Country Report

Egypt

Egypt at a glance: 2005-06

OVERVIEW In July the president, Hosni Mubarak, finally moved to address long-standing popular disquiet with the government of Atef Obeid by reshuffling the cabinet. The government of the new prime minister, Ahmed Nazif, faces a number of testing economic challenges, primarily arresting the deterioration in public finances, tackling rapidly rising inflation and raising extremely low business confidence. The economic team appointed to the new cabinet, comprising well-regarded economic liberals, would appear to have the expertise to address these problems. It has embarked on its task with vigour and imagination, outlining a far-reaching programme for reform, which includes slashing customs duties and proposing sharp reductions in income and corporate taxes. Crucially, the president has so far identified himself closely with the reform programme. However, socially unpopular measures!such as accelerating privatisation or rationalising Egypt’s costly subsidies programme!that carry a short-term social cost will prove a sterner test of the president’s resolve. Meanwhile, any liberalisation in the political sphere will be cautious and is unlikely to significantly diminish the overwhelming dominance of the state.

Key changes from last month Political outlook • The looming presidential elections have galvanised political activists in Egypt who, in an unusually bold petition, have demanded limits on the number of terms a president can serve and direct presidential elections. However, the president has said that economic reform, rather than political liberalisation, is the government’s priority. Economic policy outlook • The new cabinet has unveiled a far-reaching programme of economic reform. It will require continuous presidential support to succeed. Economic forecast • The Economist Intelligence Unit has raised its forecasts for economic growth in fiscal 2005 (July 1st 2004-June 30th 2005) and fiscal 2006 to 3.5% and 4.7% respectively to reflect our expectation of strengthening business and consumer confidence.

November 2004

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Contents

Egypt

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2005-06 7 Political outlook 8 Economic policy outlook 10 Economic forecast

13 The political scene

17 Economic policy

28 The domestic economy 31 Oil and gas 32 Financial and other services

36 Foreign trade and payments

List of tables

10 International assumptions summary 12 Forecast summary 18 New tariff structure 20 Personal income tax rates 22 Budget sector fiscal outturn 29 Inflation: IMF data 30 Inflation: national data 30 Domestic credit 31 Money supply 32 Hydrocarbons production 33 Tourism 34 Tourism arrivals 37 Quarterly current account 38 Quarterly capital account 38 Foreign reserves

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List of figures 13 Gross domestic product 13 Consumer price inflation 27 Exchange rate 36 Hermes Index

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Egypt November 2004 Summary

Outlook for 2005-06 In July the president, Hosni Mubarak, finally moved to address long-standing popular disquiet with the government of Atef Obeid by reshuffling the cabinet. The government of the new prime minister, Ahmed Nazif, faces a number of testing economic challenges, primarily arresting the deterioration in public finances, tackling rapidly rising inflation and raising extremely low business confidence. The economic team appointed to the new cabinet, comprising well- regarded economic liberals, would appear to have the expertise to address these problems. It has embarked on its task with vigour and imagination outlining a far-reaching programme for reform, which includes slashing customs duties and proposing sharp reductions in income and corporate taxes. Crucially, the president has so far identified himself closely with the reform programme. However, socially unpopular measures!such as accelerating privatisation or rationalising Egypt’s costly subsidies programme!that carry a short-term social cost will prove a sterner test of the president’s resolve. Meanwhile, any liberalisation in the political sphere will be cautious and is unlikely to significantly diminish the overwhelming dominance of the state.

The political scene Mr Mubarak has made clear that economic reform, rather than political liberal- isation, is his priority. Speculation has mounted that he will be succeeded by his son, Gamal. Opposition activists have demanded direct elections and curbs on the number of terms a president can serve. Bombings of tourist facilities in Sinai, which killed 34 people, marked the first such attacks in seven years.

Economic policy The new cabinet has unveiled a far-reaching and broad-ranging programme of economic reform. This includes the reduction of customs duties and income taxes, the reinvigoration of privatisation, reform of the banking sector, the appointment of younger, reformist-leaning figures to head key government departments and the overhaul of monetary policy.

The domestic economy Firms saw economic growth strengthen in 2004. Inflation has shown signs of easing. Lending to the private sector has continued to fall as a proportion of total credit extended. Tourist arrivals rose strongly in January-July. There was only a small downturn in arrivals following the Sinai bombings.

Foreign trade and payments The current-account surplus widened in April-June. The surplus was more than offset by the capital-account deficit, as strong capital outflows persisted. At mid- 2004 foreign reserves covered a comfortable eight months of imports.

Editors: Ben Faulks (editor); Keren Uziyel (consulting editor) Editorial closing date: November 14th 2004 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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Political structure

Official name Arab Republic of Egypt

Legal system Based on the constitution of 1971

National legislature Unicameral Majlis al-Shaab (People’s Assembly) of 444 directly elected members and ten additional members nominated by the president. Deputies serve for a five-year term. All candidates contesting the elections now run as individuals. The president may dissolve the Assembly only if he gains the support of the people in a referendum. The National Democratic Party has a decisive majority in the Assembly

Electoral system Universal direct suffrage

National elections Next elections due by October 2005 (presidential) and October-November 2005 (legislative)

Head of state President, nominated by a two-thirds majority of the Assembly and elected by referendum. Currently Hosni Mubarak, who was re-elected for a fourth six-year term in 1999

National government Council of Ministers headed by the prime minister. The president is responsible for appointing and dismissing ministers. The Assembly can require a minister to resign if it passes a motion of no confidence. Should a motion of no confidence in the prime minister be passed against the president’s wishes, the matter may be put to a referendum. Last cabinet reshuffle: July 2004

Main political parties National Democratic Party (NDP, the ruling party); Socialist Labour Party (SLP; suspended since May 2000); Socialist Liberal Party; New Wafd Party; National Progressive Unionist Party (Tagammu); Democratic Nasserist Party

Prime minister Ahmed Nazif

Key ministers Defence Mohammed Hussein Tantawi Civil aviation Ahmed Shafik Electricity & energy Hassan Ahmed Younes Finance Youssef Boutros-Ghali Foreign affairs Ahmed Abul Gheit Foreign trade & Industry Rashid Mohammed Rashid Housing & new communities Mohammed Ibrahim Suleiman Interior Habib al-Adli Information Mamdouh al-Beltagi International co-operation Fayza Abul Naga Investment Mahmoud Mohieddin People’s Assembly affairs Kamal al-Shazli Petroleum Sameh Fahmy Planning Osman Mohammed Osman Public works & water resources Mahmoud Abdel-Halim Abu Zeid Social affairs & social insurance Amina al-Guindy Supply & internal trade Hassan Khedr Telecommunications & IT Tarek Kamel Tour ism Ahmed al-Maghrabi Transport Essam Sharaf

Central Bank governor Farouk al-Okdah

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Economic structure

Annual indicators 2000a 2001a 2002a 2003a 2004b GDP at market prices (E£ bn) 340.1 358.7 378.5 415.0 445.5 GDP (US$ bn) 97.9 90.4 84.1 71.1 71.9 Real GDP growth (%) 5.1 3.5 3.0 1.8b 2.7 Consumer price inflation (av; %) 2.7 2.3 2.7 4.3 10.5 Population (m) 67.8 69.1 70.5 71.9 73.3 Exports of goods fob (US$ m) 7,061 7,249 7,250 8,987 11,820 Imports of goods fob (US$ m) -17,569 -15,750 -14,709 -15,003 -19,795 Current-account balance (US$ m) -821 249 849 3,874 1,897 Foreign-exchange reserves excl gold (US$ m) 13,118 12,926 13,242 13,589 13,843 Total external debt (US$ bn) 29.2 29.3 30.8 32.0b 33.8 Debt-service ratio, paid (%) 8.5 9.4 10.2 8.6b 8.1 Exchange rate (av) E£:US$ 3.47 3.97 4.50 5.84 6.20 a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2001/02 % of total Components of gross domestic product 2001/02 % of total Trade, finance & insurance 22.4 Private consumption 75.0 Industry & mining 20.1 Gross fixed capital formation 18.2 Social services 18.8 Government consumption 10.1 Agriculture 16.6 Exports of goods & services 15.8 Transportation & the Suez Canal 9.2 Imports of goods & services -19.6 Petroleum & electricity 6.7 Changes in stocks 0.4

Principal exports 2002/03 US$ m Principal imports cif 2002/03 US$ m Petroleum & products 3,161 Intermediate (semi-processed) goods 4,396 Aluminium, iron & steel 365 Investment (capital) goods 3,179 Cotton yarn, textiles & garments 691 Consumer goods 2,593 Agricultural products 117 Petroleum & products 2,313 Pharmaceuticals 130 Raw materials (excluding petroleum) 1,308

Main destinations of exports 2003 % of total Main origins of imports 2003 % of total US 13.7 US 13.5 Italy 12.6 Germany 7.6 UK 8.1 Italy 6.9 France 4.8 France 6.5

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Quarterly indicators 2002 2003 2004 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Prices Consumer prices (2000=100) 105.3 106.2 107.4 108.8 109.8 112.0 117.1 121.2 Consumer prices (% change, year on year) 2.7 3.0 3.2 3.9 4.3 5.5 9.0 11.4 Wholesale prices (2000=100) 110.3 111.3 114.6 122.7 125.0 129.4 139.3 144.8 Financial indicators Exchange rate E£:US$ (end-period) 4.500 4.500 5.728 6.033 6.126 6.153 6.168 6.190 Deposit rate (av; %) 9.4 8.9 8.1 8.4 8.4 8.0 7.8 7.7 Discount rate (end-period; %) 11.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 Lending rate (av; %) 13.9 13.7 13.6 13.5 13.5 13.5 13.4 13.3 M1 (end-period; E£ m) 73,457 75,781 81,104 85,970 91,268 93,520 95,955 100,620 M1 (% change, year on year) 10.4 13.0 17.0 16.9 24.2 23.4 18.3 17.0 M2 (end-period; E£ m) 308,124 332,812 357,819 375,979 392,386 403,634 412,299 428,205 M2 (% change, year on year) 7.7 12.6 18.4 18.3 27.3 21.3 15.2 13.9 EFG stockmarket index (end-period; Jan 1993=1,000) 2,204 2,307 2,840 4,007 4,885 5,818 7,022 7,087 Sectoral trends Crude oil production (m barrels/day) 0.74 0.75 0.76 0.76 0.74 0.74 0.73 0.71 Foreign trade (E£ bn) Exports fob 5.35 4.92 8.91 9.24 8.91 9.76 11.23 n/a Imports cif -14.66 -14.55 -14.98 -15.59 -15.79 -18.73 -16.25 n/a Trade balance -9.30 -9.64 -6.07 -6.34 -6.87 -8.97 -5.01 n/a Foreign reserves Reserves excl gold (end-period; US$ m) 12,887 13,242 13,037 13,603 13,568 13,589 13,176 13,576

Sources: IEA, Monthly Oil Market Report; IMF, International Financial Statistics; Oil Market Intelligence; Standard & Poor’s, Emerging Stock Market Review.

