Political reform seldom proceeds smoothly. So it has been in Egypt, with many bumps and scrapes on the way through the country’s first multi-candidate presidential election, in September, and fresh parliamentary elections, held in three rounds over November and December. On the surface, the end result barely changed the status quo – president Hosni Mubarak was elected to his fifth six-year term in office and his ruling National Democratic Party held onto a large parliamentary majority.

But it was the nature of these ballots and the manner in which they were won that was significant. At the outset, political concessions to opposition parties – allowing opposition candidates to contest the presidential election for the first time, for instance – were optimistically viewed as the first steps to political reform; by the end, state-sanctioned thuggery and intimidation of opposition supporters had marred the process, raising serious doubts about the sincerity of Mr Mubarak to pursue political reform.

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Egypt has been under emergency law since 1981, following the assassination of president Anwar Sadat, and since then Mr Mubarak has held a tight grip on power. Amid speculation that he intends handing control to his son Gamal, pressure has mounted, particularly from the US, to liberalise the political process. Ominously, Mr Mubarak appears to have tripped up at the first serious test of his resolve.

What is an awkward and ungainly, half-pushed and half-pulled shift to greater political freedom is also an attention-grabbing sideshow to another major and no-less important reform shift: since mid-2004, prime minister Ahmed Nazif and his cabinet have moved quicker than anyone expected to overhaul Egypt’s economy.

But if Egypt’s economy is steadily improving, what are investors to make of the political environment?

Muslim gains

Mr Mubarak’s re-election was widely anticipated. What was not foreseen were the dramatic gains in the parliamentary election made by the Muslim Brotherhood, a banned Islamic party whose candidates had to run as independents. With unprecedented freedoms given to opposition parties, the Brotherhood was able to field twice as many candidates as before. When fDi went to print, the Brotherhood had increased its representation in parliament more than fivefold, and was waiting on voting results that could have seen the number of seats it held rise to more than 100 out of 444 parliamentary seats being contested.

The Muslim Brotherhood, with its slogan ‘Islam is the solution’, is hardly a new force in Egyptian politics – it has been around for 77 years. However, with the government trying hard to portray Egypt as an attractive (and steadily improving) investment destination, authorities are scrambling to ease fears that the Brotherhood portends a slide towards fundamentalism – jitters that may be unfounded but are all too real in the present international climate.

Investment impact

Should the Brotherhood’s fundamentalist rhetoric be unsettling to investors, however? In short, investors probably do not have too much to worry about.

The considerable gains made by the Brotherhood caught everyone on the hop, the Brotherhood included. This partly explains the authorities’ ham-fisted attempts to rough up opposition candidates and supporters in later rounds of voting, an inglorious attempt to slow the advances of the Brotherhood’s candidates. On the last day of voting, as many as eight opposition supporters were believed to have been killed in clashes with security forces.

Many pundits believe the gains made by the Muslim Brotherhood are less an indication of support for the party’s core values and more a reflection of deep dissatisfaction with the Mubarak government. And it was hardly a groundswell – preliminary estimates pegged voter turnout between 5% and 25%, reflecting long-held apathy that elections in Egypt are little more than a charade to return the National Democratic Party to power.

Still, the Muslim Brotherhood has in the past said it would change the constitution to force the courts to comply more strictly with Sharia, would compel women to wear the veil, and would ban alcohol.

The likelihood of this happening is remote, not least because the ruling NDP still has an overwhelming majority in the parliament. Just as significantly, the Muslim Brotherhood has softened its message in the election aftermath, saying it is the economy and jobs that matter most.

The Brotherhood’s deputy leader, Mohammed Habib, told the Associated Press that “political reforms, the economy and fighting unemployment and corruption” are topping the party’s agenda.

Centrist losses

That is at least one consoling thought, particularly when considering the country’s centrist secular and liberal parties – potentially the moderate middle-ground – were comprehensively marginalised into near obscurity during the elections.

Some Egypt-watchers have been quick to label the elections a sham, not-so-secretly engineered to keep Mr Mubarak and his party in power. Authorities conceded some ground to democratic process but, say the sceptics, there was never any chance of a meaningful shift in party power.

But such an analysis may be too pessimistic, overlooking the extent to which Egypt’s educated, urban classes were shaken by the surge in support for the Muslim Brotherhood. It has re-energised a generally lifeless political scene, and underscored the need to persist with and speed up economic reform to provide hope to the disaffected masses.

It is unlikely a politically bruised Mr Mubarak will roll back democratic reform. The US, which gifts Egypt more than $2bn a year in aid, has been nudging the country towards openness and, despite an outcome that is probably at odds with US hopes for the country, it is a step in the right direction.

