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Country Commercial Guides for FY 2000: Egypt Report prepared by U.S. Embassy Cairo, released July 1999

CHAPTER II. ECONOMIC TRENDS AND OUTLOOK

The Egyptian government can view with satisfaction a number of economic developments over the last ten years. Egypt's positive macroeconomic situation at the end of the decade contrasts positively with the country's circumstances at the beginning of the 1990®s. The accomplishments of the government's reform program include respectable levels of GDP growth and international reserves, as well as sustained fiscal discipline. While not unscathed by the fallout of the financial crises of the last two years, Egypt navigated these upheavals in relatively smooth fashion in comparison with the experiences of developing countries in the Far East and South America. Foreign exchange earnings appear to be on an upward trend in such key sectors as tourism and oil and gas. The GOE reports, for example, that tourist room occupancy was at all time highs in May 1999 (although revenue recovery continues to lag behind the rebound in tourist numbers). Egypt may also benefit in the near and medium terms if oil prices hold and the Far Eastern economic recovery gathers strength, developments that could benefit Egypt in terms of increased Suez Canal receipts, worker remittances, and exports.

Egypt must deal with a number of challenges if it is to fully capitalize on these accomplishments and positive trends. Continued structural reforms remain critical to the government achieving its long-term objective of export-driven, private sector-led sustainable annual GDP growth of 7-8%. For example, renewed momentum in Egypt's privatization program, particularly in key areas such as insurance, banking, and telecommunications, could provide an important boost to investor interest and the economy. Companies also continue to cite the need for Egypt to improve the business climate by cutting transaction costs and reducing bureaucracy and red tape, among other measures. Egypt's key sources of foreign exchange (tourism, petroleum exports, Suez Canal receipts and worker remittances) remain vulnerable to external shocks and export growth is lagging, points which underscore the need to diversify the economy. Egyptian policy makers will need to consider how to address monetary and balance of payment issues in ways which impact less on investor confidence. Several trade-related decrees over the past year, for example, generated concern in the business community regarding the GOE's commitment to continuing economic reform. The Central Bank's use of foreign exchange rationing and other measures to control the outflow of foreign exchange disrupted business and sent a confusing policy message to local and international investors. These and other pressures led financial observers to question whether the Government could maintain simultaneously its current Egyptian pound/dollar exchange rate policy and domestic interest rates at their current levels.

The Government is aiming at a GDP growth rate of 6-7% in FY 1999/2000 (year ending June 30). Many analysts view this rate as overly ambitious, anticipating growth in the 5-6% range. Nonetheless, the GOE's growth target demonstrates the priority it attaches to providing opportunities for the approximately 550,000 annual new entrants to the job market, a key objective in a country with a population growth rate of around 1.9%. The construction, transportation, and industrial sectors will be the primary engines of economic growth. The Government remains committed to a set of macroeconomic policies that in recent years has achieved significant success. Its fiscal discipline is reflected in a 1998/99 budget that kept the government deficit to around $1.2 billion, equivalent to 1.3% of GDP. The GOE anticipates holding the deficit to a similar level in FY 1999/2000. The inflation rate in FY 1998/99 will likely average around 3.8%, the level recorded for the prior year and anticipated for FY 1999/2000.

The Government took several steps in FY 1998/99 to advance its reform agenda. Laws were passed, for example, laying the basis for expanded participation by the private sector and foreign investors in the banking and insurance sectors. In 1999, the Government passed a new Commercial Law, consisting of 700 articles arranged in five chapters, to effect a broad modernization of the legal environment for business. Legislation is pending to expand the application of Egypt' sales tax, an important measure for strengthening the Government's fiscal base. The GOE also instituted another round of tariff cuts. There remains, however, an extensive list of reforms yet to be undertaken. U.S. businesses look for a strengthening of Intellectual Property Rights protection in terms of increased enforcement, as well as the passage of a new patent law. Passage of a new labor law granting employers the right to dismiss employees and workers the limited right to strike has been pending for several years and may be on the People's Assembly agenda in late 1999 or early 2000. A range of hurdles hinders U.S. agricultural exports and firms are concerned by decrees setting new requirements for imports of consumer goods and automobiles. Companies continue to cite red tape, bureaucracy, and a changing and opaque regulatory environment as impediments. Senior Egyptian leaders continue to stress the Government's determination to press forward with economic reform while assuring that the social needs of the Egyptian people are met. The World Trade Organization (WTO) disciplines coming into play between 2000 and 2005 will also provide an impetus for reform.