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Outlook for 2005-06

Political outlook

Domestic politics The Egyptian president, Hosni Mubarak, moved to address growing public disquiet at the deterioration in living standards during Atef Obeid’s five years as prime minister by initiating in July a long-awaited and widely demanded reshuffle of the cabinet. The poor performance of the economy in recent years is partly attributable to regional tensions, but the consensus had hardened that uncertain stewardship was a more significant factor. The reshuffle brought to the premiership Ahmed Nazif, the former telecommunications and information technology minister who has a reputation for industry and integrity, and elevated a number of economic liberals and businessmen to key positions, raising hopes that the long-standing economic problems that have dominated public discourse and sapped the government’s energies will finally be effectively addressed. The new cabinet has applied itself to the task of reform with energy and imagination, most notably by rapidly lowering import tariffs and overhauling the customs system, and by announcing plans to make major reductions in income and corporate taxes. A range of other far-reaching proposals for economic reform have been unveiled. Crucially, the president has so far identified himself closely with the reform programme, chairing meetings and lending explicit support to the cabinet. However, socially unpopular measures! such as privatisation and the rationalisation of Egypt’s costly programme of state subsidies!will prove a sterner test of the regime’s resolve. Without overt presidential support they are unlikely to make much headway. Egyptian prime ministers!although conventionally held responsible for all economic ills!can only operate within the mandate afforded them by the president. As economic conditions worsened during the government of Mr Obeid, the president increasingly prioritised social stability over economic reform, and the cabinet’s room for manoeuvre gradually narrowed. There is no firm evidence that Mr Mubarak’s health is in serious decline, and provided he is fit, he will probably stand for a fifth term when his current period in office expires in October 2005. However, the president is 76, and concern has mounted that he is in less robust health than previously assumed, following two unusually public displays of frailty over the past year. The cabinet reshuffle has reinvigorated speculation that the president’s second son, 41-year-old Gamal, is being lined up to succeed his father. Conjecture to this effect has been supported by Mr Mubarak’s failure to appoint a vice-president (the position from which he and his predecessor, Anwar Sadat, acceded), as this, critics argue, would create an obvious rival to his son. Many of the key appointees to Mr Nazif’s cabinet are closely identified with Gamal. They had been appointed to influential positions in the ruling National Democratic Party (NDP) in late 2002, during an overhaul of the party hierarchy that saw Gamal elevated to positions that gave him influence second only to that of his father. As such, the economic reform programme presents an ideal opportunity for Gamal to win support for any putative bid for the presidency. Successfully

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addressing impediments to business would be popular among the business community; if, in the longer term, this brings an upturn in broader living standards, Gamal’s popular profile stands to benefit significantly. However, it is not clear that Gamal would be acceptable to the military/security establishment that supports the regime!he would be the first civilian head of state since the overthrow of the monarchy 50 years ago. If no successor has been established by the time of the president’s demise, the matter will probably be resolved without public dispute by Egypt’s powerbrokers. However, this cannot be guaranteed. Besides, such a process would deny Mr Mubarak’s successor the opportunity to prepare for office, undermining his effectiveness until he becomes better established. Meanwhile, political liberalisation will remain cautious at best and is unlikely to significantly diminish the overwhelming dominance of the state. In particular, the government will remain intolerant of the Muslim Brotherhood, the only meaningful opposition movement. Efforts to repress the group will be facilitated by emergency law, which will continue to allow the security forces an unchecked hand in matters considered to be of national importance.

International relations Despite the parlous state of Israeli-Palestinian relations, Egypt will continue to exert strenuous diplomatic effort in support of attempts to resolve the dispute. The task of persuading the US to put the necessary pressure on Israel to achieve this is daunting. However, the importance Egypt attaches to achieving a peaceful outcome to the conflict will ensure that it persists with its efforts. At stake, too, is Egypt’s position as regional interlocutor, a role that has stemmed from its historically close ties to the US. Relations have deteriorated significantly under the US presidency of George W Bush. The involvement of Egyptians in the September 11th 2001 attacks prompted unaccustomed scrutiny in the US of Mr Mubarak’s rule, and the Egyptian government has been alarmed by the ideological nature of the regional policies espoused by members of Mr Bush’s administration. Egypt considers that the best way to improve bilateral ties is through the pursuit of the common goal of working to bring peace between Arabs and Israelis.

Economic policy outlook

Policy trends The cabinet of Mr Nazif faces an array of difficult economic challenges. These include arresting the deterioration in public finances and bringing greater coherence and transparency to monetary policy and the management of the exchange rate. The pace at which the new cabinet has embarked on reform has surprised many who had expected a more gradualist approach, given the well- documented caution of the president. Key measures include lowering customs duties and simplifying customs procedures!a long-standing request of investors, both foreign and domestic. The cabinet has also announced a raft of proposed tax reforms!substantially reducing personal and corporate tax rates, raising the tax threshold and reimbursing sales tax charged on capital goods. The diesel subsidy has been reduced and a slew of other measures have been announced, including the reinvigoration of the privatisation programme.

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The customs and taxation reform measures aim to stimulate the economy by raising disposable income and reducing barriers to investment and production. The government is calculating that the short-term cost in terms of lower revenue will in the medium term be more than recouped by a widening of the tax net!as the incentive to evade is reduced!and a more rapid pick-up in economic activity, which will both raise the tax take and reduce pressure on government spending. Such a goal should be facilitated as consumer and business confidence strengthens, boosted by the more coherent economic management now in evidence. The pick-up in privatisation should also strengthen Egypt’s ability to finance its fiscal deficit. There are risks to the cabinet’s bold approach, however. If commitment to reform flags, economic activity may not strengthen sufficiently!and privatisation may not accelerate enough!to offset revenue shortfalls, leaving public finances in a more precarious state. Moreover, if tourism!Egypt’s main industry!suffers a sharp downturn, the government’s task will be made more difficult. The attacks in Sinai in October, at this stage, seem unlikely to have a severe impact on the industry, but any other incidents almost certainly would.

Fiscal policy The fiscal deficit is expected to widen markedly in fiscal 2005 (July 1st 2004- June 30th 2005). The cabinet’s decision to lower customs tariffs is likely to stimulate economic activity, raising consumption, investment and output!and therefore income tax and customs revenue!but in the short term the fiscal benefits will be insufficient to offset losses due to lower tariff rates. In addition, the policy of raising interest rates to counter inflation and support the Egyptian pound will raise debt-servicing costs. This will be offset to some degree by moderately strong growth in tax revenue as economic growth picks up; reduced outlays on subsidies; lower costs associated with the divestiture of loss-making companies; and broader efforts to eliminate inefficiencies. However, the overall deficit is expected to rise sharply from an estimated 6.1% of GDP in fiscal 2004 to 8% of GDP. In fiscal 2006 customs revenue will strengthen as volumes pick up, stimulated by lower tariff rates and improving business confidence, and efforts to rationalise expenditure will persist. However, income tax revenue will fall as effective corporate and personal income tax rates are slashed by more than half. In addition, domestic debt-servicing commitments will again rise strongly, lifted largely by growth in the debt stock. Overall the deficit is expected to widen to 8.7% of GDP.

Monetary policy Following years of poorly focused monetary policy, the Central Bank of Egypt (CBE), under the governorship of Farouk al-Okdah!appointed in late 2003!has introduced more coherence into monetary management. Interest rates on Treasury bills (kept artificially low for government borrowing purposes) and other savings instruments have risen in an effort to counter inflation and support the Egyptian pound. Besides this, in an effort to introduce greater sophistication (and therefore predictability) into monetary policy, and move away from direct intervention, the CBE has introduced a range of new tools to influence monetary conditions. The Central Bank now says it plans to start anchoring its monetary policy in targeting inflation in

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2005. However, the move is likely to take time. As well as properly developed instruments, this will require significant upgrading of the CBE’s research capabilities.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2003 2004 2005 2006 Real GDP growth World 3.9 5.0 4.2 4.1 EU25 1.1 2.4 2.5 2.3 US 3.0 4.3 3.1 2.9 Exchange rates ¥:US$ 115.9 109.0 107.5 106.0 US$:€ 1.132 1.227 1.270 1.298 SDR:US$ 0.714 0.680 0.671 0.662 Financial indicators ¥ 2-month private bill rate 0.03 0.00 0.05 0.38 US$ 3-month commercial paper rate 1.10 1.40 3.00 4.94 Commodity prices Oil (Brent; US$/b) 28.8 39.3 37.5 29.0 Cotton (US cents/lb) 63.3 63.6 63.3 69.0 Food, feedstuffs & beverages (% change in US$ terms) 6.6 8.6 -4.2 0.9 Industrial raw materials (% change in US$ terms) 12.8 20.2 -0.3 -4.2 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. The Economist Intelligence Unit estimates that global economic growth will have reached 5% in 2004, the fastest rate of growth for 20 years. However, there are already signs that expansion is decelerating in some major economies and the outlook for 2005-06 is for a more modest pace of growth. We forecast that world GDP growth (on a purchasing power parity basis) will slow to 4.2% in 2005 and to 4.1% in 2006. The decline may marginally curb demand for Egypt’s merchandise exports and tourism services. However, perceptions of security will be a far more significant factor in determining tourist flows. We have raised our forecasts for the benchmark dated Brent Blend over the forecast period. In 2005 we now expect Brent to average US$37.5/barrel. Although declining slightly on 2004, as global GDP growth falls and some new capacity comes on stream, prices will remain more than US$14/b higher than the ten-year average. Demand will be more robust than previously expected largely because the consumption of rapidly growing Asian countries, in particular China, has been under-reported. Besides, with spare capacity now far lower than previously realised, the market is likely to remain tighter than had previously been expected. In 2006 Brent is forecast to fall again, to US$29/b, as OPEC and non-OPEC production gradually rises, spurred on by the high prices of recent years. Nevertheless, prices will be underpinned by buoyant energy demand, particularly in the emerging world.

Economic growth Despite the Sinai bombings, we have raised our projections for economic growth over the forecast period since our previous report. The government’s

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decision to lower customs duties will free up funds for investment and consumption in 2005. The decision should also improve the accessibility of foreign inputs, supporting production. More generally the new government’s energy and apparent coherence of vision will strengthen confidence. These factors are expected to more than offset the impact of the attacks, which are likely to cause a downturn in tourism!albeit, we believe, a relatively short- lived one!which will constrain growth in exports of goods and services. Imports are projected to rise strongly, stimulated by the reduction in duties. This will constrain growth in the short term but will prove beneficial for future output. Overall, growth is forecast at 3.5%. Growth in fiscal 2006 is expected to rise to 4.7%. Private consumption and investment should strengthen as personal and corporate income tax rates are lowered. Investment will also be supported by improving confidence as the government presses ahead with legislative and administrative efforts to upgrade the business environment. Growth will be constrained by declining expansion of government consumption, as private-sector activity picks up and the government makes efforts to rationalise spending. Imports will also continue to rise strongly, holding back overall growth!although this again bodes well for the future strength of the economy.

Inflation Inflation will fall but remain relatively strong at an average of 7.7% in 2005, compared with an estimated 10.5% in 2004. The inflationary impact of the “float” of the pound in January appears to be slowly easing. In addition, the ongoing overhaul of the monetary policy framework should enable the authorities to tackle price growth more effectively, while average world non-oil commodity prices are expected to fall. However, the sharp increases in prices over the past two years have caused inflationary expectations to rise, which will fuel future price growth. Moreover, domestic demand is expected to strengthen as economic growth recovers. Inflation is likely to fall further in 2006, to an average of 5.4%, as the monetary policy framework strengthens. These forecasts assume the continued use of the current consumer price index basket, which consists largely of subsidised goods and services whose prices are rarely altered and which has hitherto proven inadequate to assess price rises across the economy. Should a more market-driven inflation measure be introduced, as is planned, reported price growth will be stronger.

Exchange rates The policy of the Mr Obeid’s government towards the exchange rate lacked transparency. The government announced a float of the pound in January 2003, but did not follow through on it, stepping in almost immediately to limit the decline of the currency via informal pressure on the banking industry; despite this intervention, however, the pound still lost about 25% of its value against the US dollar on the official market between January and August 2003! since when it has barely moved. The situation has improved markedly in 2004, because of improved foreign-currency inflows, low demand and steps taken by the new Central Bank governor to improve access to foreign currency. As a result, the differential between the official and the black-market exchange rates had narrowed from 13% in January to just a few piastres (a piastre is one- hundredth of a pound) by mid-November.

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However, despite improved confidence in the convertibility of the currency, the new government is yet to clearly lay out its exchange-rate policy. In the absence of signs to the contrary it seems likely that the government will persist with its current policy of a steady depreciation of the pound. We forecast that the pound will fall to E£6.48:US$1 by end-2005, a decline of 3.7% on the end-2004 rate, and to E£6.76:US$1 by end-2006, a fall of just over 4%. However, it remains unclear how the authorities would respond to any foreign-currency shock (such as an attack on tourists). The most likely policy would be to support the pound with Egypt’s foreign reserves and a rise in interest rates. However, the authorities might also allow the pound to fall, or even do nothing, allowing the differential between the official and the black-market rates to widen once more.