Moreover, the US has adopted an increasingly critical line on the growing number of reports of clashes, arrests of opposition members, physical abuse of election monitors and journalists, and moves to bar observers and voters from polling places. After initially generously describing elections, even then marred by voter intimidation and violence, as “an important step on Egypt’s path toward democratic reform”, the US State Department later lashed its key Middle Eastern ally for what it described as “disturbing” actions by authorities.

“We’ve … seen a number of developments over the past couple of weeks during the parliamentary elections that raise serious concerns about the path of political reform in Egypt,” State Department spokesman Adam Ereli said. “Clearly these actions send the wrong signal about Egypt’s commitment to democracy and freedom.”

US secretary of state Condoleezza Rice dressed down her Egyptian counterpart Ahmed Abul Gheit and put off a planned visit to Cairo in March, believed to be partly in protest at the detention of opposition leader Ayman Nur.

Political optimism

Although it is premature to draw firm conclusions from the outcome of the elections it is abundantly clear they rocked the political establishment, which is some kind of progress at least, leading, it is hoped, to greater political urgency to govern effectively and greater political accountability.

Now, with the elections won, but the dissatisfaction of voters noted, emphasis can be restored to reforming the economy. Despite the nature of victory, Mr Nazif is adamant the victory at the polls reflects broad support for the government’s economic reform plan.

And so far the reform plan seems to be working. In the third quarter of 2004, gross domestic product (GDP) growth had accelerated to 5.3%. Double digit inflation has been tamed to below 4%, preserving living standards. Foreign direct investment in the non-energy sector has tripled annually since 2003 from $400m to $1.2bn. And the first encouraging signs are emerging of new jobs, crucial in a country facing unemployment of up to 20%.

Mr Nazif’s cabinet, featuring liberal-minded technocrats and private sector captains of industry, inherited a number of economic challenges but has embarked on reform with vigour, slashing customs duties and income taxes. And given the country’s history of gradual change, the pace of reform has surprised everyone.

The cabinet has also embarked on a far-reaching privatisation programme, launched a process of consolidation in the troubled banking sector, and begun to overhaul commercial legislation and tackle deeply entrenched bureaucratic constraints.

In an interview with the Financial Times, a bullish Mr Nazif noted: “We have barely scratched the surface of Egypt’s potential.”

Reforming mood

Indeed, with the elections out of the way, the mood in the cabinet is to accelerate reform. Speaking to investors in Cairo at the third annual International Forum of Investment and Trade Egypt in November, minister of investment Mahmoud Mohieldin publicly reiterated the government’s pledge to reform, noting that it had delivered on its promises in the past. And, he noted, the private sector was responding: the number of new companies established in the 12 months to end-June 2005 increased by 126% while the market capitalisation of private companies as a share of GDP increased from 35% in 2004 to 72% in 2005.

According to the Economist Intelligence Unit (EIU), Egypt’s economy is expected to grow by 4.8% in 2006, up from an estimated 4.1% in 2005. It notes that the attacks in Sharm al-Sheikh in July that killed around 90 people are not expected to prove as damaging to tourism as the Luxor attack in 1997, but they will still constrain expansion in exports of goods and services and, given the key role of the industry as an employer, hold back growth in private consumption.

Nonetheless, the EIU predicts growth in private consumption and investment to accelerate, as personal and corporate income tax rates are lowered. In 2007 growth should accelerate to 5.2%, as confidence firms once more and businesses’ access to finance improves.

Questions remain over whether the government is brave enough to tackle some of its sternest challenges, specifically an annual bill equivalent to 17% of GDP on subsidies and public sector wages. With the budget deficit a gaping 10% of GDP and public debt over 100% of GDP, it is essential that the government acts sooner rather than later. But with the government’s political grip weakened, the fear is it will be less inclined to take on the biggest and riskiest reforms.

Failure to do so would certainly be consistent with historical precedent, but those more sanguine are quick to point out the incumbent cabinet has turned historical precedent on its head, revealing serious determination. These technocrats are very aware of the measures needed to reform the economy; it is up to their political masters to give them the space to do so.

Economic fillip

Working in their favour are growing signs of a reform pay-off: not only is the economy growing briskly but one year after cutting customs tariffs by on average 40%, customs revenue is down only 16% compared with a forecasted 37%. That is exactly the evidence needed to convince Mr Mubarak to stake his political fortunes on far-reaching economic reform.

Ironically, the National Democratic Party lost ground in elections just as the cabinet was beginning to show signs of economic progress. It is a fact that reform is usually painful in the short term, and Egypt will probably have to endure more pain yet, but if it is given the leeway, the cabinet of Mr Nazif shows every sign of doing what has to be done.