Egypt is now in its second economic renaissance, which started in 2004. This follows a first renaissance that was shallow and short lived, lasting from 1992 to 1999, and based largely on external debt relief and macroeconomic stabilization policies. This time around, the reforming government is more bent on structural reforms that aim to unleash Egypt’s potential and to take advantage of its supporting regional environment. The reform has touched almost all aspects of Egypt’s economy, covering tax and tariff reforms, bank privatization and consolidation, the investment and business environment and the conduct of monetary policy.
The result has been an increase in investment confidence, both externally and internally. Between 2004 and 2007 investment increased from 18% to 23% and FDI doubled to more than $10 billion. Exports also increased, marked by a rise in gas and manufacturing exports that were in turn driven by efforts to exploit Egypt’s primary resources and its free trade and QIZ arrangements, besides its efforts at industrial modernization. Domestic demand was also aided by higher public and private consumption, the culmination of which is that GDP growth is hovering at around 7% if not more — and is expected to stay there in the foreseeable future. But the price of these developments has been a surge in inflation to rates abetted by higher commodity prices and exceeding 10% in early 2008. And although unemployment fell to less than 10%, there is a widespread feeling that the boom’s fruits could have been more equally shared, with poverty rates still at a stubborn 17%.
Perhaps the best performer has been the external sector. In addition to better exports and FDI performance, favorable tourism and Suez Canal receipts and labor remittances all contributed to healthy current account surpluses at 1% of GDP, and helped accumulate more than $30 billion in foreign reserves covering about seven months of imports in 2007. This naturally led to a better outlook for the exchange rate, whose managed level saw an appreciation of close to 10% between 2004 and 2007. And with both GDP growing and the BOP service account in decent surplus, external debt as a ratio of GDP and its service as a ratio of exports of goods and services improved to 29% and 6% respectively.
The financial sector also witnessed some major improvements aimed at developing both its market-based and bank-based institutions. Besides undertaking the privatization of Bank of Alexandria and initiating the privatization of Banque du Caire, the stock market has been rationalized and upgraded to international standards. The quantitative results of these improvements saw bank assets increase by a third to $168 billion and stock market capitalization to more than double as a ratio of GDP to 115% during 2004-2007. The conduct of monetary policy has also undergone a face lift with the introduction of an interbank market for foreign exchange and the preparation for an inflation targeting monetary framework. However, work still needs to be done on strengthening the transmission mechanism between policy rates and yields on financial instruments and bank rates, and on cleaning up the banking system whose NPL remain at 25%
Although the fiscal sector underwent major revenue side reforms — increasing both tax and non-tax yields by 80% to $22.6 billion between 2004 and 2007 — expenditure side reforms were lacking. This is because these reforms relate to the subsidy and transfer schemes to basic commodities and ailing public enterprises, which carry significant political and social implications. Their absence or delay thus aims at keeping a “human face” on the reform program and at not jeopardizing its public legitimacy. But the downside, of course, is that they have left the government with a deficit of 7% of GDP and a rising domestic public debt
The outlook for Egypt, an emerging market with a diversified economic base, looks good especially given the regional boom that does not look to be subsiding any time soon. Challenges remain, though. These relate to the ability to control inflation, to reduce budget deficits and to trickle down the gains from growth. That will not be easy, however, given the continuing increase in commodity prices, the importance of subsidies for maintaining social stability, and the fact that economic growth needs time to reduce poverty, let alone reduce income inequality. Add to these the potential for political instability arising from regional tension and presidential succession, and the challenges multiply.
The best answer to these challenges is not to suffer ‘reform fatigue’, but to continue with the economic reform agenda especially as it relates to financial policy, expenditure rationalization and industrial modernization. Growth and a better management of its process — if at a lower, more sustainable rate — will prove an antidote to these challenges.
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