External sector We have revised down our forecast for Egypt’s current-account surplus in calendar 2005 as custom tariff reductions and faster economic growth are expected to stimulate imports, and the attacks in Sinai in October 2004 will constrain tourism receipts. Egypt is now projected to register a current-account surplus of about US$700m (0.9% of GDP) in 2005, down from an estimated US$1.9bn (2.6% of GDP) in 2004. The trade deficit will continue to widen. Exports are likely to continue to grow relatively strongly, supported by the recent depreciation of the Egyptian pound and by some pick-up in domestic production. Although oil prices will ease slightly they will remain extremely strong by historical standards. However, imports, stimulated by sharp reductions in tariff rates, expanding domestic output and the greater determination of the new government to ensure foreign-currency liquidity, will rise faster, causing the trade deficit to widen to US$8.9bn from an estimated US$8bn in 2004. The invisibles surplus will narrow, driven largely by a modest decline in the services surplus as growth in tourism revenue is held back by security concerns. In 2006 the current account is expected to fall into a deficit of about US$200m (0.3% of GDP). The trade deficit will widen again as imports continue to grow robustly, driven by a further upturn in domestic economic activity. Export growth will slow once more as oil prices fall by more than US$8/b. The services surplus will also contract slightly as payments associated with merchandise imports and a further pick-up in domestic activity more than offset the rise in receipts, despite the more marked strengthening of the tourism industry.

Forecast summary (% unless otherwise indicated) 2003a 2004b 2005c 2006c Real GDP growth 1.8b 2.7 3.5 4.7 Industrial production growth 1.5b 1.9 2.8 4.4 Gross agricultural production growth 3.3b 3.2 3.2 3.2 Unemployment rate (av)d 9.9b 11.5 12.4 13.1 Consumer price inflation (av) 4.3 10.5 7.7 5.4 Consumer price inflation (year-end) 5.8 9.5 7.1 4.6 Lending rate 13.5 13.4 13.8 13.4 Government balance (% of GDP) -6.1 -6.1 -8.0 -8.7 Exports of goods fob (US$ bn) 9.0 11.8 12.8 13.1 Imports of goods fob (US$ bn) 15.0 19.8 21.8 23.0 Current-account balance (US$ bn) 3.9 1.9 0.7 -0.2

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Forecast summary (% unless otherwise indicated) 2003a 2004b 2005c 2006c Current-account balance (% of GDP)e 5.4 2.6 0.9 -0.3 External debt (year-end; US$ bn) 32.0b 33.8 34.2 34.1 Exchange rate E£:US$ (av) 5.84 6.20 6.38 6.62 Exchange rate E£:¥100 (av) 5.04 5.69 5.93 6.25 Exchange rate E£:€ (av) 6.61 7.61 8.10 8.59 Exchange rate E£:SDR (av) 8.18 9.12 9.51 9.99 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d Recorded official unemployment as a percentage of total labour force. e Ratio based on calendar year GDP; national accounts use fiscal year.

Gross domestic product Consumer price inflation % change, year on year av; %

Egypt (a) Middle East & North Africa Egypt Middle East & North Africa 6.0 12

5.0 10

4.0 8

3.0 6

2.0 4

1.0 2

0.0 0 01 02 03 04 05 06 01 02 03 04 05 06 2000 2000 (a) Fiscal years ending June 30th.

The political scene

Political reform to take second It has become increasingly clear that the Egyptian president, Hosni Mubarak, place to economic reform intends to prioritise economic reform over political liberalisation. Following the attacks of September 11th 2001, in which an Egyptian played a lead role, the administration of the US president, George W Bush!and figures closely associated with it!had stepped up pressure on the Egyptian regime for movement on political reform. Internal dissent, prompted by anger at developments in Iraq and between Palestinians and Israelis, also became more brazen. Intellectuals, via open letters, warned of the dangers of the one-party state, while demonstrations over regional political events afforded the opportunity for unusually direct criticism of the ruling elite, and occasionally even of the president himself. This had raised hopes among local activists that the government might respond by easing its long-documented tight grip on the Egyptian polity. Momentum, however, has fallen away. Pressure from the US has receded as the situation in Iraq has worsened, causing the US administration to assess that this is not an opportune moment to rile a traditional Arab ally. Public gatherings are far less frequent!in part because of government efforts to prevent them, but also as a degree of resignation over regional developments has set in.

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Mr Mubarak appears to have concluded that grievances over the economy are more significant, and more widely felt, than they are over shortcomings in Egypt’s democratic or human rights. He initiated a cabinet reshuffle in July that brought major changes to the economic portfolios with the appointment of economically liberal figures!including Mahmoud Mohieddin, an outspoken critic of government economic policy under the previous prime minister, Atef Obeid (August 2004, The Political Scene)!but no meaningful alterations in the more political portfolios. The formal, public launch of Mr Mubarak’s strategy took place at the annual conference of the ruling National Democratic Party (NDP) in September. “We can’t bring about the political reform we seek given the economic situation, and we can’t attain justice without a strong economy,” the president told Mayo, the NDP newspaper, on the eve of the conference.

NDP conference is dominated Of the nine headline issues tackled by the conference, six were economic. by economic matters These were combating poverty; encouraging competitiveness and preventing monopolies; managing state assets; reforming the customs and tax systems; reforming the financial sector; and improving transparency. In particular, proceedings were dominated by the troika of economic ministers!the finance minister, Youssef Boutros-Ghali, who has been promoted from the foreign trade portfolio, and two newcomers to the cabinet, the foreign trade and industry minister, Rashid Mohammed Rashid, and Mr Mohieddin. There were only two political debates of substance that arose from the gathering. The first of these concerned oversight of parliamentary elections, due in November 2005. An electoral commission is to be established, a key demand of the opposition. However, the NDP proposed that the commission be co- chaired by the ministers of justice and the interior and include five public figures appointed by the president!prompting charges that it would be insufficiently independent from the ruling party.

Reforms suggested for Political The second issue concerned a proposal to overhaul the make-up of the highly Parties Committee disappoint conservative Political Parties Committee, which is responsible for authorising the formation of parties. Since its formation in 1977, the committee has rejected the establishment of 64 political parties. The NDP proposed that three members of the judiciary and three independent public figures should join the Shura Council chairman and the ministers of the interior and parliamentary affairs on the committee. The committee would be obliged to respond to any application to form a party within 90 days otherwise it would gain implicit approval. In addition, there were indications that the NDP would push for a relaxation in the rules governing the publishing of party newspapers, a major source of finance for an aspiring party. However, the proposals again fall well short of the aspirations of the opposition!notably as new members of the committee would again be directly appointed by the president. Moreover, the minimum membership for any new party would rise to 1,000 compared with the current figure of 50, posing a potential barrier. The proposals have not yet been implemented, but there has been little sign that the committee is adopting a more sympathetic stance. In late October it authorised (following three rejections) the establishment of al-Ghad (Tomorrow). This was only the committee’s third ever approval of a political

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party. However, the decision should not be taken as a radical departure. The party is led by Ayman Nour, a lawyer and independent MP, and former deputy leader of the liberal Wafd party, and is made up largely of dissidents from the Wa fd!the views of its members are therefore well-known. More telling was the committee’s decision to reject for the third time an application by the Islamist Hezb al-Wasat al-Jedid (New Centralist Party) and the neo-Nasserist Hizb al- Karama al-Arabiya (Arab Dignity Party) in early October. The constant rejection of these applications frustrates political activists who are unwilling to join forces with approved opposition parties, since most are ruled by ageing dogmatic leaders who have long since lost the appetite for the political fray.

Gamal Mubarak’s profile The NDP conference above all served to establish the central role of the continues to rise president’s 41-year-old son, Gamal Mubarak, as the driving force behind all aspects of policy espoused by the NDP. Indeed, since the reshuffle moved key allies of Gamal from the NDP into ministerial posts, the distinction between NDP policy and government policy has become increasingly blurred. Gamal, who heads the NDP’s influential Policy Secretariat (and is now in effect the second most powerful figure in the party after the president), presented much of the NDP’s vision, including a call for a far-reaching redefinition of the state’s role in the economy, from investor and employer, as at present, to observer and regulator. Speculation that Gamal is being lined up to succeed his father was fuelled by his image appearing on a four-storey-high billboard in Cairo’s central Tahrir Square in September, celebrating the achievements of Egypt’s Olympians. The billboard was one of four depicting Egypt’s medal winners, and was seen as an attempt to emphasise the common touch of the president’s son. The billboard was quickly pulled down, suggesting it may have been erected without Gamal’s knowledge or approval. However, whoever was responsible, the incident made an impression, as the president himself is usually the only figure depicted in this way. Meanwhile, the president and his son continue to deny that Egypt will become a hereditary republic!a position that, some argue, does not preclude accession by other means, including selection by the People’s Assembly and then confirmation by popular referendum, in the way that presidents are normally chosen.

Opposition launches petition With a presidential referendum looming and little sign of political reform, on unprecedented scale activists have become increasingly energised. The Popular Campaign for Change!an umbrella organisation for some 26 human rights and civil society groups, the banned Communist Party and the Muslim Brotherhood!has issued a petition on an unprecedented scale (signed by 700 members) calling for far- reaching political reforms. These include direct elections and a limit to the number of terms a president can serve as well as an end to emergency law, in place since 1981, which allows the security forces free rein in matters considered to be of national importance. The petition is a rare case of organised public dissent towards the Egyptian leadership, bringing together a number of groups with widely ranging beliefs. Meanwhile, seven of Egypt’s largest legal opposition parties, including the Wafd, the leftist Tagammu and the Democratic

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Nasserist Party, established the National Consensus for Political Reform in early September.

Attacks on Sinai tourism Egypt suffered its first politically motivated violence in seven years when on facilities kill 34 the evening of October 8th three almost simultaneous car bombs exploded at tourism facilities in east Sinai, killing 34 people. Thirty-two people died when a huge car bomb was detonated at the Taba Hilton. Two people were killed in similar attacks at two camp resorts to the south. Most of the victims were Egyptian, Russian and Israeli. Indeed, the attacks seemed almost certainly to target the latter. Taba is largely an Israeli tourist market!the vast majority of the 15,000 Israelis who had crossed into Sinai to celebrate the Jewish festival of Sukkot streamed back across the border after the attacks. Israeli officials quickly blamed the militant Islamist network, al-Qaida. Indeed, the bombings bore the hallmarks of other attacks that have been attributed to the group: they took place simultaneously; they appeared meticulously planned and carefully executed; and they were said to use techniques that have been identified with al-Qaida. However, after a secretly conducted investigation, the Egyptian authorities announced in late October that the attacks were in fact carried out by a group of disaffected Sinai Bedouin led by Ayad Said Saleh, a minibus driver whose family left Gaza after the 1967 Arab- Israeli war. Mr Saleh “acted in retaliation on Israeli tourists for the deterioration of the situation in the occupied Palestinian Territories,” the Ministry of the Interior said. Mr Saleh and his main accomplice were killed in the Taba attack, the ministry claimed, when the bomb went off prematurely. The authorities said they had arrested five members of the group, who were mostly from the northern Sinai town of Al Arish!two men, said to be responsible for the camp site attacks, remain at large. The ministry said that the bombs were assembled from ordnance left over from previous conflicts in Sinai (the last of which took place more than 30 years ago), and that the timers and detonators were made using spare parts of washing machines and other white goods. All the men arrested have criminal records. The explanation has been greeted with scepticism in Egypt!how, for example, could such powerful bombs have been assembled from ageing ordnance; or how could a group of uneducated discontents have gained the expertise to build bombs. From the interior ministry’s explanation, Egypt could not be perceived as vulnerable to al-Qaida. However, in some respects the ministry’s explanation is more alarming as it implies that there are young men in Egypt who are sufficiently angry and determined to launch devastating bomb attacks. These men may have been motivated by anger at Israel, but their fury did not prevent them from killing dozens of bystanders, including Egyptians.

