FROM THE ECONOMIST INTELLIGENCE UNIT
SUMMARY
As the political instability of Egypt’s transition continues, the uncertainty of the situation is having a serious impact on both the economy and the appetite for foreign investment.
According to Central Bank figures released on April 2nd, by the end of March the country’s foreign-exchange reserves had fallen to just US$15.12bn, down from US$15.72bn the previous month (and US$33.6bn at the start of 2011). This leaves the country with less than three months’ worth of import cover. Over the past year, the Central Bank has chosen to continuously draw down its reserves rather than print more money, an alternative it fears could have a serious knock-on impact on the streets of Egypt. In its latest move, the bank lowered the reserve requirement for Egypt’s banks’ local-currency deposits from 14% to 12% to boost lending to the government and private companies.
The problem is that the longer political instability continues, the further away are the prospects of an upturn in investment and the greater the strain on Egypt’s reserves. In 2011 there was a net outflow of foreign direct investment (FDI) of US$482.7m, a dramatic reversal from the US$380.9m net inflow in the second half of 2010. “There’s no doubt that since the revolution there’s been a sharp drop in FDI, with many investors sitting out until the political environment calms and settles,” says Rick Phillips, partner at Acts, a private equity firm, in Cairo.
Too many cooks
To the frustration of investors, the ongoing tussle between the army and Freedom and Justice Party, an offshoot of the Muslim Brotherhood and the largest party in parliament, has prevented a clear economic policy from emerging. “It’s not organised at all,” says one Cairo-based lawyer. “There’s no central core of decision-making power. There are a lot of different forces but they only co-operate when it’s good for them. A lot of long-term expatriates are leaving. It’s really a message.”
The problems are exacerbated by government investigations into allegations of corruption in the award of contracts under the previous regime of Hosni Mubarak. Real estate investment has largely ground to a halt pending the resolution of disputes over land allegedly sold at favorable prices by the previous government. Even companies that are not directly implicated have put their investments on hold. “People have trouble making investment decisions because they worry they may be prosecuted in two-three years’ time, says Abu Basha, an economist at EFG Hermes in Cairo.
Arbitration frustration
A lack of clarity on the proceedings is making things worse. At least three companies have now begun international arbitration proceedings over projects that have been summarily cancelled after they were unable to establish an effective line of communication with the government. “There are so many different parties involved—the government, the parliament, the ministries, the army—that the companies are not convinced the government is functioning in an organised way,” says a source close to one of the companies.
In the meantime, the lack of policy direction is providing other routes for corruption. “There is even less long-term supervision and a lot more dark corners than there were under Mubarak,” says the lawyer. “There’s no transparency. The box is all jumbled up. The opportunity is there because no one is looking.”
The divisions between the army-backed government and the FJP are also hampering the signing of a US$3.2bn IMF loan that economists say is essential to avoiding a balance-of-payments crisis. The FJP says that the government has not provided sufficient detail on what it intends to do with the money. The likelihood is that agreement will be reached on the IMF deal in the coming weeks. There is also some hope that the introduction of a new constitution and the election of a new president, both of which are due to take place in the next three months, will help to stabilise the situation.
Cometh the hour
“Right now everything hinges on the development of the transition the country is going through,” says Mr Abu Basha. “People are looking to the second half of the year for activity to improve once the new president has been elected. The boost in confidence could result in more activity.”
But divisions over the preponderance of Islamists in the constitutional assembly and the Muslim Brotherhood’s decision to nominate a presidential candidate threaten to perpetuate this period of instability. “This amount of political noise may detract from moving forward on the economy and especially the IMF loan,” says Raza Agha, an economist at RBS. “The hope is that the FJP will compromise with the secularists and the nationalists. Otherwise this is a downward spiral.”
In the meantime, investors are trying to remain optimistic. “We remain convinced that Egypt is, and will continue to be, an important investment destination for significant capital,” says Mr Phillips. However, there is little optimism that Egypt’s return to its prior status as a major magnet for international investment will happen any time soon.
Source: Risk Briefing
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