PRINCIPAL GROWTH SECTORS

Services: Tourism and the Suez Canal dominate Egypt's services sector which accounts for 32.1% of GDP and 34.7% of total exports of goods and services. Tourism is Egypt's top foreign exchange earner. Tourism revenues in FY 1997/98 were $2.9 billion. While revenues were down 19% compared with the previous year as a result of two high-profile terrorist attacks in 1997, the tourism sector has been on the upswing since mid-1998.

Suez Canal revenues dropped by 4% to $1.77 billion in 1997/98, continuing the downward trend of the previous year. Competition from alternative routes, oil pipelines, a decrease in the number of car transports, and the effect of the East Asian economic downturn are among the factors squeezing canal revenues. To encourage the use of the waterway, the Suez Canal Authority has experimented with new pricing policies and has plans to deepen the canal to accommodate super tankers.

Energy: The oil and gas sector accounted for about 6.7% of Egypt's GDP and 33.7% of merchandise exports in FY 97/98. Reflecting the global downturn in petroleum prices, the value of exports of petroleum and related products fell to $1.7 billion in FY 1997/98, down from $2.6 billion the previous year. On the positive side, oil prices have firmed in 1999. In addition, over the last five years Egypt's improved concession rates have drawn multinationals into exploration for oil and gas. The most significant developments have been in the gas sector, with promising finds made in the offshore Nile Delta region. Companies have made large investments in these fields, encouraged by attractive Egyptian purchase prices indexed to Gulf of Suez crude. Domestic gas use has grown with the construction of a 3,000-km gas distribution network reaching most major electrical plants. Egyptian gas consumption is expected to reach 59.2 billion cubic feet per day in the year 2000. New discoveries should lead to an exportable surplus of gas by early 2000.

Agriculture: Agriculture remains one of Egypt's most important sectors. However, the sector's contribution to GDP has gradually fallen from 20% in FY 86/87 to 17.3% in FY 98/99. The number of Egyptians employed in the agricultural sector has also fallen, from 33.8% of the total labor force in FY 90/91 to around 29.5% at present. Despite productivity gains since the mid-1980s, Egypt remains one of the world's largest food importers.

Construction on the Toshka Canal project began in October 1996 in the area bordering Lake Nasser, north of Abu Simbel. The project aims to double the size of Egypt's arable land in fifteen years' time. The project's estimated cost is $88.5 billion with the government committed to providing $5 billion in major infrastructure work and the balance of funding expected to come from the private sector. Government incentives for investment in Toshka-related areas include tax exemptions, customs exemptions, and low land prices. Economic and environmental impacts remain under study.

Industry: Egypt's industrial and mining sectors account for 18.6% of GDP and 13.4% of employment. As a result of the government's privatization program, the private sector's role has steadily expanded in key sectors, such as metals (aluminum, iron, and steel), petrochemicals, cement, automobiles, textiles, consumer electronics, and pharmaceuticals. The government has made development of high technology a priority, and seeks to attract export-oriented manufacturing firms. Tax and other incentives are generous for such enterprises.

Infrastructure Projects: The role of private investment in key infrastructure areas has increased significantly over the last year. The Government has announced that all future power generation projects will be constructed on a build-own-operate-transfer (BOOT) basis with the implied suggestion that over time the "transfer" requirement could drop out of the BOOT equation. Three BOOT power generation awards have been made to date, with one going to a joint venture with Bechtel as the U.S. partner. The government has sold cellular phone concessions to private firms and has opened new airports, ports, and port services to private investors. The Government's increasing receptivity to private investment in infrastructure will provide expanded opportunities for U.S. firms.