Sinai attacks may open way There was some speculation that the attacks would serve to usher in something for closer ties with Israel of a warming in ties between Egypt and Israel. The Israeli prime minister, Ariel Sharon, in the wake of the bombings, told his cabinet “not to criticise the Egyptians”. Another senior official said that “with the right policy, the attack could lead to stronger relations, based on the common threat [of terrorism]”. However, little of substance has so far materialised. Meanwhile, Egypt’s efforts to prepare for the proposed Israeli withdrawal from Gaza have continued. It has

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refused to play a direct security role in Gaza, but has agreed to play a part in strengthening Palestinian security forces in the run-up to the planned withdrawal. Egypt’s task of co-ordinating an already disparate set of forces has become more problematic, though, following the death of the Palestinian leader, Yasser Arafat, on November 11th.

Economic policy

Government launches into The government of the prime minister, Ahmed Nazif, appointed in July, has wide-ranging economic reform embarked on an economic reform programme that has surprised even the most expectant with its speed and scope. The programme has enthused the Egyptian business community, not only for its ambition, but also for its coherence. This co-ordination is no accident. The team of reformists now in the cabinet have for the past few years been preparing a programme for reform through the committees of the ruling National Democratic Party (NDP), following an overhaul of the party initiated by Gamal Mubarak, the son of the president, Hosni Mubarak. The opening gambits of the new cabinet clearly indicate that its intention is to prompt private sector-led economic growth by stimulating consumption and improving business confidence, prompting an upturn in investment. Faster growth should, in turn, take the pressure off public finances. Official figures published by the Central Bank of Egypt (CBE), which appear surprisingly strong given anecdotal evidence of sluggish!if recovering!economic activity, put real GDP growth at 4.4% in fiscal 2004 (July 1st 2003-June 30th 2004), up from 3.1% the previous year. The government is projecting 5.5% growth in fiscal 2005 and aims to raise expansion to 6-7% over the next four to five years!the rate broadly considered necessary to absorb the 600,000 or so new applicants to the job market each year and make some dent in unemployment; thereafter officials speak of targeting growth of 9-10%. Mr Nazif has identified raising investment as the key. He said that Egypt needs to raise gross fixed investment to E£100bn (US$16bn) to achieve growth of 6%; this is a substantial task given that investment stood at E£68bn in 2003, according to data published by the IMF in its International Financial Statistics. Crucially, the cabinet appears, thus far at least, to have a firm mandate from Mr Mubarak. His address to the annual conference of the NDP in late September, at which the new cabinet laid out its plans for economic reform, focused largely on economic issues, promising “radical change”. The president reiterated his long-held concerns over the social impact of reform, but nevertheless gave his public backing to the proposals. The president has also chaired many of the cabinet’s economic meetings, closely identifying himself with the process of decision-making. In addition, Mr Mubarak has stated that political reform should be put on hold until the economic situation improves. By essentially rejecting the aspirations of those pushing for political reform, the pressure will be all the greater for Mr Mubarak to deliver in the economic sphere.

Cabinet’s approach is aimed at The approach of the new cabinet seems designed to maximise popular support maximising popular support for the process from the start, as is clearly illustrated by the two most eye-

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catching reforms!sharp reductions in customs duties and in income taxes. One goal of reducing customs tariffs is to subdue inflation, a major cause of popular discontent since the mismanaged float of the Egyptian pound by the govern- ment of Atef Obeid in January 2003. Lowering income taxes!both personal and corporate!will have an even more direct impact, by raising disposable income. However, the reform process unveiled will ultimately involve measures that carry a social cost!it is at this stage that the president’s support will be most needed.

Customs tariffs are slashed The new government’s first major initiative was an overhaul of the customs and systems overhauled system, encompassing a dramatic lowering of duties and a simplification of customs administration. Under Presidential Decree 200 of 2004, introduced with immediate effect on September 8th, Egypt’s tariff bands were reduced to six from 27. According to the finance minister, Youssef Boutros-Ghali, the new rates lower Egypt’s weighted average tariff to 9.1% from 14.6%. The new tariffs reflect the degree of processing of the item!raw materials and basic foodstuffs are the least taxed, at 2%, capital goods are taxed at 5% and levies on finished goods range from 22% to 40%.

New tariff structure (%) Item New tariff Basic industrial inputs, spare parts, food staples 2 Crude oil & fuels, capital goods except for transport equipment 5 Manufactured production inputs & refined fuels 12 Non-durable consumer goods 22 Semi-durable consumer goods 32 Consumer durables 40

Source: Ministry of Finance.

The economic rationale behind the reform, in the broadest terms, is to encourage the importation of goods for use in domestic production (80% of the tariff reductions were on production inputs), while offering a degree of protection on finished products. Facilitating the supply of essential foodstuffs was another key objective. Notable reductions in duties included those on cement and fertilisers, from up to 33% to 2%; on meat, from 80% to 22%; and on tea and beans, from 33% to 5%. Inputs for the information technology sector are now exempt from duties altogether!allowing Egypt to fulfil its obligations under the Information Technology Agreement of the World Trade Organisation (WTO). In a highly populist move, the duty on cars with an engine capacity of up to 1,600 cc was lowered to 40% from 104%. Some exceptions have been retained, however, with tariffs on alcohol, tobacco and cigarettes remaining above 100% and those on luxury cars (more than 2,000 cc) staying at 135%. However, as important as the explicit impact on the cost of imports is that the decree should help lower indirect costs. Egypt’s arcane customs procedures have regularly been cited as a major barrier to investment. Customs officials exploited discrepancies and inexactitudes in the previous customs legislation to their own ends; even without having to contend with corruption, the previous regime held plentiful scope for delays.

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Decree 200 seeks to address this, firstly by reducing the number of tariff headings Egypt uses under the Harmonised System Commodity Description and Coding System, known as the Harmonised System (HS), the internationally recognised format for classifying customs duties. The HS classifies products into 21 sections and then breaks the sections down into 98 chapters. The chapters are then subdivided into 1,250 “headings” and 5,229 “subheadings”!which gives each item a six-digit code. Individual countries are permitted to make further subdivisions under ten-digit codes. Egypt previously had about 13,000 tariff headings, but the new decree has reduced this to less than 6,000!which is only marginally more than the number of HS six-digit headings. This should reduce ambiguities and overlap, significantly narrowing the scope for dispute over the classifying of imports for customs purposes. Secondly, the decree abolishes service fees and import surcharges. Previously all imports were charged a 1% service charge (for inspection, listing, classification and re- examination of imports). In addition, import surcharges of 2% were made on the 5-29% tariff range and of 3% on goods facing tariffs of 30%. These legislative changes will be backed up by efforts to improve efficiency in administration. There are plans to introduce a “pre-clearance” system and a broader simplification of inspection procedures, according to the Ministry of Foreign Trade and Industry. A rationalisation of the quality control system is also expected!a process that currently typically takes three to four weeks. In late October, Mr Boutros-Ghali appointed as head of the Customs Authority Galal Aboul-Fetouh. Mr Aboul-Fetouh had previously run Damietta Port, which under his tenure became Egypt’s most efficient state-run port. To complete the customs reform exercise, export tariffs have been abolished. These applied to 25 products!most notably iron and steel scrap, raw hides and skins, and antiques!which the government considered to be in short supply locally.

Government moves to address The new government has also moved to address controversial non-tariff non-tariff barriers barriers. Under a decree issued in late September, Egypt removed the require- ment that foreign textile factories wishing to export to Egypt must undergo inspection by a team from the Ministry of Foreign Trade (as it was formerly called)!although the requirement that individual factories (as opposed to companies) be registered was left in place. The inspection stipulation had been introduced in February 2004 (May 2004, Foreign trade and payments) immediately after Egypt had lowered huge duties on garments and textiles that far exceeded its commitments under the WTO’s Agreement on Textiles and Clothing. The rationalisation of the customs duties was in itself a response to the US move towards bringing the matter before the WTO!the US had requested WTO consultations on the issue as a first step in the dispute process. As a result, the inspections stipulation had opened Egypt up to charges of moving from tariff to non-tariff protection of its textile industry. In addition, in one of his first actions as foreign trade and industry minister, Rashid Mohammed Rashid, in early August, eliminated the anti-dumping tariffs on Ukrainian and Turkish steel rebar imports. The duties had stood at 21% for Ukrainian steel and 14-45% for Turkish imports and were not due for reconsideration until 2008. The tariffs had proved controversial locally as the price of steel trebled in Egyptian pound terms between early 2003 and July

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2004!despite a reduction in tariffs on steel imports to 5% from 20% in January 2004. (Local producers have argued that the depreciation of the Egyptian pound and the sharp rise in global steel prices!to an estimated average of US$530/tonne in 2004 from US$298/tonne in 2002!have played a major part.) Many of the measures!with regards to both tariff and non-tariff barriers!are necessary to fulfil Egypt’s obligations under bilateral and regional trade accords (most importantly the Association Accord with the EU) and under WTO rules. However, the extent and speed of the overhaul mark a notable change in attitude from reluctant adherence to commitments because of looming deadlines to an embrace of reform as a means of securing economic benefits.

Income taxes are to be The second major economic policy initiative espoused by the new cabinet was lowered sharply a sharp reduction in personal and corporate income taxes. The legislation has presidential approval and is due for parliamentary ratification during the current session, which began in early November. Given the president’s endorsement and the NDP’s domination of the People’s Assembly, approval should not be problematic and the law should go into force in fiscal 2006. The new law substantially reduces income tax obligations. As well as reducing the maximum personal tax rate to 20% from 40%, the law lowers the qualifying tax brackets considerably!for example, Egyptians earning between E£7,000 and E£16,000 will pay tax of 10% under the new law, compared with 35% now. Tax on income up to E£5,000 has been totally eliminated!previously even the lowest earners were liable for tax of 20%. In addition, the new law gives women the same exemption rights as men!previously women were treated as being single irrespective of whether they were married or had children.

Personal income tax rates Current law (Law 187 of 1993) Draft law Tax bracket Tax rate (%) Tax bracket Tax rate (%) Up to E£2,500 20 Up to E£5,000 0 E£2,501 to E£7,000 27 E£5,001 to E£20,000 10 E£7,001 to E£16,000 35 E£20,001 to E£40,000 15 Above E£16,000 40 Above E£40,000 20

Source: Economist Intelligence Unit.

The draft law states that corporate taxes will be lowered to a standard rate of 20%. Currently the basic corporate tax rate is 40% (plus a 2% state development duty). The rate is 32% for industrial and export activities. Oil companies pay 40.55%, a rate that will be unchanged. In view of the reductions, the current system of tax exemptions will be abolished. These offered exemptions of between five and 20 years to projects depending on the law under which they were established and their geographical location. Existing exemption commitments will be honoured. In addition, tax benefits introduced to encourage companies to list on the stock exchange are expected to be removed. Again, the legislative changes will be accompanied by far-reaching admin- istrative reform. This is expected to involve changes in personnel as well as in systems. Currently disputes between companies and the tax authorities are commonplace!in part because the administration is complex, allowing room for interpretation, and in part because tax officials are given incentives to raise

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takings, tempting them to challenge properly audited accounts!and cases frequently end up in the courts where they take years to process. This complicates financial planning on the part of both companies and the government. The process of tax administration, notoriously time-consuming, should be speeded up as the authorities will drop their current commitment to audit every tax return, instead taking a sample of less than 10% of returns. A Tax Supervisory Board for dispute settlement and surveillance of the Tax Authority is to be established, headed by a judge and including representatives of business organisations. This, together with the introduction of international auditing standards!an ongoing drive!should reduce the scope for dispute, and therefore make it more difficult for officials to exploit uncertainties to extract bribes. A key government goal is to reduce tax evasion. There are currently some 80,000 tax evasion court cases requiring resolution, according to the finance minister. A combination of lower rates and tougher penalties for offenders is intended to broaden the tax net, particularly among small businesses!the informal economy is officially estimated to be equivalent to around 30% of GDP. A tax amnesty will be declared to allow firms to register without paying penalties or backdated taxes. However, much will depend on effective implementation. Sales tax is also to be modified. The 10% sales tax paid on imported capital goods will be reimbursed. The four sales tax bands!ranging from 5% to 45%, with 10% as the norm!are to be replaced with a single rate, to simplify the system. The rate is yet to be announced. It is also generally expected that sales tax will be applied to a wider range of goods and services.

