998-2001 down to 0.7 percent in 2002 and 0.6
percent in 2003. Thus, with tightened regulations, Egyptian banks will need to increase earning assets as a
share of total, which also should point to the need for better loan classification, more accurate provisioning,
and essentially better credit risk management. (The Egyptian asset figure is derived from IFS assets for
banks and specialized banks at end 2002, converted to dollars, and then applying average real growth of 3
percent per year through 2008. US, European and Egyptian ROA and ROE figures are from the “Global
Financial Stability Report”, IMF, September 2003.)
4
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Policy Reform for Egypt: 2004-2008
banks over-provisioning for tax purposes, the other side is that under-provisioning
obscures the weakening solvency and financial position of the institution. At a minimum,
an evaluation should be conducted to determine if the tax system is appropriate for
modern banking practices, particularly with upcoming changes to be applied as part of
the second Basel Capital Accord.
Fundamental liquidity and market risks are related to (i) the exchange rate under the
recently introduced floating rate regime,6 given that external liabilities reported by banks
tend to be about 3:1 to assets7; and (ii) interest rate risk, particularly in local currency.8
Other risks may apply in terms of maturity mismatches, excess credit and investment
concentrations or exposures, and weaknesses in internal operating and information
systems. At a minimum, this will put pressure on banks to demonstrate their liquidity
management systems are adequate relative to gaps, exposures and risks. The onus here is
on the CBE as well as bank management teams to ensure their risk management systems
are operating properly, and that there is compliance with prudential norms. There should
be a progressive strengthening of macro-prudential risk detection at CBE and the banks,
with banks taking the lead and the CBE testing and certifying banks’ systems as adequate
in risk detection. There should also be no forbearance under any circumstances for state
banks, particularly as this would send a signal that recent recapitalization, new
management and boards, and the terms of performance contracts are less than serious.
►Reform #4: Enhance CBE Regulatory and Supervisory Capacity
With growing liberalization of financial services and a proliferation of banks in the
1990s, there has been a need to adapt to a more open, market-based system. Thus, CBE
needs to strengthen its off-site surveillance, on-site inspection capacity, policy
coordination, and contingency planning for stress and downside risks. This includes
implementation of CAMELS, and the introduction of an articulated corrective action plan
for banks that fall below 10 percent CARs.
CBE acknowledges its need to develop a program by which regular stress testing will be
conducted as a function of strengthening monetary policy implementation, financial
sector stability, and the role played by banking supervision. Additional tools that may be
included would be newly articulated criteria for deposit-taking institutions to meet
deposit safety criteria, and for non-compliance to trigger corrective actions.
6
For example, the exchange rate was 3.44 to $1 in 1999, gradually weakening to as low as 6.08 in 2Q
2002. By end 2002, the rate was 4.50. As of October 31, 2003, the exchange rate was 6.13 per $1. Thus, the
local currency has shown significant movement in recent years.
7
Banks’ external liabilities were $21.4 billion at March 31, 2003, as compared with only $7.9 billion in
external assets. Meanwhile, for non-banks, external liabilities were $8.3 billion, and assets were $5.2
billion. Thus, non-banks also have exposures and gaps, although the ratio is not as wide as with the banks.
All together, the consolidated foreign claims of reporting banks are $10.4 billion on a risk-adjusted basis.
(See “BIS Quarterly Review”, September 2003).
8
As an example, Treasury bill rates were 6.3 percent in January 2003, 7.5 percent in February 2003, and
13.6 percent in March 2003. (See International Financial Statistics, IMF.)
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Policy Reform for Egypt: 2004-2008
In general, financial information needs to be timely, complete and accurate. The
introduction of consolidated accounting for banks and other licensed financial
institutions should be a starting point to meet such information requirements. This
information should be complemented by regulatory reports that can draw on automated
systems running consolidated accounting systems (see Reform #6 below).
►Reform #5: Improve Corporate Governance
Banks need better systems for credit risk evaluation, portfolio management, identification
of risks to asset values and earnings declines, and risks to solvency and liquidity. State
banks are now under commercialized management, and performance contracts are in
effect to strengthen the recently recapitalized state banks. Audit committees and the
internal audit function should be mandatory, autonomous, and effective. All banks should
have internal risk rating systems for loans, clients, investments and portfolios for assetliability management, general portfolio management, strategic planning, investor
relations, and regulatory reporting purposes. In general, banks should be particularly
market-focused, as they are expected to tap into domestic and international markets for
additional funding (borrowings from syndicated lines) and investment (to further boost
capital). Key measures for banks to take, and for CBE to ensure are functioning properly,
include (i) required MIS for risk management purposes and regulatory reporting, (ii)
internal rating systems for prudential purposes, (iii) effective committees in place (legal,
audit, credit, investment, treasury, risk oversight) reflecting risk-based banking and
properly functioning, (iv) functional, autonomous internal audit function, and (v) “fit and
proper” shareholders and senior management. Again, there should be no double
standard for state banks vs. private banks. These reforms should be fully demonstrated by
2004, and evaluated continuously through the supervisory process.
►Reform #6: Increase Transparency and Accountability
Egyptian banks need to increase their levels of transparency and accountability to attract
greater investment, and for regulatory authorities and the public to have increased
confidence in their solvency, liquidity, management, and general (and ongoing) operating
condition. These two themes are essential, and germane to above mentioned reforms. For
example, for banks to meet rising capital figures, it is likely that outside investment will
be required as tighter rules apply to loan classification and other asset valuation (e.g. real
estate), and as traditional ROA measures suggest more than retained earnings will be
required. Moreover, a better flow of sound information is needed to restore and maintain
depositor confidence, as well as the confidence of institutions lending to banks. Thus,
more complete, accurate and timely information is needed for markets and regulators. All
banks should have their information systems (branches and headquarters consolidated
for submission to CBE) in condition to connect to the CBE credit risk information
network by 2004.9 This should be coordinated through introduction of a Uniform Bank
Performance Report for the largest banks, and required for all remaining banks no later
9
According to CBE, 37 of 57 met requirements as of June 2003. Connections are expected to be fully
functioning by end 2003.
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Policy Reform for Egypt: 2004-2008
than 2005. Credit information provided by CBE should be complemented with private
credit ratings10 for companies and households.
More generally, for markets to better function, consolidated accounting should be
required of all licensed financial institutions. This should be introduced for the largest