KEY ECONOMIC TRENDS AND ISSUES

Solid Macroeconomic Performance: Since 1991 Egypt has followed a successful course of macroeconomic stabilization. The Government's program has yielded positive growth rates (averaging 4-5% in recent years) low inflation, large foreign currency reserves (around $18.8 billion as of June 1999 or about 13 months of import coverage) and a stable currency. These developments helped Egypt receive investment grade debt ratings in 1997, which it will likely retain through 1999 notwithstanding the global financial crises, as shown by Moody's February 1999 upgrading of Egypt's sovereign rating from the speculative grade of Ba-1 to the investment grade of Baa-1.

Continuing Budget Discipline: In line with recent policies, the Government submitted a FY 99/2000 budget that holds the deficit to around 1% of GDP. The draft budget calls for new spending of LE 34.5 billion to be focused on social services to help ensure that economic reform policies do not adversely affect lower income groups. Indications that the deficit could increase to as much as 1.3% of GDP are a source of some concern. Moreover, donor nations have expressed concern that the Government should do more to ensure that all Egyptians share the benefits of economic reform. Certain aspects of the budget, such as defense spending, are not transparent.

Balance of Payments: According to the Central Bank of Egypt, the country's balance of payments turned negative in FY 1997/98. This was due primarily to a deteriorating current account, which registered a $2.8 billion deficit in FY 97/98, a significant negative turn from the previous year's surplus of $118.6 million. Egypt's merchandise trade deficit contributed to this trend, registering $11.8 billion in FY 97/98. Preliminary data for FY 1998/99 suggest that Egypt's trade deficit is continuing to grow. As of the end of March 1999, the trade deficit stood at around $9.3 billion, ahead of the figure of $8.6 billion at the same time last year. Concern about the direction of the Balance of Payments and the squeeze on foreign exchange earnings may have played a role in the Government's decision to implement trade-restricting decrees in 1998, including a measure requiring that consumer goods be imported directly from the country of origin. Investors will look to the Egyptian Government, as it manages these difficult issues, to devise strategies, which do not disrupt the trade and business environments.

Boosting Savings and Investment Rates: Structural reform will play a critical role in Egypt's effort to increase its private savings and investment rates to the levels needed to fuel economic growth. Egypt's projected 1998/99 savings rate (16.2% of GDP) and investment rate (19.2% of GDP) are well behind other emerging markets, as are levels of foreign direct investment (FDI) and portfolio investment. The stock of non-petroleum foreign direct investment grew to $6.7 billion in 1998, up from $6.5 billion in 1997, according to the Egyptian government's General Authority for Investment and Free Zones (GAFI). These figures indicate that FDI flows in 1997/98 totaled around $245 million. GAFI statistics put the stock of non-petroleum U.S. investment in Egypt in 1997/98 at $543 million, down from $707 million the prior year. According to the U.S. Department of Commerce, the stock of American investment in Egypt (including the petroleum sector) totaled $2 billion as of end-1998. Official Egyptian statistics indicate that the United States topped the list of non-Arab investing countries in 1997/98, contributing 16% of FDI.

STRUCTURAL ADJUSTMENT AND PRIVATIZATION: KEYS TO GROWTH

The Government is working to translate macroeconomic stabilization into private sector-led, export-oriented sustainable GDP growth rate of 7-8%. It is a critical goal in a country with 1.9% annual population growth, an annual 3.2% increase in the labor force, and significant unemployment (8.2% by official estimates though unofficial estimates by some observers range as high as 25%). The flagship effort of this process is Egypt's privatization program. Through this program, the Government seeks to reduce the size of the civil service, expand the share of private sector activity in the economy, and boost Egypt's investment and savings rates. The programs include plans for the privatization of one of the four public sector banks as well as one of the three public sector insurance companies, although timing for these actions is unclear.