Customs and tax measures The lowering of customs and income tax rates should stimulate consumption should stimulate growth and investment. Mr Boutros-Ghali has said that the Treasury will forgo revenue of between E£3.5bn and E£5.5bn a year over the next two to three years because of the income tax measures, cash that can be reinvested or spent by individuals and companies. Likewise, the government said that it expects to lose about E£3bn over the next 18 months as a result of the customs tariff reductions. As a result, at least E£5.5bn will be directly freed up over the first full year that both measures are in effect, equivalent to about 1.5% of GDP. Indeed, Mr Boutros- Ghali said that he expects the customs measures alone to stimulate additional real GDP growth of between 1.5 and 2 percentage points.

A short-term deterioration in This also implies a significant direct loss to the Treasury!equivalent to 7.1% of the fiscal account seems likely current revenue in fiscal 2004, according to newly released data, and 6.7% of overall revenue. Clearly, the government does not expect the impact to be anywhere near as great as this. The additional economic growth generated by both measures is expected to add to income tax revenue and to stimulate additional imports. Moreover, the broadening of the tax net, and probably of the range of goods and services on which sales tax is levied, should help offset the impact. Spending growth is likely to be curbed by some rationalisation of the subsidies programme (see below), and financing should become less problematic if privatisation picks up (see below).

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Budget sector fiscal outturn (E£ m unless otherwise indicated; fiscal years ending Jun 30th) 2002/03 2003/04 % change Total revenue & grants 86,484 96,580 11.7 Total revenue 83,530 93,655 12.1 Current revenue 81,449 91,987 12.9 Tax revenue 57,486 65,581 14.1 Income tax 23,189 27,622 19.1 Goods & services 22,782 25,797 13.2 International trade 11,354 12,014 5.8 Other 161 148 -8.1 Non-tax revenue 23,963 26,406 10.2 Capital revenue 2,081 1,668 -19.8 Grants 2,954 2,925 -1.0 Total expenditure & net lending 111,913 123,750 10.6 Total expenditure 111,786 123,487 10.5 Current expenditure 95,226 106,005 11.3 Wages & salaries 31,549 35,234 11.7 Defence 11,215 12,433 10.9 Interest 26,849 31,146 16.0 Domestic 24,498 28,741 17.3 Foreign 2,351 2,405 2.3 Other 25,613 27,192 6.2 Capital expenditure 16,560 17,482 5.6 Lending minus repayments 127 263 107.1 Balance -25,429 -27,170 6.8 % of GDP -6.1 -5.9 - Total financing 25,429 27,170 - Foreign -4,316 -4,440 - Domestic 34,387 35,558 -

Sources: Ministry of Finance; Central Bank of Egypt.

However, it would seem highly optimistic not to expect at least a short-term deterioration in the fiscal account. Imports are already heading for an all-time high by some margin in calendar 2004 (see Foreign trade and payments). To make up an annual loss in customs revenue of E£2bn (equivalent to 17% of receipts in fiscal 2004) following a sharp reduction in tariff rates would require an extremely large upturn in volumes. The pick-up in economic growth in the near term is unlikely to fully compensate for the effective slashing of income tax rates by more than half. Moreover, cuts in subsidies sufficient to radically alter government finances are unlikely in the near term, given the political sensitivity of such measures. The approach therefore does carry a risk. Should the upturn in economic growth fall significantly short of the government’s targets!possibly because of an external shock, most likely to the key tourism industry, or because the political will to see the reform programme through falls away!public finances, which have deteriorated in recent years, could worsen markedly.

Energy subsidies are lowered The most sensitive measures implemented by Mr Nazif’s government in its first few months in office!and the third main plank of its reform programme!were reductions in a number of subsidies. Price setting for energy!primarily petrol and electricity!which is the most costly element of Egypt’s programme of state

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support, had been expected to result in implicit losses of E£29bn in fiscal 2005 (although this projection was made before the sharp rise in oil prices that began in July). In early September, the retail price of diesel was raised to E£0.6/litre (10 US cents/litre) from E£0.4/litre. The price of diesel, which is widely used in public and private transport for generators and by industry, had been unchanged for more than ten years, a subsidy that cost the government some E£5bn a year. The move is unlikely to have a major impact on government finances!cost price is currently around E£2/litre. Nonetheless, the move provoked something of a public uproar, prompting the government to clarify that bakeries producing the subsidised, or baladi, bread on which poor Egyptians rely would continue to receive diesel at E£0.4/litre. Despite the furore, the government has also pressed ahead with raising the price of fuel oil, which now stands at E£300/tonne (US$50/tonne), up from E£180/tonne at the start of the year!although this remains below cost price. Natural gas prices were also raised, by 30%, in late September to what is believed to be close to cost price!only 3% of natural gas is consumed by households, with some 65% used in power plants and the rest in industry. Meanwhile, the state-owned Holding Company for Cairo Water and Sewerage (HCCWS) almost doubled water prices in early October to E£0.23/cu metre from E£0.12/cu metre, bringing it into line with the standard rate nationwide. HCCWS produces around one-third of Egypt’s water, around 5.6m cu metres/day. Again, however, the measure leaves retail prices far below cost price!HCCWSA says that the water costs E£0.8/cu metre to produce. The government has also said that it intends to target direct subsidies (mainly on bread but also on transport and housing) more effectively. These were budgeted to cost the government E£15.6bn in fiscal 2005, almost twice the budgeted outlay for fiscal 2004 because of the fall of the Egyptian pound and the rise in the global prices of food staples. Mr Nazif has made clear the government has no intention of lifting the bread subsidy, but he has said that the government is considering removing the subsidies on other commodities and replacing them with direct financial compensation for those who currently hold ration cards, some 10m people. This would appear to be a logical first step towards means testing, a process that would be impossible to introduce effectively at the moment, given the inadequacies of the public records system.

Government aims to The fourth element of the new government’s programme is to rejuvenate the reinvigorate privatisation privatisation programme that has slowed markedly in recent years as economic conditions have deteriorated. On average 20-25 companies a year were!at least partially!privatised from the inception of the programme in 1993 to 2000, raising E£15.5bn, according to the July 2004 issue of Economic Trends, published by the US embassy in Cairo. The rate fell to 13 in 2001 (generating E£1.1bn), to six in 2002 (generating E£51.2m, equivalent to US$8.3m) and to nine in 2003 (raising E£114m). The new investment minister, Mahmoud Mohieddin, said in mid-September that the “strategic” designation previously applied to certain industrial sectors deemed sensitive!such as pharmaceuticals, flour milling and tobacco!would no longer apply. He said that all 172 industrial companies still under government control, which employ some 410,000 people, would be subject to a financial review and that those not deemed fit for privatisation

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would be restructured with a view to sell-off in the longer term. The government’s holdings in all 695 companies formed as joint ventures with the private sector are also to be sold. Proceeds from the sales will be used to settle the firms’ debts and to restructure other enterprises. To begin the process, ten profitable companies in a range of sectors were put up for sale in late September. Maamoura Housing & Development and Alexandria Mineral Oils were to be completely divested and stakes ranging from 15.4% to 87.9% were to be sold in the remainder of the companies. Since then the sales of the public stakes in Bisco Misr and the National Paper Company have also been announced along with EgyptAir’s decision to sell 40% of its in-flight services company (a non-industrial company). The president has approved the establishment of a five-member committee to decide on the evaluation of all companies (whether in the industrial, the utilities or the financial sectors) due for privatisation. This will comprise the Central Auditing Agency, the Capital Market Authority, the Ministry of Finance, the CBE and the Egyptian Society of Accountants and Auditors. The broad range of participants appears to be an attempt to give the pricing of these firms the widest possible legitimacy!in the past there has been frequent criticism from opposition media and in parliament that assets have been sold off too cheaply. However, disagreements over valuations (together with the controversy this provoked) were also a key reason for the slowdown in asset sales, and the breadth of the new committee leaves scope for disagreement. To avoid this, if the committee fails to settle on a valuation within 30 days the company will automatically be offered at the price originally suggested by which ever state entity put the asset forward for sale.

Plan for banking sector reform The government has announced a comprehensive plan to overhaul the is unveiled banking sector, the fifth plank of its economic reform programme. The plan has been under formation since the appointment of Farouk al-Okdah as governor of the Central Bank of Egypt (CBE) in late 2003. The sector has suffered in recent years as the economy has deteriorated following rapid credit extension with often insufficient due diligence in the late 1990s, causing the proportion of non-performing loans (NPLs) to rise to as much as 30% of outstanding lending, by some estimates. The first goal is to strengthen the sector by effecting consolidation. The CBE has decided to enforce compliance by July 2005 with the E£500m minimum paid-up capital requirement set down in the Unified Banking Law of 2003 (August 2003, Economic policy)!a fivefold rise on the previous stipulation. Banks had originally been given one year to comply with the requirement, expressly introduced to prompt mergers, but the CBE had been permitted to extend the period to a maximum of three years. As part of this drive, Misr Exterior Bank, El Mohandes Bank, Nile Bank, Egyptian Unified Bank, Commerce and Development Bank and Islamic Investment Bank are to be taken over by the four large fully state-owned banks (National Bank of Egypt, Banque Misr, Banque du Caire and Bank of Alexandria) within 12 months. The six smaller banks are controlled by the state, although non-state entities own minority stakes. The banks were deemed unable to meet the capital requirement and too weak for purchase by the private sector. The merger of Misr Exterior with its parent bank, Banque Misr,

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was announced in September. Meanwhile, in the private sector, the CBE approved the merger of the small American Express Bank with the thriving Egyptian American Bank (a joint venture between American Express and the state Bank of Alexandria) in mid-September. The sale of the state’s remaining holdings in the joint venture banks with foreign banking institutions is to be completed within two years. The govern- ment has repeatedly stated its intention to sell these stakes, but state-owned banks have resisted, unwilling to cede key sources of revenue. The proceeds from these sales are to be used to restructure the four dominant state-owned commercial banks!addressing issues such as NPLs, over-staffing and technological inadequacies. The CBE deputy governor, Tarek Amer, said in early October that one of the four banks will be privatised next year!although no details on the method of sale were officially announced, officials strongly indicate that the government intends to cede control to a major banking institution rather than simply offer shares through an initial public offering. The likely candidate is strongly rumoured to be the smallest!Bank of Alexandria. Meanwhile, the CBE is to establish a new unit charged expressly with addressing the issue of NPLs, as well as an arbitration committee to mediate between banks and debtors without resort to the courts.

Insurance sector is to be The underdeveloped insurance industry is also due for reform. New chairmen, reformed who have worked at international insurance companies, have been appointed at two of the four dominant public-sector insurance and reinsurance firms, Al Charq and Egypt Re. The investment minister announced his intention to begin privatisation of the state-owned insurers. The state insurance companies were evaluated in 2001, but no moves towards privatisation have been made since. The minister has also replaced Khairy Selim as head of the industry regulator, the Egyptian Insurance Supervisory Authority (EISA), with Mohammed Youssef!a member of the EISA board. Mr Selim had been considered too conservative. However, under government plans EISA will soon be abolished, as a financial services authority is to be established within the coming year to supervise the insurance industry as well as the capital markets and the mortgage, leasing and factoring sectors. Supervision of the banking sector is to pass from the CBE to the authority within three years.

