Africa Weekly Review: Egypt and its vulnerability to the global turmoil.

I was in Egypt earlier this week, and found policymakers satisfied with the solid foundations of the banking sector if a little complacent about the impact of the global slowdown on the domestic economy.

Egypt: The value today of conservative policies.

The ratio of total loans to total deposits in the banking sector stands at no more than 55 per cent. (For transactions denominated in foreign currency, the ratio is about 30 per cent.) This highlights the conservatism of the banks, which have barely penetrated the huge lending segment of SMEs. It shows that their balance sheets are not in need of external finance. Finally the ratio reflects the conservatism of the regulator, which is a department of the Central Bank of Egypt (CBE).

Within the reform programme that began with the appointment of Ahmed Nazif as prime minister in 2004, the regulator has insisted on a thorough clean-up of banks’ loan books. This has brought a steep write-off of loans. Non-performing loans to state-owned enterprises at the end of 2007/08 (July-June) had been trimmed to EGP6.6 billion (US$1.2 billion). This represented less than 2 per cent of total credit extension of EGP401 billion.

Chart 1:NPLs of state-owned enterprises (end-period)

Banks’ strong balance sheets

Government ministers like to make the point that Egyptian banks have not loaded their balance sheets with what Youssef Boutros-Ghali, the finance minister, calls “funny” debt instruments. Maged Shawky, the chairman of the Egyptian Exchange (EE, formerly the Cairo and Alexandria Stock Exchanges), traces the global crisis to the loosening of credit controls in the US (i.e., the supply of mortgages to consumers with a poor repayment profile). In Egypt there are proposals from the Capital Markets Authority (CMA) and the EE for the launch of derivative products: however, these would be listed on the exchange and valued daily, rather than traded on the over the counter market.

Shawky is also comfortable on the question of margin calls. Licensed brokers have to insist on cash for at least 50 per cent of equity purchases. The EE now looks at brokers’ overall positions on a daily basis to ensure that clients are not exceeding the 50 per cent rule. Shortfalls have to be covered by additional cash, failing which the broker sells stock. Shawky’s general point is that present market conditions require more rather than less regulation. For example, the EE, the CMA and the CBE are together working on the structure of a new regulator for all non-bank financial institutions. The new body is scheduled to open its doors in early 2009.

No real estate bubble

Banks cannot allocate more than 5 per cent of their loan books to real estate. Homebuyers cannot borrow more than 85 per cent of the property value. Total mortgage outstandings in June 2008 were no more than EGP2.5 billion (US$450 million). Real estate developers, both Egyptian and from Gulf countries, will have to work harder to sell their unsold stock because they tended to focus on one market segment (the high net worth individual) and because the consumer has become more cautious.

Figures, admittedly from the industry, indicate that there is still a shortage of 2.5 million housing units. While the banks and mortgage companies would not consider providing credit for most of these units, there is not a bubble in the sense of development running ahead of demand. The share price of Palm Hills Developments, one of the better known listed companies, has retreated from EGP22 in early May to EGP9. This shows that the company was overvalued, not that banks are exposed to the sector.

Boutros-Ghali insists that growth in 2008/09 (July-June) will reach 6 per cent, compared with 7.2 per cent in 2007/08. He accepts that the global slowdown will have an impact on exports of goods, tourism, inward remittances, Suez Canal revenues and, probably, foreign aid. We would add foreign investment to his list.

Chart 2: Destination of merchandise exports, 2007/08 (percentage share)

Fallout from G7 slowdown/recession

In our view the minister is understating the domestic impact of the global slowdown. Given the consensus that G7 economies are facing either recession or negligible growth, there are some vulnerable points in the Egyptian economy. The US and EU together had a 65 per cent market share of Egyptian exports in 2007/08. The same countries provided 40 per cent of workers’ remittances and 65 per cent of gross foreign direct investment: in both cases the greater part of the balance originated from Gulf countries, where growth is slowing.

Although import volumes are set to contract, not least due to lower commodity prices, the combined impact on the balance of payments will be negative. If we take just the 2007/08 data for the surpluses on the current account (0.5 per cent of GDP) and on the overall balance (3.3 per cent), and for net FDI (8.1 per cent), it is not difficult to see some gentle pressure on official reserves and the exchange rate. At the end of September, net reserves had reached US$35 billion, equivalent to eight months’ import cover.

Reduced availability of external financing

In view of the easing of external demand, the government is anxious to accelerate its own investment programme. It has some scope for such an expansion since falling commodity prices have dramatically reduced the cost of its subsidies. The current 2008/09 budget projected total subsidy costs (principally of fuel) of EGP100 billion (about 11 per cent of GDP). Even non-government sources see a “saving” of at least EGP30 billion.

However, the government may well struggle to secure external co-financing for its full programme. The evidence is necessarily anecdotal: one Cairo-based legal practice with a name for its project finance work told us of a sharp fall-off in new enquiries. Egypt’s sovereign ratings (foreign currency) are not investment grade, for which its poor fiscal and domestic debt ratios are largely responsible.

Providers of external financing have no shortage of credit applications on their desks. They are not shunning Egyptian risk: this week Orascom Construction Industries, part of Egypt’s best-known corporate group, secured a five year, US$740 million syndicated loan package. There are many sovereigns in the EM universe with a far worse credit profile in the present conditions yet it is safe to assume some scaling down of the government’s programme.

Asset sale deferred

A final sign of the global slowdown to mention is that the government has deferred the sale of a strategic stake in Banque du Caire and its auction of a second fixed-line telephony licence. The proceeds would have been useful for the financing of its budget deficit, which Boutros-Ghali insists will not exceed 6.9 per cent of GDP this year.

Don’t mention the succession

Arrangements for life after the presidency of Hosni Mubarak are not a public talking point. The consensus view remains that his son Gamal will succeed, and that the ruling National Democratic Party will continue to dominate political life with help from the judiciary, the police and the army. In the event of a level playing field for elections, there is a strong possibility that the Muslim Brotherhood would triumph and leave the armed forces hierarchy with a dilemma similar to that which confronted their Algerian counterparts in late 1991.

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South Africa Quarterly: Policy continuity until the elections
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With best regards,

Gregory Kronsten
Director, Africa Research
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