The past 18 months have marked a historic turning point for Egypt. The resignation of former president Hosni Mubarak on February 11, 2011, marked the end of 30 years of autocratic rule and opened the doors to a new era promising change, freedom and, ultimately, democracy.

However, the political unrest that has ensued since Mr Mubarak’s regime was ended has put the brakes on the country’s economic development, with real GDP recording a notable slowdown in growth from 5.1% in 2010 to just 1.8% in 2011. Furthermore, Egypt’s GDP saw negative growth of 4.2% in the first quarter of 2011, a contraction not seen since the Central Bank of Egypt began publishing quarterly data in 2001.

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In particular, the sectors that constitute Egypt’s main foreign currency earners have suffered a steep decline in revenues. Egypt posted FDI outflows of $482.7m in 2011, compared with inflows of $6.4bn a year earlier, while tourism, a key pillar of the economy that employs about 10% of the country’s population, saw arrivals decline by 30% last year, according to central bank data. Receipts from Suez Canal traffic and exports also dropped considerably due to lower external demand. 

Resilient response

“If you look at Egypt over the past 15 months, it would be fair to say that the economy fell off a cliff in the first quarter of 2011 and has been trundling along ever since,” says Andrew Long, chief executive of HSBC Egypt. “However, if you look at the published results of the banks, you would expect there to have been a lot more problems and provisions taken but our provisioning hasn’t changed dramatically and the banking sector seems to be in fairly good health.”

Since the resignation of Mr Mubarak, Egypt’s ruling military council has shored up the economy and the currency, principally by drawing on its foreign reserves. These reserves shrank from about $36bn at the start of 2011 to $16.3bn at the end of January 2012. They had fallen by a further $600m by March to $15.12bn.

Concerns over Egypt’s ability to pay off its debts have pushed up borrowing costs in the country, as witnessed when the Ministry of Finance offered a record-high yield of 15.92% on a nine-month bond and treasury bill it floated in early February this year. Even so, investor appetite was only lukewarm, with final sales 31% lower than what had been targeted.

Consequently, the government has relied heavily on borrowing from domestic banks, which has sent interest rates to historic highs as funds grow tighter.

External concern

Egypt’s external funding requirements are estimated to amount to $11bn until April 2013, at a time when many countries across the world are firefighting their own debt crises. This makes the approval of the $3.2bn loan from the International Monetary Fund (IMF) all the more urgent for two reasons. First, foreign donors are showing reluctance to provide financial assistance without the IMF’s involvement, and second, it should help regain the confidence of international investors.

FDI is continuing to fall – after dropping by 68% in 2011 it declined 72% year on year during the first quarter of 2012. Aside from investors’ concerns over the lack of visibility within Egypt, the drop in investment has been further exacerbated by the deepening eurozone crisis that has led to a spike in international borrowing costs and tightening liquidity.

Furthermore, the potential devaluation of the Egyptian pound is also a big concern for foreign investors, who have steadily withdrawn billions of dollars from Egyptian equities since May 2011, reversing the trend of steady inflows in 2009 and 2010, according to EPFR Global, a fund flow data provider. 

FDI drive

“The IMF loan is just a rubber stamp to help open the door to others who are potentially looking to invest,” says Hisham Ezz Al-Arab, chairman and managing director of Commercial International Bank (CIB), Egypt’s largest private sector financial institution and the third largest bank by asset size. “The $3.2bn won’t turn around the economy but it will help encourage the private sector to go and invest.”

Of foreign investment, Hisham Okasha, deputy chairman of National Bank of Egypt, says: “We definitely need more FDI as this is where we’ve been hardest hit. But I’m hopeful because the relationship between Egypt and Arab countries is a very solid and fruitful one. The Gulf has a lot of money and Saudi Arabia’s support is obviously a positive move.”

On May 10, the Saudi Arabian government transferred an eight-year $1bn deposit to the Central Bank of Egypt to ease foreign reserve pressures and has also pledged a $2.7bn aid package. A memorandum of understanding has also been signed for an additional $500m of financial aid aimed at shoring up a range of sectors. Saudi Arabia has also confirmed that it will fund $250m of butane exports to Egypt as well as $200m in support for small and medium-sized enterprises.

“The important thing to recognise is the readiness of the economy to grow,” says Mr Okasha. “We have all the key ingredients – demand from consumers, labour force availability and the need to grow the infrastructure. Egypt needs to develop a better rail and road network, expand its gas grid, its resource utilisation and so on.

“I expect infrastructure projects will grow tremendously once stability kicks in. We will direct a lot of our corporate capital expenditure here – we recently signed an agreement with the Ministry of Transport to build a 40-kilometre extension of the ring-road around Cairo.”

A return to stability

Of course, the one thing that no one can be sure of is when stability will return to Egypt, despite the Muslim Brotherhood’s Mohammed Mursi being elected president in June.

“It had been hoped that the completion of the presidential elections would mark the end of the transition,” says Mr Long at HSBC Egypt. “But people are now saying that this will only be the start of the second phase of the transition. Investors want certainty and with so much uncertainty, they are holding back. We are still awaiting a constitution.”

The new constitution has emerged as a sharp point of conflict between Egypt’s fractious political parties; it aims to resolve crucial questions such as the powers of the president, the relationship between Islam and politics, and the military’s involvement in civilian rule. 

Re-establishing political stability and overall security will be integral to attracting foreign investment and returning the economy to its former healthy growth. In turn, this will enable a restoration of the balance of payments and reserve currency at the central bank, relieving the pressure on the banking sector, which is facing increasing liquidity challenges, as indicated by a reduction in the sector’s core liquid assets to 17% of total assets at December 2011, down from 23% a year earlier.  

“Some banks are struggling to access short-term liquidity,” says Mr Long. “And companies that have been sitting on cash reserves have been running them down and loans will have been extended. That’s why you tend to have more problems at the end of a recession than at the beginning.”

Clearly, there will be many more bumps in the road to economic recovery. After posting real GDP growth of 1.8% in 2011, the IMF is forecasting even weaker growth for Egypt this year of just 1.5% before rebounding to 3.3% in 2013.

Home to the Arab world’s most populous nation, 40% of the country’s 84 million-strong population lives on $2 or less a day. Egypt’s long-term challenge will be to generate jobs and a more equitable distribution of wealth in order to stamp out the problems that were at the root cause of the revolution.