Sweeping changes in Indeed, changes in personnel mark a sixth clearly identifiable strand of the economic personnel are made government’s reform programme. Young, reform-minded figures have been appointed to key regulatory bodies. The chairman of the Cairo and Alexandria Stock Exchanges (CASE), Sameh Torgoman, has been reassigned to head the General Authority for Real Estate Finance, the body responsible for overseeing (and nurturing) Egypt’s mortgage market!which is yet to make any impression. Maged Shawki, like the investment minister a former aide of Mr Boutros-Ghali, has been appointed to the new post of deputy head of CASE. A lawyer and another former aide to Mr Boutros-Ghali, Ziad Bahaaeddin, has been made chairman of the General Authority for Investment (GAFI). Mr Mohieddin has been critical of GAFI’s bureaucratic procedures and envisages the authority moving towards promotion rather than merely approval of projects. A board of

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nine members, including well-regarded private-sector figures, has been appointed. In addition, a 16-member board of trustees has been selected for the first time, again including a number of well-known private-sector figures. This will be chaired by Mr Mohieddin and is intended to advise GAFI on how to improve the investment environment. Linked to the drive to enhance human capital is the much broader goal, touched on by the new government, of improving the education system to better meet the demands of the job market. At a conference in late August, Mr Mubarak talked in broad terms about the establishment of public-private partnerships. How this potentially radical approach will be implemented is yet to become clear, although the aim would appear to be to address the central issue of underfunding. However, Mr Mubarak was more specific on the goals, which were named as improving the quality of education by overhauling the curriculum and improving teaching methods, rather than just the facilities; promoting scientific research; paying greater attention to children with special needs; and reorganising the university system into smaller more specialised units. To facilitate decentralisation of the education system (as well as to raise standards) a new independent monitoring body is to be established. Independent of this, the government has hinted at rationalising outlays and generating greater efficiency in further education. A new national university, financed by student fees and private donations, is under consideration. Although it has continued to stress its commitment to free higher education for all, the government has also indicated that it may start to charge fees for the most popular university courses.

Overhaul of monetary policy The seventh broad plank of the new government’s economic policy drive is the continues development of a coherent monetary policy via the establishment of an effective framework!a process that began to make serious advances following the appointment of Mr Okdah as governor of the CBE in December 2003. The trend towards higher interest rates has continued!a measure intended both to counter the sharp rises in inflation prompted by the float of the Egyptian pound in January 2003 and to support the local currency. Most notably, National Bank of Egypt (NBE) and Banque Misr (Egypt’s two largest banks, accounting for 35% of assets and 42% of deposits) in August simultaneously issued what they called “advantage certificates”, instruments carrying a return of 12%, 2 percentage points higher than any other savings vehicle. A rush of public interest!NBE said that it sold E£3bn of the instruments in the first three weeks!has prompted other banks to issue instruments offering the same or, occasionally, higher returns. The decision clearly reflects the bidding of the Central Bank, which is keen to raise rates. However, it also serves as a reminder that the most effective way to influence monetary conditions remains direct intervention (rather than via indirect means). For example, the raising of rates on auctions of three- and six- month Treasury bills (to above 11% from 6.8% in January) has had no impact on either deposit or lending rates offered at banks. These have changed little since the start of 2004 (7.9% for one-year deposits and 13.4% for loans of one year or less.) However, the CBE appears to judge that the use of the more sophisticated

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monetary policy instruments that it has been developing!including the use of repos and reverse repos, as well as commercial bank deposits at the Central Bank!will be sufficiently advanced to launch a more ambitious monetary policy targeting framework. The CBE intends to switch from its current policy of targeting broad money to targeting inflation, with the overnight interbank rate as the operational target. The switch is expected early in 2005. To facilitate this, the Central Bank is expecting to launch in the first half of 2005 a regular report carrying inflation forecasts well in advance, together with a range of data likely to have an impact on inflationary conditions in Egypt. This will assist the CBE’s Monetary Policy Committee in setting targets. Meanwhile, efforts to establish a more credible measure of inflation, central to effective monetary policy, appear to be focusing on improving the existing consumer price index rather than on creating a new one, as had been suggested. A new (more sophisticated) household survey will be completed in 2005 and published in 2006, which will be used to upgrade the index.

Confidence grows in Higher interest rates have supported the Egyptian pound, helping the exchange-rate management differential between the official and black-market exchange rates to diminish further. In mid-November the official rate stood at E£6.23:US$1 and the black market rate at E£6.25:US$1, a differential of 0.3%, down from 1.5% in mid-August (August 2004, Economic policy), 5% in April and 13% in January. The official and black-market rates have also converged on occasions, for the first time on October 4th. The continuous narrowing of the differential between the two rates is indicative of strengthening confidence in the convertibility of the pound!uncertainty over the currency has been a long-standing economic sore.

Exchange rate E£:US$ 6.4 6.2 6.0 5.8 5.6 5.4 5.2 5.0 4.8 4.6 4.4 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov 2003 04

Source: Bloomberg.

More important in prompting the convergence between the two exchange rates than the rise in interest rates has been Egypt’s strong current-account position, coupled with Mr Okdah’s determination to ensure the availability of hard currency. An interbank market for foreign exchange began operations on a trial basis in early October and the number of banks participating has since risen to 15. This has facilitated the smoother allocation of foreign currency through the banking system and the interbank market now has a turnover of some US$20m a day. Officials point out that the surrender requirements introduced on the eve of the US-led attack on Iraq (May 2003, Economic policy) have been

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quietly allowed to lapse. If broader confidence in the economy strengthens, prompting an upturn in inflows of direct and portfolio investment as well medium- and long-term debt, and a downturn in the massive capital outflows of recent years, the position of the pound would be further bolstered. However, it remains unclear what exchange rate Egypt now has. Although officials say there is no government interference, the official rate clearly is not floating. It has depreciated extremely steadily since August 2003. The pound fell on the black market (albeit modestly and for short periods) following the reduction of customs duties in September, as demand peaked in the run-up to Ramadan, and in the wake of the Sinai bombings in October, but there was little impact on the official rate. It is therefore unclear how the authorities would react to any serious foreign-currency shock (such as an attack on tourists in mainland Egypt). The authorities would most likely choose to support the rate with Egypt’s foreign reserves and, possibly, raise interest rates further. However, the authorities could also allow the official rate of the pound to fall. If the authorities chose neither to support the pound nor to allow it to fall, the differential between the official and black-market rates would widen once more, undermining confidence once again in the convertibility of the pound.

The domestic economy

Survey sees economy The latest semi-annual Business Barometer, a qualitative survey of 165 expanding in first half of 2004 manufacturing firms, 35 construction companies and ten tourist firms carried out by the Egyptian Centre for Economic Studies (ECES), indicates that there was an upturn in economic growth in January-June 2004. Of the firms surveyed, 76% reported no change or an increase in production during the first half of 2004, up from 69% in July-December 2003. The upturn was led by rising external demand, with 79% of firms reporting higher or stable levels of exports. ECES attributes this to exchange-rate competitiveness and favourable conditions abroad (as growth strengthened in the US and Europe). Some 72% of firms also reported higher or constant domestic sales. Companies in the tourism sector reported the greatest improvement, again a result of external demand. However, there were indications that domestic demand has also strengthened. The findings were more positive regarding employment too. The survey found that 77% of firms reported higher or stable levels of employment compared with 72% in the previous survey. However, there was no significant pick-up in investment. Of those sampled, 50% reported no change in the level of investment during the first six months of 2004 and the rest were divided evenly between those reporting an increase in investment and those reporting a decrease. Access to finance was cited as the most serious constraint on operations, followed by access to imports, limited market demand and skills shortages. This is the same ranking of constraints as in the previous survey. The survey does not quantify how serious each constraint is.

Survey sees growth rising in The companies surveyed were optimistic about the prospects for growth in July-December 2004 July-December 2004!a trend that policymakers will welcome given that the

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survey took place before the appointment of the new government, a development that is likely to have caused confidence to strengthen further. Of those asked, 91% said that they planned to increase or maintain the same level of production, 85% expected exports to grow or remain stable and 90% believed domestic sales would increase or be unchanged. As a result, 82% expected to increase or maintain the same level of employment. However, there was no indication that investment was likely to strengthen, indicating that confidence, at this stage, remains fragile. Indeed, ECES states that the economy continued to operate below full potential and that “it will take a major wave of new reforms to put the economy on a sufficiently higher growth path to create enough jobs for the rapidly growing labour force”.

Survey points to an easing in The survey points to an easing in inflation in July-December 2004. Of the inflation companies surveyed, 38% expected higher final product prices, compared with 56% who assessed that prices had risen in January-June. Most firms thought that no change in final product prices (52%) was likely in July-December, up from 36% who believed that prices had remained stable in January-June. Expectations of higher input prices eased more markedly, with 66% of the companies surveyed stating that they expected input inflation in July- December, down from an overwhelming 98% who assessed that input prices had risen in January-June. Some 20% of the firms expected input prices to be unchanged and 14% thought they would fall!none assessed that input prices had fallen in January-June.

Inflation eases in May-July Data published by both the IMF in its International Financial Statistics and the Central Bank of Egypt (CBE) underscore the assessment that inflation is easing. Although year-on-year consumer price inflation rose to 11.9% in July, from 10.4% in March and 5.8% at end-2004, the spike is largely attributable to sharp rises in the consumer price index (CPI) from January to April (inclusive), during which period the index rose by a substantial 7.5%!just over 22% on an annualised basis. From May to July (inclusive) the index has risen by a mere 0.9% (3.6% on an annualised basis). The trend with regard to wholesale prices is even more marked. The wholesale price index (WPI) rose by 12.3% between January and April (inclusive), equivalent to a huge 36.8% on an annualised basis. The WPI has since then witnessed deflation, falling in May and June before rising, albeit marginally, once more in July. The downturn appears to indicate that price rises associated with the 25% depreciation of the Egyptian pound between January and August 2003!following the failed flotation of the currency!have begun to pass through the economy.

Inflation: IMF data 2003 2004 Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Consumer price index 109.8 110.6 111.3 112.1 112.7 114.9 117.3 119.2 121.1 121.2 121.3 122.2 % change, year on year 4.4 4.6 5.2 5.6 5.8 7.4 9.3 10.4 11.6 11.3 11.2 11.9 Wholesale price index 125.6 124.7 128.4 129.3 130.5 137.5 138.9 141.4 146.5 145.4 142.6 142.8 % change, year on year 13.9 11.8 16.8 15.9 16.1 21.7 21.7 21.2 21.5 16.8 15.9 14.4

Source: IMF, International Financial Statistics.

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Data from the CBE and the Ministry of Foreign Trade and Industry reveal a similar trend. Year-on-year rates are unavailable following the decision of the Central Agency for Public Mobilisation and Statistics to rebase and reweight the CPI (August 2004, The domestic economy: Economic trends). However, following a sharp rise in consumer price inflation in January-April, the index has risen far more slowly. Year-on-year WPI inflation has fallen!closer analysis of WPI inflation is problematic as no index values are presented.

Inflation: national data 2003 2004 Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Consumer price index 134.1 134.9 135.2 136.1 122.1 124.6 126.7 128.7 128.8 128.9 129.9 % change, year on year) 4.7 5.2 5.1 5.5 ------Wholesale price index (% change, year on year) 11.8 16.9 15.9 16.1 21.7 21.6 21.1 21.4 16.8 15.9 14.4

Source: Central Bank of Egypt; Ministry of Foreign Trade and Industry.

Private sector’s share of credit The private sector’s share of outstanding domestic borrowing dwindled to falls below 50% beneath 50% in July for the first time in recent years. The declining share of lending to the private sector is a long-standing trend caused in part by crowding out by central government as the fiscal deficit has widened, although inflation, low domestic demand and a high-profile governmental clampdown on abuse of power in the banking sector have also played a part. Credit extended to the private sector rose by a mere 1.4% between January and July. Credit extended to the central government, in contrast, rose by 10.2% over the same period, raising its share of outstanding lending to 37.7%, up from 35.9% at end-2003. Lending to non-financial public enterprises has bucked recent trends, rising by 6.7% in January-July and lifting its share of lending, albeit marginally, to 11.1%.

