Africa Weekly Review: Fiscal space for Egyptian subsidies; concerns about the DCR/China mining and infrastructure deal

Egypt: Revenue growth to cover sharply higher subsidies and salaries

The draft budget for 2008/09 (July to June) is notable on the expenditure side for the sharp increase in allocations for both salaries and subsidies. This has cast doubt on the government’s plans for a gradual easing of the fiscal deficit to 3 per cent of GDP by 2011/12 (in annual reductions of one percentage point). For 2007/08 the deficit was projected at 6.9 per cent, and for the new fiscal year it is forecast just slightly lower at 6.7 per cent.

The higher expenditure can be explained in terms of the government’s desire to address social tensions, which are linked to the soaring cost of living as well as to political paralysis. The direct catalyst was probably the violent clashes at a state-owned plant between textile workers and the police in the first week of April at Mahalla al-Kubra. The haste with which the company offered an increase in basic salaries and allowances suggests a determination to contain demands from employees of other organisations. However, the protest has emboldened workers, particularly those such as doctors and university lecturers who work in core government services, to press their cases. It also strengthened an informal pro-democracy coalition of lawyers, intellectuals and Islamists.

Another result of the protest was the announcement by President Hosni Mubarak in his annual May Day speech that the 2008/09 budget would raise public sector salaries by 30 per cent. The draft budget also allocates substantial funds for subsidies: EGP62.7 bn (US$11.8 billion) to the General Egyptian Petroleum Corporation and EGP21.5 bn (US$4.3 billion) to the General Authority for Supplied Commodities. These allocations are, respectively, 71 per cent and 127 per cent higher than those in the previous year’s budget. We can see from the chart below that projected subsidies for fuel and food exceed the forecast deficit.

Chart 1: Budget deficit and principal subsidies (in per cent of GDP)

In our view the government will depend on the fiscal receipts of rapid economic growth to fund the increases. If this involves slippage in the five-year target to reduce the fiscal deficit to 3 per cent of GDP, the authorities are unlikely to be overly concerned. Industrial users may see higher fuel price increases, but households are unlikely to see a major increase in their fuel bills.

The growth dividend

Growth during the first nine months of the last fiscal year (July 2007 - March 2008) was 7.5 per cent year on year, supported by strong FDI and remittances, as well as tourism. Net FDI in the same nine-month period accelerated to US$10.8 billion (from US$8.6 billion), and workers’ remittances rose to US$6 billion (from US$4.4 billion). In both cases Egypt’s close ties with the Gulf states help to explain the strong growth in inflows. Gulf money has poured into the country, notably in real estate and tourism projects. The price/earnings ratio of real estate companies listed on the Cairo bourse has risen to as high as 60 in some cases. The rise in remittances can also be attributed to the economic boom in the Gulf, where many Egyptian workers are based. The expansion of tourism is more broad-based, reflecting strong marketing and investment in infrastructure.

We believe these factors are likely to support medium-term annual growth of above 6 per cent, which would give the government some fiscal room for manoeuvre. Headline inflation has now crossed the 20 per cent year on year threshold and food price inflation is closer to 30 per cent. The monetary policy committee (MPC) raised its overnight deposit rate by 50 basis points to 10.5 per cent at its most recent meeting on 26 June because the MPC detects the influence of local demand conditions (as well as international food inflation) in rising price pressures. The committee may well tighten again on 7 August.

That said, the transmission signals from monetary policy to price levels are weak in Egypt. We believe the MPC will not chase inflation so aggressively as to derail the currently booming rate-sensitve sectors of the economy. The transmission signal from the exchange rate is, by contrast, strong, and the appreciation of the pound in relation to the dollar (7 per cent since the start of the year) has helped to contain the rise of inflation.

DRC: The mechanics of the Chinese deal

New entrants into the Congolese mining sector are facing uncertainty regarding the nature of the agreement signed last year with Chinese mining investors and the outcome of the mining contract review. We have seen the Chinese agreement, dated 17 September 2007, and can explain its outlines. We note that the mechanism for resolving disputes does not inspire great confidence: “in the event of force majeure, the parties will work through friendly negotiations to adapt this Protocol to new conditions” (Article 12).

The parties to the agreement are the Congolese government and three Chinese institutions (Sinohydro, the Chinese Railway Engineering Company and the Export-Import Bank of China). The agreement builds on mining development accords that had been signed with the three organisations over the two previous months. The underlying idea is that the Chinese side will execute specified infrastructure projects, with these works financed by the development of mining concessions granted by the government to a new JV in which the Congolese and Chinese parties have stakes of 32 per cent and 68 per cent respectively.

The agreement sets out three stages in the life of the joint venture. In the first, profits will be dedicated in full to cost recovery for the initial investment in mining and related industrial investment. In the second, 66 per cent of net profits of the joint venture will be allocated to fund a first tranche of identified infrastructure projects, with the balance of 34 per cent to be divided between the shareholders. The agreement foresees projects in this first tranche costing a total of US$3 billion. (Annex II shows a minimum programme of projects drawn up by the Ministry of Infrastructure, Public Works and Reconstruction with a total cost of US$6.5 billion. In the third and final stage of the joint venture, all profits will be distributed to the shareholders.

Plan B in the event of a revenue shortfall

It is clear why the agreement is viewed with concern by the mining industry both inside and outside the DRC, along with the donor community and the IMF. Under Article 6, the government has the right to grant additional fiscal privileges and mining concessions to the joint venture. The same article airs the possibility that the government’s share of its profits from the venture will not suffice to pay for the infrastructure projects and stipulates that it could instead negotiate a loan from Exim Bank of China.

These outlines of the agreement reinforce two commonly-held views about Chinese policy in Africa: first, that it is driven by a chase after natural resources; and second, that it scores poorly in terms of governance. China is of course not alone its voracious appetite for African commodities. However, the red flags raised by this agreement could have grave repercussions for the government and a negative impact on the sentiment of non-Chinese investors in DRC mining. Having held, in 2006, its first democratic elections since independence (with substantial donor funding), the government may have anticipated a smooth path to substantial debt relief via the standard IMF credit facility for low-income countries. However, the agreement with China has likely created some obstacles along that path. .

Recent researchreports:

South African mining: Opportunities in a changing regulatory environment
Government negotiations are not one-sided

Ivory Coast: Electoral risk ahead
A strong economic rebound would likely follow a successful election outcome

DRC: Viable state, frayed at the edges
The central government’s authority extends to core mining provinces

With best regards,

Gregory Kronsten
Director, Africa Research
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