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EGYPTIAN SNAPSHOT 2015 Quarter 1 Inflation – After slowing in the first half of 2014 (reaching a low of 8.2% y-o-y in June 2014), consumer price inflation surged in July after the government raised the prices of administered fuels and other energy-related products. Since then, consumer price inflation has remained high: the most recent data from the Central Bank of Egypt (CBE) shows that it reached 11.5% y-o-y in March 2015. Inflation in regulated items (i.e. subsidised and government-regulated products) increased to slightly above 25% y-o-y in March. Growth – Economic growth has been weak since 2011, as high political risk and uncertainty about the country’s economic prospects have led to a sharp decline in investment. Real GDP growth did however rebound to an estimated 4.2% in the 2014 calendar year. Growth was especially high during the second half of the year, averaging 5.5% y-o-y, although this was largely due to base effects, following a disastrous second half of 2013. There was a particularly strong rebound in investment, while both private and government consumption expenditure continued their strong upward trend. National development plan – Egypt hosted a widely-publicised economic conference over the weekend of March 13 - 15 where the government gathered thousands of potential investors from around the world in an attempt to lure investment back to Egypt. The government also passed some investor-friendly measures in the lead-up to the summit. Most notably, it reduced the top income and corporate tax rate from 30% to 22.5%. It also reduced the sales tax on equipment used for production from 10% to 5% and reduced customs duties on equipment used for production to only 2%. The government also approved a new investment law that is supposed to reduce red tape and make investment laws less vulnerable to legal disputes. OPPORTUNITIES STRENGTHS Large and growing middle class provides substantial opportunity in the consumer goods industries. Natural gas potential is large; production could increase significantly over the medium term if policies and political climate are attractive. Immense scope for wind and solar power generation via the Desertec programme in the Sahara Desert. The planned mega-projects will provide large-scale opportunities in the construction sector over the short to medium term. Well diversified economy that showed very strong growth prior to the uprising. Proximity to Europe and the Middle East provides companies with a large market. The government has the backing of Saudi Arabia and other Arab countries; these countries are providing substantial financial support to Egypt. Well developed, well regulated, and liquid capital markets. VULNERABILITIES WHAT IS BEING DONE? Tourism sector is susceptible to terror attacks. The terror risk remains elevated The army’s counter-terror operations in the Sinai are expected to eventually as conventional avenues of contestation have effectively been shut down. reduce the terror threat, but it will take some time. The government has reduced energy subsidies. However, planned megaPublic debt is very high at above 90% of GDP. The pace at which the projects will put additional pressure on fiscal finances and we expect the fiscal government plans to reduce the fiscal deficit is also slow. deficit to remain wide over the medium term. Therefore, the country will remain dependent on aid from Gulf Cooperation Council (GCC) countries. Egypt was one of the best reformers on the World Bank’s Doing Business Limited economic freedom and challenging business environment. Index in the five years prior to the uprising, but progress has slowed. Currency risk is high due to a sharp decline in foreign exchange reserves since Government has secured large amounts of foreign funding from Arab the start of 2011. governments to prevent a currency and/or fiscal crisis. MEGA TRENDS Population 86,895,099 (July 2014 est.); Age 15 - 64: 62.9% Population growth rate (%) 1.84% (2014 est.) Life expectancy at birth Total population: 73.45 years; male: 70.82 years; female: 76.2 years (2014 est.) HIV/AIDS Adult prevalence rate: <0.02%; People living with HIV/AIDS: 7,439 (2013 est.) Adult literacy rate (age 15 and over can read Total population: 73.8%; male: 82.2%; female: 65.4% (2015 est.) and write) Urbanisation Urban population: 43.0% of total population (2013); Urban population growth: 1.7% (2013) Population below national poverty line 26.3% (2013 est.) Unemployment rate 13.4% (2013 est.) Employment (% of total) Agriculture: 29.2%; Industry: 23.5%; Services: 47.1% (2011 