Features: Country Report: Egypt

BREAKING OUT

 

Egypt sidestepped the worst effects of the global crisis and is reinforcing its position as a regional economic power.

 

By Anita Hawser

 

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Egypt is building on its historical relationships with the Middle East, Europe, Asia and Africa to position itself as a major investment gateway

As a bridge between Europe, the Middle East, Africa and Asia, for hundreds of years Egypt has taken advantage of its strategic position to facilitate trade and investment. The country has a more stable political and economic climate than some of its nearest neighbors, and the gradual liberalization of its economy and investment in infrastructure have garnered international attention. In 2007 foreign direct investment (FDI) inflows into Egypt reached almost $12 billion, an increase of 15% on 2006 levels, according to the United Nations Council of Trade and Development’s 2008 World Investment report.

 

The rise in foreign investment came on the back of continued privatization of state-owned companies and investor-friendly reforms, including easing procedures for setting up special investment zones. In the World Bank’s Doing Business report this year, Egypt moved up 11 places in the “ease of doing business” ranking, from 125 in 2008 to 114. Richard Fox, head of Middle East and Africa sovereign ratings at Fitch Ratings, says Egypt’s four-year economic reform program contributed to its historically high GDP growth—in excess of 7% in 2007 and 2008—rising investment and FDI, as well as a declining debt burden and an improved business climate.

 

“Egypt continues to modernize its infrastructure and to create an investment-friendly environment in order to attract foreign investors,” says Wael Ziada, head of research at investment bank EFG-Hermes. So enthusiastic is EFG-Hermes about the prospects for investors in Egypt that it organized an Egypt Capital Markets Day at the London Stock Exchange last November to introduce investors to some of Egypt’s leading companies, representing a cross-section of industry including banking, telecom and construction.


Banking Reforms Spur Progress

A substantially reformed and conservative banking sector has also helped Egypt ride out the recent financial crisis. “A loan-to-deposit ratio of 55.9% system-wide makes the banking sector highly liquid and cushioned to liquidity shocks that have been witnessed by other banks internationally,” remarks Sherif Khalil, head of investor relations at Commercial International Bank (CIB), a leading private sector bank in Egypt. CIB is one of the Egyptian stock exchange’s most-traded bank stocks and claims to be one of the most stable financial institutions in the region, thanks to a combination of prudent risk management, superior asset quality and a conservative credit culture. When it comes to asset quality, CIB has maintained a relatively low non-performing-loans-to-gross-loans ratio, which stood at 2.8% in the first half of this year. Khalil says CIB has also “conservatively” managed its liquidity and proactively reduced its foreign currency exposure to those customers susceptible to foreign exchange risk. CIB’s foreign-currency-loans-to-deposits ratio fell from 80.1% in the third quarter of 2008 to 66.9% in the second quarter this year.

 

Egypt’s banks have proved an increasingly attractive draw for foreign investors in recent years. In 2006 Italy’s Sanpaolo paid approximately $1.6 billion to acquire 80% of Alexandria Bank, and last year a number of foreign banks, including the UK’s Standard Chartered and Samba Financial Group of Saudi Arabia, bid for a 67% stake in Egypt’s third-largest bank, Banque du Caire. However, the Egyptian government postponed the privatization, saying the bids from the five foreign bidders were too low.

 

While Egypt’s banking sector emerged from the global economic crisis relatively unscathed, the wider economy felt the brunt of deleveraging by foreign investors. In 2008 FDI inflows almost halved to just over $7 billion. According to Mary Nicola, MENA economist at Standard Chartered Bank, FDI from the United States fell 48% year-on-year in the first half of this year. “Investment from the EU was [also] flat,” she stated in a June research report. In recent years Egypt has also relied heavily on investment flows from the Gulf, but these declined by more than 50% in the first half of this year.

 

As one of the world’s largest importers of wheat, Egypt suffered when food prices spiked in 2008. As the economic crisis unfolded, Egypt’s inflation rate soared, peaking at 24% in August 2008. Inflation declined to 10% by July this year, however, but inflationary pressures remain. Given its increased social spending and subsidies to reduce the impact of high food and commodity prices, the Egyptian government is faced with the grim prospect of a rising fiscal deficit, which Standard Chartered predicts will widen to 8% of GDP next year. Because of spending to boost the economy, Fox of Fitch Ratings says the Egyptian government ran down reserves it held in the banking system. “The biggest drain,” he says, “was the petrol subsidy.” Nicola of Standard Chartered writes that repealing the petrol subsidies, which now account for 21% of total government expenditure, is a subject of much debate. “Given the decline in oil prices this year, a move by the government to reduce oil subsidies and eventually eliminate them would benefit the country in the long run,” she explains.