Domestic credit (E£ m unless otherwise indicated) 1999 2000 2001 2002 2003 2004 Dec Dec Dec Dec Dec Mar Jun Jul Total domestic credit 278,013 309,006 342,342 387,126 438,479 449,974 454,504 460,546 % change, quarter on quarter n/a n/a n/a n/a n/a 2.6 1.0 2.1 To private sector 159,958 176,693 197,038 207,089 225,023 227,209 229,834 228,138 % change, quarter on quarter n/a n/a n/a n/a n/a 1.0 1.2 -0.6 % of total 57.5 57.2 57.6 53.5 51.3 50.5 50.6 49.5 To central government 68,623 86,720 94,091 127,216 157,489 166,563 167,137 173,498 % change, quarter on quarter n/a n/a n/a n/a n/a 5.8 0.3 5.3 % of total 24.7 28.1 27.5 32.9 35.9 37.0 36.8 37.7 To non-financial public enterprises 43,138 39,318 43,393 44,316 47,999 48,674 50,179 51,200 % change, quarter on quarter n/a n/a n/a n/a n/a 1.4 3.1 4.0 % of total 15.5 12.7 12.7 11.4 10.9 10.8 11.0 11.1

Source: IMF, International Financial Statistics.

Money supply growth Money supply growth has continued to slow. Year-on-year expansion of M2 fell continues to ease to 13.6% in July, from 15.2% in March and above 20% for much of the second half of 2003. Overall money supply growth has been dragged down by slower growth in quasi-money (time and savings deposits). Quasi-money expansion rose year on year by 12.2% in July down from 14.3% in March and an average of 24.3% in the second half of 2003. Growth of quasi-money in 2003 had been

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driven by the rise in the value of foreign-currency deposits measured in local- currency terms as the Egyptian pound depreciated sharply. However, the impact of this has almost passed through!the official rate of the pound has barely depreciated since August 2003. M1 (money outside banks and in demand deposits) has continued to rise more rapidly!by 18% year on year in July. However, M1 growth has also slowed!it averaged 24.7% in the second half of 2003, as the value of foreign-currency demand deposits was also lifted by the fall of the pound. The widening discrepancy between M1 and M2 growth rates probably reflects the rates on offer on savings instruments in the banking system. These would have been negative in real terms, according to IMF inflation data.

Money supply (E£ m unless otherwise indicated) 2003 2004 Mar Jun Sep Dec Mar Jun Jul M1 81,104 85,970 91,268 93,520 95,955 100,620 104,709 % change, year on year 17.0 16.9 24.2 23.4 18.3 17.0 18.0 M2 357,819 375,979 392,386 403,634 412,299 428,205 434,853 % change, year on year 18.4 18.3 27.3 21.3 15.2 13.9 13.6 Foreign-currency deposits 129,032 138,054 145,042 148,652 152,973 157,469 159,412 % of total 36.1 36.7 37.0 36.8 37.1 36.8 36.7 Egyptian pound liquidity 228,787 237,925 247,344 254,982 259,326 270,736 275,441 % change, year on year 9.3 7.2 14.1 8.9 13.3 13.8 14.9

Source: IMF, International Financial Statistics.

Oil and gas

Egyptian LNG exports to begin Egypt’s first exports of liquefied natural gas (LNG), from the Spanish Egyptian in December Gas Company’s (SEGAS) Damietta plant, should begin in mid-December, Union Fenosa, the Spanish power giant, announced in early October. Union Fenosa Gas (UFG; equally owned by Union Fenosa and Eni of Italy) has an 80% shareholding in the US$1.3bn Damietta plant, which with a capacity of 5m tonnes/year (t/y) will be the world’s largest LNG train. The remaining 20% is held by the Egyptian government via Egyptian General Petroleum Corporation (EGPC) and the Egyptian Gas Holding Company (EGAS). UFG is contracted to purchase 60% of the plant’s capacity over a 20-year period. Its share will be shipped to Spain mainly for use in Union Fenosa’s power plants. EGAS has committed to sell the remaining 40% of output. Meanwhile, BG Group of the UK announced in late September that together with its upstream partners EGPC and Petronas of Malaysia it will toll gas for export through the SEGAS plant, starting in the first quarter of 2005. BG said that it would toll around 225m of standard cu ft/day of gas through the plant for the first four years of a five-year contract and about 150m of standard cu ft/day in the final year. The gas will come from the BG-operated Scarab Saffron fields in the West Delta Deep Marine concession, offshore in the Nile Delta. The agreement will see BG purchase about 0.7m t/y of LNG produced by the plant.

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ELNG due to start exporting in Egypt’s second LNG plant, Egyptian LNG (ELNG)!a consortium comprising BG the third quarter of 2005 Group, Petronas, EGPC, EGAS and Gaz de France!is due to start exports from its Idku plant in the third quarter of 2005. The entire output of the first train (3.6m t/y) has been sold to Gaz de France. BG Gas Marketing is to take all the 3.6m t/y output from the second train and is expected to send the LNG to the US starting in 2006 and to Italy a year later. The European Investment Bank said in mid- October that it was about to finalise a US$280m loan for the second train, having provided US$372m in finance for the first phase.

Egypt’s output falls below The start of LNG exports is coming at a time when the rate of decline of Egypt’s 600,000 b/d crude oil output appears to be on the increase. Average oil production for the first three quarters of 2004 fell to just under 596,000 barrels/day (b/d), the Cyprus-based Middle East Economic Survey reported, down by almost 23,000 b/d compared with the 2003 average of 619,000 b/d. The declines in the previous two years were around 10,000 b/d. Oil output has fallen steadily from a high of 878,685 b/d in 1995. Gas and condensate production, in contrast, has risen steadily!although output of the latter fell in January-September compared with the 2003 average.

Hydrocarbons production 2004 2000 2001 2002 2003 1 Qtr 2 Qtr 3 Qtr Oil output (barrels/day) 700,000 639,478 628,153 618,589 600,364 588,456 598,448 Gas output (bn cu ft/day) 2.04 3.00 2.98 3.33 3.48 3.47 3.72 Gas sales (bn cu ft/day) n/a 2.38 2.58 2.90 3.08 3.06 3.32 Condensate output (barrels/day) 68,330 80,185 87,402 94,084 87,553 84,429 74,348 Liquid petroleum gas output (barrels/day) 35,110 38,735 35,570 36,998 37,735 33,184 33,384

Sources: Middle East Economic Survey; Egyptian General Petroleum Corporation; Economist Intelligence Unit.

Globeleq buys Sidi Kreir An emerging markets power company, Globeleq, owned by the UK-based CDC power station Group, announced in mid-September that it has agreed to purchase InterGen’s majority stake in Egypt’s first build-own-operate-transfer (BOOT) power plant established on the north coast at Sidi Kreir. The sale comes in the context of a drive to sell InterGen’s assets worldwide by the majority shareholder, Shell. A US construction firm, Bechtel, owns the remaining stake in InterGen. Shell is seeking to raise cash from the sale to invest in its core activities following the recent downgrading of its global oil reserves by nearly 25%. The Egyptian government purchases electricity produced by the Sidi Kreir plant!and two other plants set up under similar BOOT contracts!in dollars. This has become problematic as the Egyptian pound has depreciated, since the Egyptian government is reluctant to raise local electricity tariffs to compensate.

Financial and other services

Sinai attacks likely to have a The October 8th bomb attacks on tourist facilities in Sinai that killed 34 people limited impact on tourism seem unlikely to cause a major downturn in tourism, Egypt’s most important industry, despite the global profile the incidents were given. The attacks on the Hilton Hotel in Taba near Egypt’s border with Israel and at two resorts further south on the east Sinai coast marked the first such incidents since the massacre

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of 58 foreign tourists at Luxor in November 1997. The Luxor attack had a severe impact on the industry, prompting mass cancellations followed by a downturn in bookings. However, unlike the 1997 attack, which prompted a slew of travel warnings, Israel was the only country to advise against travel to Egypt after the Sinai bombings. The otherwise more muted response seems largely attributable to the fact that the attacks do not appear to have been indiscriminate, but rather seem to have targeted Israelis!who numbered 13 of the dead. The Egyptian authorities’ claims that the attacks were prompted by Israeli policies towards the Palestinians and that the operations had no international involvement have also served to limit the potential impact. Resorts in east Sinai, which are highly dependent on the Israeli market, have suffered a major downturn and may see low occupancy over the coming year. Israeli visitors account for a not insignificant 5% of the total arriving in Egypt each year. This may delay the 36 tourism projects under construction in the area. However, in early November the deputy tourism minister, Ahmed al- Khadem, said that tourism inflows had fallen by only 5% nationwide since the Sinai attacks. The absence of travel warnings may have mitigated the impact as this prevents those who cancel from claiming on insurance. It is possible therefore that there may be a more substantial effect on future bookings. However, the initial muted reaction indicates that the industry will not be severely affected.

April-July tourist arrivals The latest data!which predate the Sinai attacks!indicate that tourism has reach 4.5m continued to boom. Visitors in the second quarter of 2004 grew to 1.9m, and the total for the first seven months rose to 4.5m, up from 2.9m over the same period last year, according to data published by the CBE. The rise is partly explained by the impact of the US-led invasion of Iraq launched in March 2003, which raised concerns over security and deterred tourists during the first half of last year. Nonetheless, the growth is still substantial, pointing to 7.7m arrivals on an annualised basis, which would far surpass the 6m arrivals in 2003, itself a record.

Tourism 2003 2004 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Jul Number of visitors (‘000) 1,184 1,063 1,939 1,857 1,803 1,911 793 Receipts (US$ m) 813 909 1,633 1,229 1,292 1,321 n/a Receipts/tourist (US$) 687 855 842 662 717 691 n/a

Sources: Ministry of Foreign Trade; Central Bank of Egypt; Ministry of Tourism.

Egypt aims for 12m tourists The rapid growth of the industry would seem to indicate that a newly unveiled by 2014 government target of 12m arrivals within ten years is realistic. The target was announced by the presidential spokesman, Maged Abdel Fattah, in late September following a ministerial meeting on tourism and civil aviation chaired by the president, Hosni Mubarak. To reach this target would require annual growth of 7.2%. This is not beyond past trends!from 1998 to 2003 the number of arrivals grew by an average 8.9% a year. However, the expansion in nominal terms!a doubling of the arrivals recorded in 2003!is substantial. Moreover, the performance of the sector has been highly erratic. Arrivals fell by

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13% in 1998 and by 16% in 2001, largely as a result of the Luxor and the September 11th attacks respectively. Arrivals rose by almost 40% in 1999 as the industry recovered strongly from the Luxor attack.

Tourism arrivals 1998 1999 2000 2001 2002 2003 Arrivals (‘000) 3,454 4,797 5,506 4,648 5,193 6,044 Growth rate (%) -12.8 38.9 14.8 -15.6 11.7 16.4

Source: Ministry of Foreign Trade and Industry.

Mr Abdel Fattah outlined a number of initiatives to facilitate the attainment of the target. These included broadening private-sector management in the sector (presumably via privatisation of state-owned tourism companies) and modernising travel-related infrastructure and services. He named broader goals as the elimination of bureaucratic constraints and improving the training of employees in the sector. He said that the Supreme Council for Tourism will be revived to play a co-ordinating role between the government and the mainly privately run industry. These areas have long been identified as among those central to unlocking Egypt’s potential as a tourism destination!the key will be the extent to which the pronouncements are followed through on. Mr Abdel Fattah has named another key initiative as the development of new tourism destinations, in particular the Mediterranean coast. This coastline has so far catered largely to the local market and has only operated in the summer season. Encouraging the development of the coast, which would in turn open up the remote Siwa Oasis in the Western Desert, has been a major focus for the new tourism minister, Ahmed al-Maghrabi. Mr Maghrabi, who has set a target of 10,000 hotel rooms to be built in the area within seven years, announced the first major tourism project on the north coast in mid-September. The E£500m (US$80m) development at Marsa Matrouh, 290 km west of Alexandria, involves the construction, over five years, of nine four-star hotels with around 4,300 rooms. Investors include the German travel giant, TUI, and the local Travco Group. Egypt currently has over 142,000 hotel rooms and another 100,000 under construction, the vast majority of the latter in Red Sea resorts.