financial institutions (including insurance companies) by 2004, for all banks and
insurance companies with deposits and/or savings exceeding $1 million-equivalent by
2005, all banks and insurance companies by 2006, and all institutions by 2008. Such
accounting reform should be verified by international auditors, and all institutions’
financial statements should meet ISA standards of audit and be consistent with
consolidated accounting standards according to IAS by 2005.11 This includes mark-tomarket accounting for real estate values held as assets on bank balance sheets, as well as
any adjustments required regarding classified assets following international guidelines
and any revisions to prudential norms and risk weights that might be required by CBE
between now and then.
C.
The Securities Markets and Venture Capital
Egypt is generally inactive in international equity markets, while its exposure to
international debt markets fluctuates. With the exception of a $300 million12 equity issue
in 2000, there have been no recorded issues (by nationality of issuer). 13 This is broadly in
keeping with regional trends. Middle East markets in general point to low levels of stock
market capitalization and debt securities, relying more on bank-oriented systems.14 The
markets in Egypt suggest slightly more market development relative to GDP than as
compared to these trends, but still well below most other regional markets.
Total “emerging market financing” (loans to, bonds, and equity investments in) for Egypt
has fluctuated in recent years, from as high as $2.545 billion in 2001 to as low as $646
million in 1998 and $670 million in 2002. (No figures were published for 2003.) The
2001 figure was largely due to $1.5 billion issued in bonds, with the rest from
international loan syndications. Equities have remained limited, as noted earlier.15
Meanwhile, price-earnings ratios in Egypt are generally about half the norm for emerging
markets in Europe and the Middle East, and just slightly better than half the ratios of
emerging markets in general. There also appears to be a penchant for paying out
dividends, rather than retaining earnings for needed investment and growth. Egypt’s
dividend-yield ratios have been among the highest in emerging markets since 1998,
averaging about three times the norm for emerging markets and three to four times the
10
At the moment, there is no private credit information bureau in Egypt.
Banks have reported according to IAS since 2000.
12
Another source cites this as $319 million. (See “Global Financial Stability Report”, IMF, September
2003.)
13
See “BIS Quarterly Review”, September 2003.
14
The Middle East stock market capitalization in 2002 was $52.5 billion, or 6.5 percent of GDP. Bond
markets were valued at $18.9 billion, or 2.3 percent of GDP. By contrast, bank assets were 103.8 percent of
GDP. (See “Global Financial Stability Report”, IMF, September 2003.)
15
International equity issues totaled $102 million in 1998, $89 million in 1999, and $319 million in 2000.
Figures since 2001 have been zero. (See “Global Financial Stability Report”, IMF, September 2003.)
11
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Policy Reform for Egypt: 2004-2008
norm as compared to emerging markets in Europe and the Middle East. This may partly
reflect the need to pay out dividends to attract short-term investment, as well as relatively
easy access to bank credit for listed firms.
All of these trends point to the need to bolster domestic securities markets, while also
pursuing international issues. For markets to function closer to their potential, Egyptian
enterprises need to become more competitive to attract needed investment and credit,
from foreign as well as domestic sources (see Private Sector Reforms below). In this
regard, financial sector reforms are critical in the banking system to increase the
provision of needed services. However, with several internationally recognized and rated
banks in Egypt, the problem is less access to needed financial services (albeit cost is an
issue for many firms), and more the ability to implement needed efficiencies at the firm
level to attract institutional investment. This is more likely to occur in the domestic
market than from abroad. At a minimum, increasing the domestic securities market
reduces the risk of institutional investors from abroad reducing their exposures to Egypt
for exogenous (to Egypt) portfolio management reasons, while also reducing the risks to
local enterprises of dependency on bank borrowings. Furthermore, development of the
domestic markets would also facilitate local development via municipal financing,
greater housing finance as has occurred with recent changes in mortgage markets, and
consumer finance through various asset-backed securities that can be marketed and
securitized.
Beyond these market development needs, there is a strong push around the globe to
develop venture capital markets. The link to advanced technologies and innovative
processes is directly tied to these markets, as evidenced by pioneering products and
services from the United States and other markets where venture capital has figured
prominently. Nonetheless, for VC to function, information needs to be openly
disseminated, standards need to be in place, products and markets need to exist, and exit
mechanisms need to be in place for VC investors to generate the returns needed to sustain
their businesses and investments. These are generally lacking in Egypt, as evidenced by
low levels of transactions on the Cairo and Alexandria exchanges. In addition to the
fundamental private sector reforms needed for innovative businesses to have an
opportunity, the markets in Egypt do not appear positioned to absorb and trade such
companies. Open market operations require greater levels of financial information and
transparency for these transactions to occur, and for sufficient liquidity to be available.
Moreover, in many cases, such firms are bought and sold via private placements, which
are affected by discriminatory treatment in the tax code.16 Thus, substantial market
development will be required for viable VC to take off in Egypt.
16
Capital gains legislation treats bonds and income from other securities issued by joint-stock companies as
exempt if they are publicly traded and registered with one of the stock exchanges in Egypt. However, for
securities not publicly trade, the tax rate is 32 percent. (See “Egypt: tax regulations”, Economist
Intelligence Unit, August 19, 2003.)
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Policy Reform for Egypt: 2004-2008
The following reforms are proposed to more fully develop the securities markets:
►Reform #1: Increase Equity Market Participation
There are currently 79 firms with equities traded on the Cairo and Alexandria Stock
Exchanges, with stock market capitalization equivalent to $7.3-billion as of October 31,
2003.17 Meanwhile, international equity listings have been limited in number and value,
with no activity since 2001. In fact, since 1998, international equity listings by Egyptian
firms have approximated $510 million, against an emerging market total of $102 billion,
equivalent to 0.5 percent. Reforms should be focused on increasing market capitalization
(including international equity listings as contribution to capital) to levels that
approximate emerging standards by 2006-08. Notional targets should be as follows:
Stock Market Capitalization Targets
Increasing market
capitalization (including
international equity
listings as contribution to
capital) to:
2006
Half the norm for emerging
markets (12.35% of GDP),
or notionally about $12
billion.
2008
The norm for emerging
markets (24.7% of GDP),
or about $26 billion.18
To achieve these targets, significant reforms need to occur in the real sector as these are
the firms that are currently underserved by the financial markets. (The financial sector
also needs to pursue reforms, particularly if they want to eventually issue equities and
bonds. However, the issues are more pressing for enterprises.) Basic reforms include:








Requiring companies that list to be fully compliant with IAS
Increasing the availability of timely information with notes for the investment
community to evaluate company prospects and performance in detail
Promoting development of the NBFI sector to increase the involvement and role
of institutional investors in the market
Ensuring the depository continues to function properly and meet all requirements
for integrity and operational efficiency
Maintaining an investment-friendly environment to attract investment from
abroad
Promoting the issuance of small-value denominations to increase retail
participation in the equity markets
Promoting development of secondary markets to encourage liquidity and turnover
Eliminating any tax discrimination that serves as a disincentive to equity
investment
17
See http://www.egyptse.com/main.asp. Exchange rate cited from CBE web site.
The emerging market norm was stock market capitalization equivalent to 24.7 percent of GDP in 2002.
Thus, if the same in 2008, this would be equivalent to about $25.6 billion if real GDP grows at 3 percent
per year through 2008.
18
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Policy Reform for Egypt: 2004-2008
►Reform #2: Develop Debt Markets
As equity markets are underdeveloped in Egypt, so to are debt markets. In the Middle
East, debt markets account for less of a share of GDP than do the feeble equity markets.
In Egypt, this is not the case, with debt markets accounting for about 10 percent of
GDP.19 Further development of the money market is expected with recent changes in the
design and implementation of monetary policy in Egypt. However, the corporate debt
market and asset-backed securities market is underdeveloped throughout the Middle East,
including in Egypt. Thus, a reasonable target is to achieve emerging market norms by
2008, largely by promoting non-governmental debt securities during the five-year period
so that there is a reasonable mix of public and private debt in the markets by 2008.
Targets for achievement in the distribution of public and private debt are comparable to
ratios achieved in global emerging markets. These would be:
Bond Market Value Targets
Establish a viable debt
market and asset-backed
securities (bond) market,
including for mortgages,
municipal bonds, and
Government securities to:
2005
Half the norm for emerging
markets (17.3% of GDP),
or notionally about $17
billion.
2008
The norm for emerging
markets (34.6% of GDP),
or notionally about $36
billion.20
Meanwhile, based on emerging markets norms for 2002, Government bonds (including
municipals) could approximate 58 percent of total debt markets, while private debt
securities (mainly corporate and financial institutions) could account for 42 percent in
2008. Based on the above notional targets for debt securities, this would translate into
about $21 billion in government financing, and about $15 billion in corporate and
financial institutions’ debt financing. All of these figures are still small relative to bank
financing, particularly if capital and deposits grow, and considering that banks would be
among the leading issuers of corporate debt securities. Nonetheless, they add new
instruments, and impose new kinds of discipline on issuers that are beneficial in terms of
financial management and economic competitiveness. Basic reforms needed to build debt
markets are similar to those referenced above in terms of equity markets.
D.
Reform of the Insurance Sector and Pension Funding
Egypt’s underdeveloped insurance sector deprives businesses and households of needed
protection, and the capital markets of needed long-term investors. Life insurance is a
particular challenge in the region. Life insurance sales are undermined in the Middle East
region by generous retirement benefits and religious objections. However, in the case of
the former, many governments including Egypt cannot afford these benefits. Meanwhile,
19
See http://www.egyptse.com/main.asp. Exchange rate cited from CBE web site.
The emerging market norm was debt securities market values equivalent to 34.6 percent of GDP, of
which about 58 percent is government and 42 percent is private. Thus, if the same in Egypt in 2008, this
would be equivalent to $35.6 billion if real GDP grows at 3 percent per year through 2008.
20
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Policy Reform for Egypt: 2004-2008
other forms of insurance resembling life insurance might be devised without being
inconsistent with religious norms. Key reforms that should be pursued include:
►Reform #1: Strengthen the Legal Framework for Insurance
A modern legal framework that promotes a sound and well-managed insurance sector can
help to attract investment, strengthen institutions, and encourage business growth. Any
legal changes in the insurance framework should accommodate measures that would
reduce impediments to market development on the condition they are also consistent with
principles of financial stability, good governance, market efficiency and consumer
protection. This might include mandatory health insurance (e.g. for foreign workers) and
motor insurance, and any other areas where fiscal imbalances may be deepened as a
result of insurance omissions, as well as movement towards pension reform to encourage
employees to contribute to professionally managed savings plans. Basic measures
include:

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
Bringing legislation in line with IAIS guidelines
Separating insurance from banking
Separating life and non-life
Bringing investment policy guidelines in line with international standards
Establishing consumer protection measures that apply to rate-setting, policies and
claims
Establishing an Ombudsman for dispute settlement
►Reform #2: Strengthen the Regulatory and Supervisory Framework
A sound insurance sector cannot emerge without suitable regulations and supervisory
oversight. As with banks, failures in the insurance sector undermine public confidence.
Likewise, abuses by companies also weaken prospects for market development. On the
other hand, the business of insurance is about providing financial coverage for risks.
Thus, rights and responsibilities should be fully understood by all parties. Standardized
contracts may reduce the risk of abuse, while also clarifying payment obligations on both
ends. Key reforms in this area should include:




Bringing prudential norms and ratios in line with IAIS-recommended guidelines
and/or in countries where models appear potentially relevant and useful to Egypt
Establishing reporting guidelines consistent with international standards so that
financial information is timely and accurate
Building capacity for surveillance and inspections to verify financial information
(e.g. solvency ratios)
Developing capacity for contingency planning in the event that major insurance
failures cause distress for large numbers of households, or potentially adversely
impact the financial sector and the economy
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Policy Reform for Egypt: 2004-2008
►Reform #3: Support Development of the Actuarial Profession
Development of an actuarial profession takes time and reliable statistical data. At the
same time, incentives must be available to encourage a sufficient number of trained
actuaries to take on the profession in the first place. Development of the insurance sector
depends on actuaries and sufficient information for actuarial sciences to be applied.
Insurance sector development, along with pension reform, would provide the incentive
needed to further develop the profession, as market demand along with public sector
requirements would increase demand for such high-level information and services.
Moreover, development of actuarial sciences is in keeping with efforts to achieve a more
knowledge-based economy. Basic reform efforts should focus on establishing and
refining standards and guidelines by 2004, and then constructing and refining databases
for insurance companies to evaluate risk and introduce insurance products accordingly.
Such development would also have a “knock-on” effect in other financial markets, such
as housing finance, and would increase the knowledge base for broader portfolio and risk
management applications.
►Reform #4: Link Insurance Sector Development with Pension Reform
As Egypt stabilizes its fiscal position and seeks to expand its fiscal base, it will need to
project out the degree of funding needed to cover the first pillar of the pension system.
More importantly for the next generations, Egypt will need to move forward to establish
a vibrant 2nd pillar of the pension system, and preferably a 3rd pillar in time as long-term
confidence grows, markets mature, and resources are available for voluntary
discretionary savings. In the meantime, efforts need to be made to ensure that
preconditions for effective 2nd pillar management are in place. These include
(i) regulatory capacity to ensure mandatory pensions are prudently managed according to
investment policy parameters, (ii) custodial capacity to ensure the safety and veracity of
transactions and portfolio information by account, and (iii) general reporting mechanisms
to ensure that all financial and accounting data are accurate. Movement in this direction
should serve as an incentive for life insurance firms to play more of a role in the financial
sector, including as major institutional players in securities markets. Meanwhile,
movement in the direction of a 2nd pillar should then serve as a potential harbinger of
eventual movement towards a 3rd pillar, adding to financial market opportunities and
instruments.
E.
Other NBFI Issues
In addition to the major components of financial sector development—banking, securities
markets, and contractual savings—there is room for development of other specialized
areas of finance. These include leasing, factoring, warehouse receipt financing, housing
finance, and municipal finance.
Leasing is largely an asset-based credit function by which equipment value secures the
loan. The benefit of an active leasing market is that it provides SMEs with financing
operations without requiring large down payments. Key incentives to develop this market
12
Policy Reform for Egypt: 2004-2008
are depreciation schedules, and the impact on taxes paid. There is also a need for
secondary market trading in equipment to establish salvage values. For growth to
increase among SMEs, a more active leasing market would help.
Factoring is largely a commercial credit function in which portfolios of small credits are
bundled and sold at a discount for immediate cash. This resembles the syndicated loan
function. A key ingredient is consumer credit data to test for credit worthiness. Absence
of such information either makes this market impossible to function, or at least adds
significantly to the risk of assuming the portfolio.
The three other areas—warehouse receipts, housing, and municipal finance—are all
closely related to the development of securities markets. Warehouse receipts are largely
secured financing transactions backed by inventories that have been weighed, graded, and
in some cases processed and prepared for shipment. Housing finance in Egypt is currently
bank-based, with little market development beyond basic home loans. Municipal finance
exists at a low level. In all three areas, there are prerequisites to adding to the financing
volume that could eventually be used as products for securities markets development.
Warehouse receipts are an obvious product in a country with large numbers employed in
the primary sector. Housing finance is likewise an area of potential growth, particularly
with urbanization and high population growth rates. Meanwhile, municipal finance would
be expected to grow over time as local governments build capacity to administer some
local infrastructure and service needs. In this regard, housing finance trends are closely
linked to municipal finance capacity, as property tax assessments are often the main
financing source for municipalities.
►Reform #5: Promote Development of a Broad Range of NBFIs
Several areas can be supported to stimulate growth of NBFIs. Accounting and tax reform
related to more accelerated depreciation schedules for equipment might serve as a useful
stimulus for leasing market development, triggering increased lending to and investment
in SMEs. Expansion of the credit information effort of the CBE might assist with the
development of factoring markets. An evaluation should be made as to whether it would
be commercially feasible to establish a private credit information agency. 21 Electronic
information flows might help make markets in the agricultural sector, facilitating
development of a warehouse receipts market on local exchanges. A clear legal framework
(based on creditors’ rights) for secured housing transactions would help pave the way for
primary financing of housing, as well as eventual secondary market purchases via bonds
or other securities. Adoption of modernized appraisal standards and mark-to-market
accounting for property values would assist local governments with property tax
assessments, increasing their capacity to float bonds for needed investment and services.
21
This would not require government involvement. Rather, it could simply be an announcement of changes
(or planned changes) to make the environment more conducive, and then solicitation of expressions of
interest to establish a private credit bureau.
13
Policy Reform for Egypt: 2004-2008
III.
Private Sector Reform
A.
Background
Egypt’s GDP is fairly large, ranking about 38th in the world in 2001.22 Recent economic
performance also has highlighted many sound macroeconomic fundamentals, including
reasonable inflation rates, low fiscal deficits, adequate hard currency reserves, a stable
debt profile, and recent improvement in export performance (including non-oil, and a rise
in services).23 However, GNI per capita is only about $1,470, which is fairly low by
international standards. Compared with 13 Middle East countries for which data are
available,24 Egypt ranked higher only than Yemen, Morocco and Syria. As compared to
Portugal, which has the lowest per capita income among EU countries at $10,840,
Egypt’s GNI per capita would only represent 13.6 percent in relation. While the
unemployment rate was last listed in 1999 at 8.1 percent, this figure is considered low
when accounting for levels of under-employment. Meanwhile, recent reports produced by
the Arab Fund for Economic and Social Development and UNDP put many of Egypt’s
human development indicators at fairly low levels, and certainly sub-optimal levels
relative to potential.25 Therefore, a number of reforms are needed to further galvanize
Egypt’s efforts to narrow the income gap with advanced and middle-income countries, to
provide needed stability, and to increase access to quality education, health care and jobs
for sustainable development.
B.
Policy and Institutional Reforms
As noted above, an appropriate policy and institutional framework is needed to increase
the effective use of information across all sectors of the economy, and to promote
entrepreneurship to better use and adapt such knowledge and information for economic
growth and development. Key policies (with supporting laws, regulations and
institutions) include:







Macroeconomic stability
Good governance
Judicial systems that help to improve enforcement of a sound legal framework.
Openness to trade and (foreign direct) investment as a function of free and fair
competition
Low barriers to entry and exit
Credit, investment and financial sector policies to deepen financial intermediation
Labor market flexibility combined with investment to increase the supply of
knowledge-workers while providing incentives to companies to hire and retain
through enhanced productivity and performance
22
See Swiss Re.
See Abul-Eyoun, “Egypt: Economic Performance FY 2002/03”, CBE, 2003.
24
Algeria, Iran, Israel, Jordan, Lebanon, Morocco, Oman, Saudi Arabia, Syria, Tunisia, UAE and Yemen.
25
See “Arab Human Development Report” for 2002 and 2003.
23
14
Policy Reform for Egypt: 2004-2008
Specific to the business environment, Egypt shows positive developments in some areas,
and the need for progress in others. According to the World Bank, 26 areas in which Egypt
is not too far from recommended OECD standards and/or is consistent with regional
norms among the Middle East countries cited are (i) flexibility in hiring employees,
(ii) number of procedures and days to enforce contracts, (iii) procedural complexity in the
enforcement of contracts, and (iv) the cost and efficiency of closing a business. Thus,
there has been some clear labor and judicial reform, as well as progress in reducing
barriers to bankruptcy, restructuring and liquidation. However, areas where Egypt’s
performance lags are several. These include:
26

Business Start-up: Starting a business requires 13 procedures and 43 days. This is
typical of many regional economies, as well as some of the less efficient or
developed OECD countries. However, it is significantly more than the most
competitive OECD countries, and several of the countries in the region with
higher GNIs than Egypt. Importantly, the cost of business start-up is high, at 61
percent of GNI per capita (about $900). Among “high” OECD countries, only
Greece is higher as a percentage of GNI. Italy is the second lowest performer
among the OECD countries, at 24 percent, about 40 percent of the relative cost in
Egypt. Furthermore, minimum capital to start a business is high in Egypt, at 788.6
percent of GNI (about $11,600). Only four of the Middle East countries have
higher ratios, and none of the OECD countries are anywhere close. (Greece and
Austria are about 140-145 percent.) Thus, Egypt has very high costs of entry, and
this stifles private sector development and fiscal base expansion.

Conditions of Employment: Egypt’s conditions of employment appear protective
of workers, making it difficult to release unneeded workers. Such an impediment
carries the risk that companies are less interested in taking on permanent
employees, while also possibly overstating employment rates in national statistics
due to difficulties releasing those currently employed yet de facto redundant. This
adds to cost, undermines productivity, and reduces economic competitiveness.

Contract Enforcement: Egypt’s performance with regard to contract enforcement
is comparatively good. However, it is costly to firms, as indicated by the high cost
of enforcement. In Egypt, contract enforcement costs are equivalent to 30.7
percent of GNI, or about $450. While cheap by OECD standards, Egypt’s costs
relative to GNI are twice that of Finland, where relative costs are highest among
“high” OECD countries. The average cost is also high by regional standards, with
only Israel, Lebanon and Syria having higher relative costs.

Business Closure: While contract enforcement appears largely adequate in Egypt,
business closure takes an exceptionally long time. The average is 4.3 years, with
only Denmark and Switzerland (among “high” OECD countries) taking as long.
In the Middle East, Egypt’s performance is in the mid-range, with several
countries taking approximately as much time, and Oman and UAE taking 5-7
See “Doing Business”, World Bank.
15
Policy Reform for Egypt: 2004-2008
years. However, such long proceedings and closure procedures run the risk of
asset stripping, political and judicial corruption, and higher costs of contract
enforcement.
To remedy these weaknesses, needed reforms include:
►Reform #1: Broad Policy and Institutional Reforms
Business start-up costs are far too high and need to come down as a percentage of GNI.
This calls for the streamlining of procedures, lowering overall costs of licenses/permits
for start-up, and lowering capital requirements for non-financial enterprises. Conditions
of employment need greater flexibility, and less employee protection. Contract
enforcement mechanisms appear costly, and efforts should be made to streamline these
costs if possible. Business closures should not take more than four years. Thus, more
efficient resolution procedures, including specialized commercial courts or other forms of
alternative dispute resolution should be introduced.
IV.
Movement Towards a Knowledge-based Economy
The progression towards a knowledge-based economy within Egypt should focus on
(i) developing a coherent national strategy to build and sustain a knowledge-based
economy; and (ii) providing the conditions needed for establishment of a knowledgebased economy, including the infrastructure for networking and sharing of knowledge, as
well as the openness and transparency of information flows needed for cooperation,
coordination and balanced development of key sectors of the economy. Both actions
should be broad-based in approach, involving government and private sector actors
across all sectors of the economy, and should target the development of the following
synergies between stakeholders:
16
Policy Reform for Egypt: 2004-2008
Egypt should work towards building a comprehensive program to achieve movement
toward a knowledge-based economy. This program would emphasize the following
characteristics:

An appropriate policy and institutional framework that provides economic and
other incentives to increase the use of information across all sectors of the
economy, irrespective of the source of that information (i.e., domestic or foreign),
and to promote entrepreneurship to harness the use and adaptation of such
knowledge and information for economic growth and development. Basic
components of such an effort include macroeconomic stability, governance
standards and the rule of law, competition policy, labor market flexibility, the
regulatory environment, openness of trade and investment, entry/exit of firms,
credit and financial sector development, and intellectual property rights.

Establishment and maintenance of a skilled, flexible and innovative work force
with increased access to education and opportunities, based on a mix of public
and private sector funding. Such focus on education and human capital investment
can be measured in a number of ways, from basic literacy/numeracy and
enrollment in primary, secondary and tertiary institutions to more efficient and
effective R&D, issuance of new patents, and general levels of intellectual
property development.

Development of a dynamic information systems infrastructure—Information and
Communications Technologies (ICTs)—that thrives on increasing competition
and innovation in the use of information, and that is harnessed to adapt/apply such
information and processes to all sectors of the economy to support rising
efficiency and competitiveness. This includes high-end systems such as the
internet and mobile telephony, as well as lower end methods of transmission (e.g.
radio, television, other media, computers) and storage/archiving.

Coordination of firms, scientists, engineers, research centers, universities, think
tanks, and other institutions to help implement the knowledge-based framework,
including elimination of duplicative efforts, and simultaneously pooling
efforts/resources when feasible for large-scale and ambitious projects.
A.
Enablement of e-Government Services (G2G, G2B and G2C)
With efforts to further professionalize the civil service, enhance public sector service
delivery, and reduce the scope for corruption, Egypt’s reform program should include
modernization, use of advanced technologies and information systems, and increased
application of electronic services. These may include:

Establishing an e-civil service registry compatible with the current payroll system
to permit cross-referencing of staffing and salary data.
17
Policy Reform for Egypt: 2004-2008
B.