est.) Labour participation rate (% of total population ages 15+) 49.1% (2013) Business languages Arabic, English, French Telephone & Internet users Main lines in use: 6.82 million; Mobile cellular: 99.7 million; Internet users: 43.07 million (2013) Sources: CIA World Factbook, World Bank, UNESCO, ITU, UNAIDS, Ahram Online, CAPMAS & NKC Research 1 Total Egypt Corruption Perceptions Index 2014 (1 least, 175 most corrupt) Doing Business 2015 (1 best, 189 worst) 189 112 Global Competitiveness 2014-15 (1 most, 144 least competitive) 148 119 Economic Freedom 2015 (1 most, 178 least free) 178 124 HDI Ranking 2013 (1 most, 187 least developed) 187 110 0 Source: NKC Research 175 94 20 40 60 80 100 120 140 160 180 200 Risk environment / Risk outlook Sovereign Risk Ratings S&P Fitch Moody’s B-/Stable B/Stable B3/Stable Moody’s Investors Service upgraded Egypt’s sovereign credit rating from “Caa1” with a stable outlook to “B3” with a stable outlook in April 2015. Moody’s provided three main reasons for the upgrade: improving macroeconomic performance; a reduction in external vulnerabilities; and, ongoing commitment to fiscal and economic reform. Despite the upgrade, the rating remains constrained by Egypt’s weak fiscal finances, with both the fiscal deficit and public debt levels still exceeding the median for “B3”-rated countries. In addition, elevated security risk and a challenging business environment also weigh on Egypt’s rating. Following the upgrade, the rating is equivalent to the “B-” rating afforded by Standard and Poor's (S&P). Specifically, S&P affirmed its long-term foreign-currency sovereign risk rating on Egypt at “B-” with a stable outlook in November 2014, saying that the country’s political landscape has begun to stabilise and that the security situation is improving. According to S&P, the recent improvement in political stability has resulted in a mild uptick in economic growth. It also made note of an international investor conference in March 2015, where a number of projects are set to be unveiled. The agency expects these projects, combined with the recent sale of hydrocarbon exploration licences and the paying off of arrears to oil companies, to improve Egypt’s economic prospects. Finally, Fitch Ratings upgraded its long-term foreign currency sovereign credit rating for Egypt by one notch to “B” with a stable outlook in December 2014. This came on the back of the policy measures implemented by the government in recent months, especially fuel subsidy cuts and tax increases (although some of these tax increases have been reversed since then). According to S&P, power shortages are also being addressed, oil debts to foreign oil companies are being repaid, and disputes with foreign investors are being settled. Lower international oil prices will also help to reduce the subsidy bill, thereby leading to a narrower budget deficit. The rating agency also noted that foreign reserves have stabilised at below three months’ worth of imports and that it does not expect a significant increase in import cover over the next few years. Infrastructure Diversity of the Economy Banking Sector Continuity of Economic Policy Signs of Well improvement Insufficient for developed by Well diversified under President large population African Abdel Fattah alstandards Sisi GDP Growth Key Balances Foreign Investment Large budget Slow, but Strong prior to deficit & current signs of uprising; low account deficits improvement currently since 2008 Market Cap Socioeconomic Development Forex Reserves Moderate Low; foreign aid/loans needed to prevent further decline Dominant Sector Daily Trading Volume 112 million shares ($81m) Stock Market Listed Companies Liquidity Egyptian Exchange 250: 225 on main market; 25 listed on Nilex Liquid Capital Market Development Liquidity Maturity Range Municipal Bonds Corporate Bonds Yes Developed Liquid 91-day to 20-year No Yes $71.7bn on main market; Telecoms, Construction, $150m on Nilex Financials Macro-economic overview Real GDP growth rebounded to an estimated 4.2% in the 2014 calendar year. Growth was especially high during the second half of the year, averaging 5.5% y-o-y, although this was largely due to base effects, following a disastrous second half of 2013. There was a particularly strong rebound in investment, while both private and government consumption expenditure continued their strong upward trend. On a sectoral basis, the manufacturing, construction, telecommunications, Suez Canal, and real estate sectors all grew strongly over the first three quarters of 2014. Looking forward, the construction sector is expected to grow