 

Economic Crisis Fallout

Other key sources of revenue for the Egyptian economy have also been adversely affected by the financial crisis. Nicola says Suez Canal receipts registered a decline of 29% year-on-year in May. Hotel bookings fell by more than 30% year-on-year in January. Declining revenues saw GDP growth forecasts revised downward, and Nicola predicts that growth will slow to 3% this year. However, she says that annual growth of at least 6% is needed to create enough jobs for the 650,000 new applicants that enter the labor force every year.

 

Although medium-size and larger companies are still able to access capital, Ziada of EFG-Hermes says smaller companies are finding it more difficult. SMEs are the backbone of the Egyptian economy, accounting for more than 80% of employment. Recognizing the importance of this sector to Egypt’s future economic growth, the Central Bank of Egypt exempted SME lending banks from the 14% reserve requirements. Potential sources of funding for SMEs have also been boosted by the establishment of the Nile Stock Exchange (NILEX), the first small- and mid-cap stock market in the Middle East and North Africa (MENA) region.

 

“[The SME] segment is the largest business sector in the economy and yet faces remarkable financing difficulties, forcing them to accept higher interest rates,” says Khalil of CIB. He says the central bank and NILEX initiatives should create the proper environment that in turn will encourage banks to tap into the under-served SME market. However, if banks are to overcome “inherited obstacles” in the SME segment, Khalil says they need to possess a suitable platform that will lower the embedded risks and take the default rates to a minor level.

 

One sector of the Egyptian economy that is flying the flag for SMEs is information and communications technologies (ICT). Although Egypt is perhaps better known for its natural gas, which accounts for 26% of total exports, in an effort to diversify its export base the government has invested heavily in the IT services sector and plans to increase IT export revenues to $1.1 billion by 2010.

 

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Reda, ITIDA: The multilingual aspect is unique to Egypt

Ahmed Reda, media and communications manager at Egypt’s Information Technology Industry Development Agency (ITIDA), says considerable investment has gone toward providing the right infrastructure, education curriculum and skill sets to enhance the capabilities of local Egyptian IT companies and to attract foreign investors to Egypt’s IT sector. Egypt currently produces approximately 30,000 graduates per year with technology, science or engineering degrees, but it wants to increase that to 40,000 by 2011.


Making a Mark

In a January 2009 report titled “Beyond BRIC, Offshoring in non-BRIC Countries,” the London School of Economics and Political Science’s Outsourcing Unit stated that Egypt “provided the highest market potential of any country studied in the report,” due to its cultural fit with Western European countries, its strong language fluency, its “convenience for cost-effective ‘nearshoring’ for European business” and as a gateway to the Arabic world.

 

“Egypt has come from nowhere in terms of outsourcing,” says Catherine Griffiths, co-founder of the LSE’s Outsourcing Unit. “Historically thought of as a developing country, it is suddenly making headlines by being a country that has the fundamental infrastructure and education. Years ago people left Egypt to pursue careers; now they are returning to help build local capabilities and knowledge,” she points out.

 

While it may be tempting to compare Egypt’s flourishing ICT services sector with the rise of India as a major outsourcing center, Reda says that the Indian model does not apply to Egypt. “For example, in India,” he says, “you won’t find the multilingual aspect, which has been a characteristic of Egypt for quite some time.”

 

The ICT sector in Egypt currently provides IT desk support, call centers and personal customer interfacing for Western companies, yet Griffiths says there are encouraging signs that Egypt will be able to move further up the value chain. “A good indicator for the future,” she says, “is the fact that there are a lot of people starting their own technology and software companies.”

 

Egypt has also signed up to intellectual property and copyright laws. “They are trying to be a good international player and recognize the force of law and follow that through,” says Griffiths.

 

ITIDA’s Reda is hopeful that with the right policies and strategies, Egypt will be able to produce technology companies with the international standing of a Microsoft or India’s Wipro.

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