Introducing electronic intra-governmental interaction to modernize systems and
processes, and to enhance communications and information flows within and
between ministries and different governmental organizations. This initiative might
include e-budgeting to enhance efficiency and transparency in public
expenditures, as well as to facilitate the monitoring of revenues, expenditures and
variances for ongoing management and planning needs.

Establishing an e-taxation system to improve revenue collection, enhance
transparency, and increase the efficiency of collection.

Increasing electronic applications to more broadly disseminate information, and to
better deliver Government services. These could include:
o e-Justice, to streamline and automate case handling and reporting systems,
with the objective of reducing multi-year backlogs and increasing
efficiency in the courts.
o e-Health, to provide access to vital information for service providers, and
statistics to enhance service delivery.
o e-Land Cadastre, to improve access to land records and title information
for the development of land markets, and to promote investment in
housing and commercial property development.
Innovation and the Work Force (G2B, B2B and E2B)
Establishment and maintenance of a skilled, flexible and innovative work force is a
prerequisite for a competitive economy. Thus, education at all levels is essential, as is
recognition of the permanence of the process. A corollary to this point is recognition that
on-the-job training is sometimes the most effective method of education and training for
people on an ongoing basis, notwithstanding the clear importance of literacy and
numeracy for entry into most jobs. From a policy standpoint, this must be accompanied
by an open and conducive environment for free and fair competition.
►Reform #1: Enforcing a Sound Competition Policy
Domestic competition policy should be designed to promote sustained economic growth,
and to ease the entry and exit of firms into and from the market. In recent years, Egypt
has been fairly open to entry. However, exit has been a different matter, adding to
distortions in the market. Measures that can be pursued to ensure Egypt’s competition
policy is consistent with best practice and international standards include (i) aligning the
country’s intellectual property rights regime with that of the WTO; (ii) enforcing antimonopoly regulations, and strengthening anti-monopoly institutions; (iii) promoting
private sector investment into new technological ventures without biasing the incentive
structure in favour of specific firms vs. other non-preferred firms; (iv) supporting a more
efficient banking system, and the formation and growth of non-banks (e.g. venture
capital, leasing, insurance, private pension funds, mutual funds) and markets (e.g.
securities markets, venture capital markets); and (v) adopting tax policies that are
18
Policy Reform for Egypt: 2004-2008
straightforward, easily understood, easily administered, fairly regular in terms of rates
and conditions (to encourage investor certainty and investment planning predictability),
and competitive with or better than tax rates and administrative practices abroad (to
reduce the risk premium associated with investment in Egypt).
►Reform #2: e-procurement
The e-procurement initiative would need to be accompanied by a review of procurement
processes, including thresholds for types of firms and methods of awarding contracts, as
well as the criteria used to evaluate bids and the general process of scoring and
announcing awards. However, recognizing that these are universal challenges, movement
in this direction would represent progress, stimulate competition, potentially reduce costs
of government services, and provide greater private sector opportunities.
►Reform #3: e-licensing/registration
Movement to introduce a web-based license application and renewal process would
streamline bureaucratic procedures, reduce corruption, and stimulate business formation
and investment. Such a process would need to be accompanied by information
verification procedures and company identification numbers (linked to tax and customs
administration). However, by and large, such a process would contribute to the numbers
of small businesses operating, reduce government administrative costs, potentially reduce
the costs of licenses and renewals, accelerate the process (beneficial to companies),
streamline the numbers of permits required, and likely contribute to a broadened fiscal
base.
►Reform #4: e-investor
Movement to introduce a web-based investment approval process would be similar to the
e-licensing/registration service, and would provide prospective investors with
information on the status of their investment application process. Such a process would
provide confirmation that registration requirements (e.g. tax-related) were in order, and
the status of any remaining approvals regarding permits and licenses. This would reduce
paperwork, accelerate investment, and likely make the approval process more efficient as
the electronic format could be tied to “no objection” triggers based on days required for
formal approvals.27
Given that a sound competition policy is adopted, specific measures can and should be
taken to strengthen investment in human capital. These include:
►Reform #5: Enhancing Human Capital via Education
Egypt has a long tradition of higher education and learning. However, as with many
developing countries, there is also a challenge of broad-based access beyond primary
27
Many investment promotion frameworks make approvals automatic if no objection has been issued
within a specified time line.
19
Policy Reform for Egypt: 2004-2008
levels. Adult literacy rates are 65 percent for men and only 40 percent for women (1997
figures).28 Meanwhile, many individuals with secondary educations find it difficult to
find work commensurate with education and skill levels. Thus, several reforms can be
adopted to improve the role of education and training. These include: (i) modernizing
curricula and testing/examination processes at all levels to meet the needs of industry and
international standards; (ii) aligning students’ academic research towards industry needs;
(iii) establishing or restructuring Education Councils and Boards to include private sector
representatives and sponsors, to ensure alignment with industry needs, and to introduce
commercial practices; (iv) creating Qualification Assurance Systems to certify
competencies of individuals and accredit institutions/firms; (v) designing national
(unified) testing systems for Higher Education establishments to provide unified
requirements to future students and making admissions more transparent, as well as to
reduce the cost of the admissions process; (vi) expanding vocational training through
private sector partnerships to meet labor market demands; (vii) providing re-training for
workers to adapt their skills to the knowledge economy (e.g. internet training, business
and marketing skills); (viii) training/assistance for redundant employees to re-orient them
towards prospective jobs as well as to teach new skills; (ix) introducing and expanding
the use of distance learning—internet-based education; (x) improving computer literacy
and internet-based skills by introducing computers, basic programming and software
early in schools, and connecting schools, universities and vocational training centers to
the internet.
With a sound competition policy in place and measures to strengthen human capital,
economic “push” and “pull” can come from measures that support the development and
increasing efficiency of innovation. A series of reforms can be pursued to broaden the
scope of innovative processes and procedures in Egypt.
►Reform #6: Advancing Innovation
Several measures can be introduced or expanded to advance innovation in Egypt. These
include: (i) support for competitive research programs for research centers, think tanks
and universities, including enhanced information dissemination; (ii) support for
Metrology and Patent offices with greater legal, institutional and laboratory infrastructure
capacity; (iii) establishment and refinement of national standards (in line with
international standards) via a National Accreditation and Quality Council; (iv) support for
the commercialization of R&D outputs, research centers, think tanks, universities and
enterprises by upgrading laboratory facilities and staff skills, modernizing HR systems
and business processes, improving marketing and commercialization functions,
enhancing incentives for applied research, introducing competitive research programs,
and promoting joint projects with industry and other R&D organizations; and (v)
promotion of technology parks and centers to encourage integration and niche clusters.
28
See “World Development Report”, World Bank, 2000.
20
Policy Reform for Egypt: 2004-2008
C.
Financial Sector Reform and Movement to a Knowledge-based Economy
(B2B and G2B)
As Egypt’s financial sector modernizes, technology and advanced information systems
will be highly featured. This will relate significantly to fundamental financial stability
and risk management issues, as well as basic competitiveness requirements at the
institutional level. Some additional measures either have been carried out, or can be
carried out in Egypt to ensure this process continues for increased economic
competitiveness. These include:



D.
Facilitation of the use of digital signatures, to enhance the speed of business-tobusiness transactions, and to improve the efficiency of business contracting
(which would presumably be beneficial to financial sector players as creditors and
investors).
Introduction of an e-Credit information system to improve the availability of
borrowers’ credit histories to financial institutions to enhance access to finance by
SMEs. The CBE is in the process of expanding its public credit registry for retail
and SME application. Having most banks’ systems linked electronically to that of
the CBE constitutes progress to date. All other banks should be required to do so.
(Whether this impedes the private credit bureau option should be evaluated.)
Facilitation of the increasing use of the e-Pledge registry for movable assets to
improve creditors’ rights, and thereby reduce risks of lending to SMEs; moving
on to automate the immoveable registry, and to have this available for public
review on a computerized basis.
Information Systems Infrastructure (G2C, G2B and B2B)
Development of a dynamic information systems infrastructure is also a prerequisite for
economic modernization, competitiveness and growth. This includes the use of high-end
systems (e.g. internet, mobile telephony) as well as more traditional technologies
(e.g. radio, television, other media, computers) to assist with the transformation of
information dissemination, production, processing, distribution and financing from
traditional methods to more electronic methods. Examples would be expected to include
business-to-business exchanges of information, as well as business-to-client exchanges of
information, services and payments. (Government and financial sector applications are
also discussed in subsequent sections.) For this to occur, a policy and program of ICT
support should be in place.
►Reform #1: Supporting Information and Communications Technologies
Fundamental measures to support ICT include (i) modernizing telecommunications
networks, including liberalization and privatization of the traditional fixed line company;
(ii) promoting alternative communication tools (wireless services); (iii) universalizing
access to telecommunications (including for low-income and rural dwellers) to “bridge
the digital divide”; and (iv) promoting affordable internet access. Among other measures,
one approach to increasing access is to make these services available at post offices,
21
Policy Reform for Egypt: 2004-2008
libraries, and other public agencies that are commonly found throughout Egypt.
Commercialization and partial privatization of the postal system could include such a
component for revenue generation to cross-subsidize losses from traditional core
operations (along with other electronic upgrades, such as transmission and receipt of
domestic and international money orders/transfers/remittances).
E.
Coordination (G2G, G2B, G2C, B2B and E2B)
Coordination of public and private sector institutions is of critical importance for a
knowledge-based strategy to be effectively and efficiently implemented. Firms, scientists,
engineers, research centers, universities, think tanks, and other institutions are all needed
to help conceptualize and implement the knowledge-based framework. This includes
areas of focus and investment, the elimination of duplicative efforts, and the pooling of
efforts/resources when feasible for large-scale and ambitious projects.
►Reform #1: Supporting a Knowledge-based Economy via Enhanced
Coordination
Several measures can be taken to improve coordination. This includes (i) setting up
and/or strengthening Technology Policy Institutions to enable them to carry out policy
studies, serve as data centers on technology issues (for private and public sectors, both
locally and internationally), and conduct technology outreach and public awareness
activities; (ii) align Science and Higher Education Policy with the needs of the economy;
and (iii) improve the research base, while integrating it with the international community
through joint collaborations on publications and projects.
V.
Tax Policy and Government Reform Efforts
A.
Basic Fiscal Position
Egypt’s fiscal balances have tended to be reasonable in recent years, particularly as its
debt profile has been well managed. Fiscal deficits have come down since 2001 as a share
of GDP, suggesting there has been improvement in fiscal management even though the
economy has experienced a slowdown (in dollars) since 2001. (Real growth in 2002/03
was reported by CBE to be 3.1 percent.) The following table highlights revenues,
expenditure and balances relative to GDP since 1998.29
Government Balances: 1998-2002
1998
24.32
Fiscal revenue (% of GDP)
25.32
Fiscal expenditure (%GDP)
-1.01
Fiscal Balance (%GDP)
Sources: HSBC Bank, IMF(IFS), World Bank
1999
24.24
28.45
-4.21
29
2000
21.25
24.57
-3.32
2001
20.5
22.30
-1.8
2002
20.1
21.80
-1.7
These figures are subject to some error as they are derived. Government balances have not been
published in International Financial Statistics since 1999.
22
Policy Reform for Egypt: 2004-2008
The informal sector is estimated to account for about 35 percent of GNI. This is at the
high end for the Middle East countries, with only Morocco and Tunisia estimated to have
higher rates. (Egypt, Algeria and Lebanon are similar.) By contrast, “high” OECD
countries (apart from Greece at nearly 29 percent) generally do not exceed 23 percent
(Belgium, Portugal and Spain), and most are about half that of Egypt or less. All of this
points to better systems of collection and compliance, even in the weakest of the “high”
OECD countries.
►Reform #1: Reduce Impediments That Keep the Informal Sector Large
Many of the private sector reforms proposed would help to bring informal enterprises
into the formal sector. While lower tax rates may help, including a flat tax if introduced,
many enterprises often stay informal for other reasons. These are because corruption (e.g.
bribes) serves as a tax that is unrecorded. Beyond that, the number of licenses, permits,
procedures, inspections, etc. becomes so cumbersome, time-consuming, discretionary and
costly that formalized procedures are not worth pursuing. In addition, with low incomes,
there is an added incentive for people to underreport income to avoid paying taxes. Thus,
to reduce the size of the informal sector, a multi-faceted approach to tax administration,
tax rates, and public sector management needs to be implemented. Should rates come
down and administration become less cumbersome, it is likely that the informal sector
share of the economy would decline.
Structure of Tax Revenues30
B.
Based on data from 1999-2000, Egypt’s revenues approximated 22.8 percent of GDP.
This was slightly below the average of 25.3 percent for eight Arab countries.31 Egypt’s
revenue contribution to GDP was broadly distributed as follows:







6.8 percent from hydrocarbon revenue fees, dividends, and CBE profits; placing
non-tax revenue below the eight-country norm of 7.6 percent
4.5 percent from VAT/general sales and turnover; marginally below the 4.8
percent norm
4.2 percent from corporate taxes; well above the 3.4 percent norm
2.8 percent from import duties; below the 4.3 percent average
1.8 percent from individual taxes; in line with the norm of 1.7 percent
1.5 percent from excise taxes; less than the 2.2 percent average
1.2 social security taxes; slightly above the 1.0 percent norm
This structure suggests that there is reasonable distribution. Non-tax revenue serves as a
huge supplement to general fiscal revenues, while direct taxes (corporate and individual)
account for about 26 percent of total. Egypt’s structure in this regard appears to generate
a bit lower revenue than the three Maghreb countries (e.g. Algeria, Morocco, Tunisia),
Figures for this section all from K. Nashashibi, “Fiscal Revenues in South Mediterranean Arab
Countries: Vulnerabilities and Growth Potential”, IMF, 2002.
31
Algeria, Egypt, Jordan, Lebanon, Morocco, Syria, Tunisia, and West Bank/Gaza.
30
23
Policy Reform for Egypt: 2004-2008
while being consistent with the Mashreq countries (e.g. Jordan, Lebanon, Syria, West
Bank/Gaza).
By comparison with middle income countries,32 Egypt’s fiscal revenues to GDP appear
fairly consistent, although slightly lower than the 23.6 percent recorded on an unweighted
basis. However, G-24 countries of the OECD averaged 32.5 percent revenues to GDP,
with far higher revenues generated from individual income (7.2 percent of the 32.5
percent), as well as far higher Social Security taxes (8.5 percent). Corporate tax revenue
was only 2.6 percent of GDP (less than Egypt), whereas reliance on VAT was 6.2 percent
of GDP (greater than Egypt).
►Reform #2: Marginal Reconfiguration of the Structure of Revenues
Egypt’s distribution is not too far from many reasonable models. Should there be
changes, the main changes needed appear to be (i) slightly expanding the net of
VAT/sales tax items, although increasing application of electronics through POS and
other systems may suffice; and (ii) tightening customs administration, perhaps to raise
collections on imports and associated excise taxes. The main focus is likely to be on
reducing rates and closing out exemptions, combined with better collection.
C.
Tax Rates
In several cases, Egypt’s tax rates appear to be reasonable by global standards. For
instance, corporate taxes are projected to come down to 32 percent (from 42 percent). 33
The 32 percent rate is already in effect for industrial activities, and would come down in
services and trade. While some countries have lower rates, including some of the more
dynamic and/or advanced economies, the 32 percent is within range of international
norms. Moreover, this rate is uniformly applied to resident and non-resident enterprises,
public and private. There may be gaps or abuses in the number of activities that enjoy
exemptions, including donations to government agencies and “approved” charities (the
latter up to 7 percent of annual taxable “profit”), and remuneration paid to company
directors (although this is presumably taxed as personal income). Any move to lower
rates and/or to move to a flat tax would also call for the closing of many/most exemptions
to broaden the fiscal base without sacrificing revenue.
Personal income tax rates range from 20 percent to 48 percent. These are higher than
many emerging markets, although these rates are not necessarily inconsistent with many
OECD countries. The main challenge for Egypt is to increase individual incomes so that
the proportion of individual tax revenues increases by virtue of rising incomes. The role
of personal income taxes would also need to be factored into flat tax considerations. By
excluding personal income, it lowers the base of taxation to corporations. On the other
32
Includes five transition European countries, Turkey, four southeast Asian countries, and six South
American countries.
33
This includes a 2 percent “development duty”.
24
Policy Reform for Egypt: 2004-2008
hand, a flat rate applied to individuals and companies broadens the base, and provides an
opportunity to lower rates.34
Sales tax rates in Egypt are a universal 10 percent. Major reform in the general sales tax
has transformed this into a VAT. Over time, this should assist with collections and fiscal
balances. However, this will also depend on systems for collection, overall compliance,
and a sufficient base (few or no exceptions) to keep the rate(s) down.
Some attention has been put to introducing a corporate flat tax for simplification. While it
has worked well in some countries at certain times,35 there is no guarantee it would solve
Egypt’s fiscal challenges. Advantages to this approach include clarity and simplicity, as
well as a vehicle to reduce government corruption. However, choosing an appropriate
rate is subject to risk if the rate is too low (leading to insufficient revenues) or high
(possibly perpetuating high levels of non-compliance). Moreover, there is an issue of
what is subject to taxation, which also points to issues such as depreciation schedules and
exemptions. On the other hand, progressive tax systems often are complicated, involve
exemptions, and invite avoidance and corruption.36
►Reform #3: Reforms in the Administration of Tax Rates and Collection
Basic measures the government can take to improve tax administration and collection
include closing exemptions, and reducing the scope for negotiation with Government tax
officials. An additional item is to review depreciation schedules to investigate how
accelerated rates might encourage more investment. As of now, depreciation schedules
are extended, while many of the leading edge industries that are knowledge-focused have
far more accelerated schedules. A review of the strengths and weaknesses of moving to a
flat-tax regime is also warranted.
34
The Slovak parliament approved a 19 percent flat tax applied to individuals and companies on October
28, 2003.
35
For example, Russia has introduced a 13 percent flat tax, and fiscal revenues have exceeded expectations.
However, this coincides with a booming economy, and it is uncertain if the flat tax would work if
commodity prices dropped and/or unemployment claims increased with other expenditure during an
economic slowdown.
36
The recently adopted flat tax legislation in the Slovak Republic is designed to both increase collections
and reduce corruption. This was also one of the motivations in Russia, where the flat tax has achieved
results well beyond expectations.
25