strongly over the short to medium term on the back of the planned mega-projects. However, once the construction phase of these megaprojects is completed, Egypt is expected to struggle to maintain high real GDP growth rates. In our view, the policies of the new government are not enough to address the structural constraints to economic growth. In particular, macroeconomic risk and microeconomic distortions will remain substantial; high government financing requirements will continue to crowd out private sector lending; and, export competitiveness will remain poor due to an overvalued exchange rate and structural constraints such as a challenging business environment, low human capital, and the State’s dominance in many sectors. The CBE devalued the pound from E£7.15/$ to E£7.63/$ during the second half of January. Despite this, the currency is still considered overvalued. In fact, the International Monetary Fund (IMF) found evidence that the pound was up to 28% overvalued in October 2014. In turn, this has contributed to the widening current account deficit and constant pressure on foreign exchange reserves. Since July 2013, though, the country has benefited from billions of dollars of aid from GCC members, which has ensured that foreign exchange reserves have remained fairly stable despite a large current account deficit and limited foreign direct investment (FDI) inflows. At the recent economic summit, GCC countries pledged a further $12bn in aid to Egypt, which will boost foreign exchange reserves significantly in the near term and help to ease macroeconomic risk. 2 Economic Structure as % of GDP 2014 Estimate Source: NKC Research Agriculture/ GDP 14.5% Service/GDP 45.6% Industry/GDP 39.9% The Egyptian economy is well diversified; however, the government maintains significant involvement in the economy. Official figures show that the public sector accounts for almost 40% of GDP. Egypt is almost entirely covered in desert with only 3% of the country’s land surface being arable. Nonetheless, farming is an important part of the economy, with the sector employing roughly 6.6 million people, or almost 30% of total employment. Egypt recorded strong real GDP growth during the 2000s – in the last seven fiscal years (FY, July - June) before the uprising, real GDP growth averaged 5.6% p.a. However, this growth did not generate enough jobs to absorb the growing population into the workforce. Furthermore, growth was accompanied by widening macroeconomic imbalances as it was mainly driven by consumption rather than investment, and as there was a decline in net exports. Real GDP Growth & Net FDI/GDP 6.0 4.0 Source: NKC Research 5.0 3.0 4.0 2.0 3.0 1.0 2.0 0.0 1.0 -1.0 2009 2010 2011 2012 2013 2014E 2015F 2016F GDP Growth (y-o-y, %, fiscal years) (lhs) Net FDI/GDP (%, calendar years) (rhs) The Red Sea resort of Sharm Al-Sheikh hosted the much-anticipated EEDC over the weekend of March 13 - 15. The summit was successful in attracting investment in the energy and real estate sectors. The energy-related investments, in particular, should provide a significant boost for the Egyptian economy, as the country has been struggling with power shortages for a number of years, partly because of a drop in natural gas output. In fact, Egypt’s gas production has declined to such an extent in recent years that the country has gone from being a fairly sizable gas exporter over the 2006-10 period to a net-importer. As a baseline, we forecast that real GDP growth will average 3.5% in the 2014/15 FY, up from 2.1% in 2013/14. However, this is a conservative projection; following the strong performance in the first half of the FY (July - December 2014), the government is projecting growth of 4.3% for the FY as a whole. For the 2015/16 FY, we project real GDP growth of 3.6% on the back of mega-projects and a continued recovery in tourist activity. In the subsequent two FYs, we project an average growth rate of 3.9% p.a. This is much lower than the government’s target of around 5.8% p.a. In our view, once the construction phase of the planned mega-projects is completed, Egypt will struggle to maintain high real GDP growth rates unless more structural economic reforms are made. Exports ($ bn) Imports ($ bn) 2014E 2015F Main Imports: % share of total 2016F Mineral fuels, oils & distillation products Machinery 2014E 2015F 2016F Mineral fuels, oils & distillation products 21.09 14.99 15.69 Machinery 10.13 11.07 10.81 Cereals 7.86 8.26 7.68 Iron & steel 6.42 7.08 6.92 Cereals Iron & steel Oil & gas Main Exports: % share of total Electrical & electronic equipment 2016F Oil & gas 40.65 29.84 