New government postpones Meanwhile, the dispute between the tourism companies and the government rise in tourism sales taxes over a sudden hike in sales tax has abated. The government of the previous prime minister, Atef Obeid, announced in May that sales tax would rise to 10% from 5% on hotel, restaurant and tourist transportation charges with immediate effect (August 2004, The domestic economy: Financial and other services). The rise would have damaged the sector’s profitability, companies argued, since they could not pass the charge on to consumers as rates charged to international operators were fixed until the next negotiating round in October. The new government decided to suspend the enforcement of the increase until end-October.

Orascom Telecom buys In early September Orascom Telecom (OT) announced its acquisition of a Bangladeshi mobile operator Bangladeshi mobile-phone company, Sheba Telecom, for US$50m in cash and US$10m in debt. OT said that it intends to invest US$250m in Sheba over the coming few years to expand the network from its current subscriber base of

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60,000. OT, which is 57% owned by the Sawiris family, is arguably Egypt’s most high-profile company with operations in ten countries in the Middle East and Africa and more than 8m mobile-phone subscribers.

New bond sales reflect In a sign of improving monetary conditions, three companies have revealed improved monetary conditions plans to sell Egyptian pound-denominated corporate bonds. In mid August OT announced plans to raise about E£1.6bn (US$258m) through the sale of a seven- year bond in two tranches: the first tranche, of E£700m, will be priced at 2.5 percentage points above the CBE discount rate; the second tranche, denominated in US dollars, will raise US$150m and will be priced at 2.25 percentage points above Libor. The sale will be underwritten by three of the four dominant state-owned commercial banks: National Bank of Egypt, Banque Misr and Bank of Alexandria. OT said that the bond will be used to repay bank debt and to “strengthen [OT’s] financial flexibility”. Telecom Egypt, the state-owned fixed-line telecommunications monopoly, announced in mid- August that it is to sell Egypt’s largest corporate bond, raising E£2bn. The bond will be in two tranches, one carrying a floating rate, the other a fixed rate, and will have a maturity of between five and seven years. Meanwhile, Amoun Pharmaceuticals, a local privately owned pharmaceutical company, has revealed plans to sell bonds worth E£150m. Sales of Egyptian pound-denominated bonds (already scarce) had essentially been put on hold as monetary conditions deteriorated in 2003. The weakening of the Egyptian pound!in particular its 25% fall against the US dollar in the first eight months of 2003!was a strong deterrent to the purchase of new issues of local-currency-denominated bonds. Uncertainty over the outlook for the currency also complicated issuers’ efforts to settle on pricing!particularly given that supposed government benchmark interest rates proved unresponsive to the fall of the pound. The strengthening of confidence in the official rate of the Egyptian pound during 2004!as signalled by the steady narrowing of the differential between the official and black-market exchange rates!has eased concerns. Besides this, the CBE’s efforts to overhaul the monetary policy framework has seen benchmark government interest rates rising to better reflect market conditions!rates at auctions of three- and six-month T-bill rates have risen from 6.8% in January (offering a negative real return) to 11% in September, and one-year bills offered returns of above 12% in September. OT’s decision to fix its bond against the discount rate is therefore somewhat surprising. The discount rate currently stands at 10%, implying a return of 12.5% on OT’s bonds!barely above the return currently offered on shorter-term government paper. Moreover, the discount rate remains highly inflexible!it stood at 12% in 1998-2000, fell to 11% in 2001 and has stood at 10% since!and essentially plays little role in government monetary policy.

Stockmarket surges upwards The Cairo and Alexandria Stock Exchange has continued to surge upwards, reaching new highs, driven largely by optimism over the prospects for the economy under the new government. Having risen more than 9% in August, the benchmark Hermes Financial Index (HFI), comprising the most actively traded stocks, rose 15.5% in September, 7.7% in October and 5.2% between November 1st and November 11th. The latest rises in the index bring the upturn

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in the HFI to November 11th to more than 90%!despite a period between start- May and end-July when the index showed no net gain. Notably, the bombings of tourism facilities in Sinai on October 8th caused only a one-day (albeit 4%) decline in the index.

Hermes Index 24,000 22,000 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov 2003 04 Source: Bloomberg.

Foreign trade and payments

Current-account surplus The current-account surplus widened in April-June 2004 because of a widens in April-June strengthening of the non-merchandise surplus. Export revenue rose for the third successive quarter. Non-oil export earnings grew strongly once more, rising to almost US$2bn, a trend that policymakers will welcome!particularly given the strengthening of the US dollar during this period (against which the Egyptian currency has been closely fixed). The increase in non-oil receipts was sufficient to offset a decline in oil revenue, which occurred despite a rise in average prices over the period. The rise in exports was more than offset by strong growth in import spending, however, the fifth successive upturn. Import costs rose to US$5.2bn and on an annualised basis (the Economist Intelligence Unit’s external data are for calendar years) imports look set to approach US$20bn, a 33% increase on 2003 and a total that exceeds the previous high of US$17.6bn registered in 2000 by a considerable margin. As a result, the trade deficit widened for the fifth successive quarter. The wider trade deficit was more than offset by rises in the services and income surplus and the transfers surplus. The widening of the services surplus was driven by an increase in tourism and Suez Canal revenue and a decline in services payments!in spite of the growth in merchandise imports. The transfers surplus widened markedly. Workers’ remittances rose because of the strengthening of economic activity in oil-rich Arab states brought about by rapidly rising oil receipts and because of the improvement in foreign-exchange liquidity in Egypt since the appointment of the Central Bank of Egypt governor, Farouk al-Okdah, in late 2003, which is likely to have eased concerns about repatriating funds through formal channels. Official transfers also rose, following the release in June by the US Congress of a one-off aid payment of US$300m approved in 2003 to compensate Egypt for the negative economic

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impact of the Iraq war. Overall, the current-account surplus rose to US$1bn from US$531m the previous quarter.

Quarterly current account (US$ m unless otherwise indicated; fiscal years ending Jun 30th) 2002/03 2003/04 2002/03 Apr-Jun Jul-Sep Sep-Dec Jan-Mar Apr-Jun Full year Full year % change Trade balancea -1,279 -1,627 -1,835 -1,941 -2,122 -7,525 -6,615 13.8 Export proceeds 2,300 2,227 2,287 2,890 3,046 10,450 8,205 27.4 Oil 881 827 875 1,149 1,060 3,910 3,161 23.7 Non-oil 1,419 1,400 1,412 1,741 1,989 6,542 5,045 29.7 Import payments -3,579 -3,854 -4,122 -4,831 -5,168 -17,975 -14,820 21.3 Oil -675 -490 -646 -629 -805 -2,571 -2,313 11.1 Non-oil -2,904 -3,364 -3,476 -4,202 -4,364 -15,405 -12,507 23.2 Services and income (net) 1,427 2,287 1,550 1,543 1,939 7,318 4,949 47.9 Services and income receipts 2,694 3,541 2,963 3,126 3,352 12,981 10,441 24.3 Suez Canal dues 639 682 692 727 748 2,849 2,236 27.4 Travel 909 1,633 1,229 1,293 1,321 5,476 3,796 44.2 Services and income payments 1,267 1,254 1,413 1,583 1,413 5,663 5,493 3.1 Transfers (net) 1,024 855 936 930 1,213 3,935 3,609 9.0 Official net 254 133 185 178 392 888 664 33.8 Private net 771 723 752 752 820 3,046 2,946 3.4 Current-account balancea 1,172 1,516 652 531 1,031 3,729 1,943 91.9 a May not sum because of rounding. Source: Central Bank of Egypt.

These trends are largely replicated in the current-account surplus over the full fiscal year (July 1st 2003-June 30th 2004), which widened to US$3.7bn (equivalent to 5.1% of our estimate of nominal GDP) from US$1.9bn in fiscal 2003. Export revenue rose strongly to US$10.5bn. The growth is in part attributable to the strengthening in average global oil prices over the period. However, non-oil exports rose even more markedly, by close to 30%. To a large degree this is a result of the depreciation of the US dollar against which the Egyptian pound has been in effect fixed, which raised the competitiveness of Egyptian goods (compounding the impact of a 25% depreciation of the Egyptian pound in 2003) and boosted export revenue when expressed in dollar terms. Imports grew even more strongly over the year in nominal terms to US$18bn as foreign-exchange liquidity improved, domestic demand tentatively strengthened and the US dollar fell, raising imports when expressed in dollar terms. As a result, the trade deficit widened to US$7.5bn from US$6.6bn. This was more than offset by rises in the non-merchandise surpluses, in particular the services and income account, which rose by close to 50% to US$7.3bn, driven by the extremely strong growth in tourism earnings.

Egypt registers a wide capital- Trends in the capital account have continued to more than offset the current- account deficit in April-June account surplus. The capital account registered another substantial deficit in April-June, of US$1.4bn, little changed on the previous quarter. Inward direct investment rose to US$223m, although the gain was offset to some degree by an unusually large flow of direct investment abroad. Inward portfolio investment showed a relatively strong net outflow. Net borrowing picked up somewhat. However, in line with long-standing trends, the capital account was thrown

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sharply into deficit by a strong deterioration in Egypt’s “other assets” position. These reflect capital outflows through the banking system and elsewhere that are not captured under other definitions. Other asset outflows stood at US$1.3bn. Outflows of “other liabilities” came to US$150m. The overall balance of payments registered a surplus, however, because of high positive net errors and omissions.

Quarterly capital account (US$ m; fiscal years ending Jun 30th) 2002/03 2003/04 2002/03 Apr-Jun Jul-Sep Oct-Dec Jan-Mar Apr-Jun Full year Full year Direct investment abroad -3 -6 -2 -13 -168 -190 -30 Net direct inward investment 123 34 56 95 223 407 701 Portfolio investment abroad -2 -4 -8 -43 -12 -67 -16 Net inward portfolio investment 73 4 -23 19 -225 -226 -405 Net borrowing (incl bonds) -84 12 346 -9 239 588 144 Other assets -1,135 -1,858 -1,190 -1,391 -1,266 -5,705 -3,068 Central Bank -4 -22 -16 4 12 -21 -32 Banks -518 -688 -517 -678 -710 -2,593 -493 Other -614 -1148 -657 -716 -569 -3,090 -2542 Other liabilities 28 -506 -197 -107 -149 -959 -59 Capital-account balancea -1,001 -2,324 -1,020 -1,448 -1,359 -6,152 -2,734 Net errors & omissions 427 664 395 500 705 2,264 1,337 Overall balance of payments 598 -144 27 -417 377 -158 546 Change in reserve assets -598 144 -27 417 -377 158 -546 a May not sum because of rounding. Source: Central Bank of Egypt.

The fourth-quarter shortfall brought the capital-account deficit for the fiscal year to US$6.2bn, equivalent to about 8.6% of our nominal GDP estimate. Direct investment fell to just US$407m (0.6% of estimated GDP), and net inward portfolio investment was negative. Borrowing strengthened to just under US$600m. However, this was dwarfed by the outflows of “other assets” of US$5.7bn and “other liabilities” of just under US$1bn. The overall balance of payments registered a small deficit of about US$160m, compared with a surplus of about US$550m in fiscal 2003. The deficit would have been considerable larger had net errors and omissions not been heavily positive, registering US$2.3bn.

Foreign reserves edge up to As a result of the balance-of-payments surplus for April-June, foreign reserves US$13.6bn edged up by some US$400m to US$13.6bn. Foreign reserves excluding gold at end-2003 were equivalent to almost 11 months of imports. Annualising imports for the first half of calendar 2004, reserves at the end of June would cover just over eight months of imports!a still robust ratio.

Foreign reserves (US$ m) 1998 1999 2000 2001 2002 2003 2004 Dec Dec Dec Dec Dec 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Total reserves excl gold 18,124 14,484 13,118 12,926 13,242 13,603 13,568 13,589 13,176 13,576 Source: IMF, International Financial Statistics.

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