29.91 Electrical & electronic equipment 4.64 5.49 5.40 Fertilisers 4.15 4.79 4.71 Gold 3.94 4.92 5.08 Fertilisers Gold Source: NKC Research 2014E 2015F 0.0 3.0 6.0 9.0 12.0 15.0 Egypt’s trade deficit is estimated to have widened by 27% from $29.3bn in 2013 to $37.2bn in 2014. This was because of a 4.3% drop in exports to $25.4bn and a 12.1% increase in imports to $62.6bn. Declining oil and gas production contributed significantly to both the decrease in exports and the increase in imports. Hydrocarbon export earnings (which account for nearly half of Egypt’s total exports) decreased by an estimated 12.3% to $11.5bn, while hydrocarbon imports increased by 12.7% to $13.6bn. It is unlikely that there will be a rebound in oil and gas production in the short term; therefore, hydrocarbon export volumes are expected to decline further, while import volumes will increase. As a result, the country is set to start importing liquefied natural gas (LNG) this year. Although the trade deficit is forecast to remain wide (averaging 11.5% of GDP in 2015-17), the current account deficit is forecast to remain reasonably narrow (averaging 2.7% of GDP in 2015-17) thanks to foreign aid and remittances from Egyptians working abroad. Tourism revenues are also forecast to continue recovering on the back of a more stable security situation, and to reach $8.1bn in 2015 and $9bn in 2016. 3 Current Account & Budget Balance (% of GDP) 0.0 -5.0 -1.0 -7.5 -2.0 -10.0 -3.0 -12.5 -4.0 Source: NKC Research -15.0 2009 2010 2011 2012 2013 2014E 2015F 2016F Current Account/GDP (%, calendar years) (lhs) Budget Balance/GDP (%, fiscal years) (rhs) The fiscal position remains very weak: the country has been recording budget deficits of 10% of GDP or higher over the past four FYs, public debt is above 90% of GDP, and debt interest payments are nearing 40% of total fiscal revenues. In recent years, the central bank has also financed a large share of the fiscal deficit, which has kept inflation high. Under the presidency of Mr Sisi, however, the government implemented significant fuel subsidy cuts in July 2014 in order to improve fiscal finances. This, combined with a sharp decline in global oil prices, is expected to result in a 41.6% decline in fuel subsidies this FY – from the equivalent of 6.3% of GDP to 3.2% of GDP. This is forecast to limit total government spending growth to 6.5% this year. Even so, we still project a budget deficit of around 11% of GDP due to declines in grants and oil-related revenues. Thanks to the drop in fuel subsidies, however, we now expect the deficit to move into single digits in the 2015/16 FY. Average CPI (% change, y-o-y) 13.0 Source: NKC Research 12.0 11.0 10.0 9.0 8.0 7.0 6.0 2009 2010 2011 2012 2013 2014E 2015F 2016F The central bank’s Monetary Policy Committee (MPC) lowered its policy interest rates by 50 bps at its meeting on 15 January 2015. Although core inflation has been stable of late (in the region of 7% y-o-y to 8% y-o-y), we do not think there was much scope to loosen monetary policy. By keeping real interest rates negative, the central bank is putting further pressure on foreign exchange reserves and the currency; it also signals that the authorities are not overly concerned about inflation. In its recent Article IV Consultations, the IMF also stated that Egypt’s central bank independence needs to improve and that a slowdown in inflation would be critical to “support competitiveness, protect the poor, and foster [economic] growth”. For now, though, monetary policy remains accommodative, partly with the aim of keeping borrowing costs for the government down. CBE data also shows that central bank lending to the government has continued to rise at a rapid rate, reaching E£535.5bn in January 2015 (an increase of 35.3% y-o-y and 4.6 times higher than in January 2011). CONTACT DETAILS KPMG NKC NKC Independent Economists CC Hatem Montasser – designation is Partner Tel +20235362211 Email [email protected] 12 Cecilia Street Paarl, 7646, South Africa P O Box 3020, Paarl, 7620 Tel: +27(0)21 863-6200 Fax: +27(0)21 863-2728 Email: [email protected] GPS coordinates S33°45.379' E018°58.015' The foregoing information is for general use only. NKC does not guarantee its accuracy or completeness nor does NKC assume any liability for any loss which may result from the reliance by any person upon such information or opinions. © 2015 KPMG Hazem Hassan Public Accountants & Consultants, an Egyptian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. MC7204 KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. 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