The Government has made significant progress, privatizing 125 of 314 target companies as of March 1999. To speed the sale of more marginal state-owned firms, the Government plans to turn increasingly to anchor investors. Problems related to the valuation of state-owned companies have hindered such efforts in the past. The Government has the ambitious goal of completing privatization of all public enterprises by 2002.

The Government launched additional structural reform efforts on several fronts the last year. It expanded the role of foreign and domestic private firms in key areas previously reserved for the public sector by selling concessions for cellular telephone systems and opening the power sector to BOOT investment. The Government built on earlier efforts to rationalize and modernize Egypt's legal and regulatory environment, with the Parliament passing laws to streamline procedures for establishing companies, permit the privatization of public sector banks and insurance companies, strengthen the rules on government procurement and open port facilities and services to private investors. The lessons of the East Asian financial crisis have not been lost on the Egyptian leadership. For example, increased emphasis is being placed on implementing international accounting and reporting practices for banks and firms listed on the Cairo Stock Exchange. USAID is funding a major capital markets modernization program and programs to strengthen the regulatory environment for business. USAID is also engaged in efforts to assist the GOE in improving its enforcement of Intellectual Property Rights.

INFRASTRUCTURE

Y2K Problem: Although some ministries, such as Petroleum and Defense, had initiated their own earlier efforts, the Government of Egypt began to comprehensively address the Y2K issue in late May 1998 when Prime Minister Ganzouri formed a senior inter-ministerial committee to oversee the problem. The U.S. Government is assisting the Egyptian Government in its Y2K efforts in such key areas as air traffic control, power, water and waste water, and telecommunications. Other efforts are specifically focused on testing and contingency planning training. A USAID-funded contractor, Duke Power, is also helping the Ministry of Energy manage its Y2K program.

ECONOMIC COOPERATION

The U.S.-Egypt Partnership for Economic Growth and Development: The U.S. Egypt Partnership for Economic Growth and Development is the framework through which the United States supports Egypt's economic transformation. Launched by Vice President Gore and President Mubarak in September 1994, this unique initiative seeks to address the barriers to sustainable Egyptian economic growth through four intergovernmental subcommittees. These subcommittees support joint efforts in trade and finance; science and technology; the environment; and education. The partnership is designed to maintain high-level government dialogue speed implementation of reforms and engage senior business leaders from both countries. A key private sector component is the President's Council, an advisory group of 15 American and 15 Egyptian business leaders.

U.S. Support for Trade and Investment: The Overseas Private Investment Corporation (OPIC), the U.S. Export-Import Bank (Ex-Im Bank), and the Trade and Development Agency (TDA) have expanded their efforts over the last year to support the growth of U.S.-Egyptian bilateral trade and investment, as well as the activities of the U.S. firms throughout the Middle East and Sub-Saharan regions. High level delegations from all three agencies visited Egypt in 1999. In July 1999, Egypt and OPIC signed an updated investment agreement to facilitate the ability of the agency to provide political risk insurance for U.S. private investment as well as for bid, performance, advance payment, and customs bonds and guarantees issued on behalf of U.S. suppliers and contractors in Egypt. To date, 25 U.S. investment projects in Egypt have been covered by OPIC insurance. Since its inception in 1981, the U.S. Trade and Development Agency (TDA) has provided a total of around $35 million in funding for feasibility studies, orientation visits, training grants, and conferences that support economic needs and priorities in North Africa and the Middle East. TDA's most recent activities in Egypt include a $750,000 grant awarded in March 1999 to the Egyptian Arab Trading Company for a feasibility study on the construction of the Suez Petrochemical Complex. In April 1998, TDA awarded a $400,000 grant to the Egyptian Civil Aviation Authority to fund a feasibility study for the complete technical, financial, and environmental review of the conversion and expansion of the Borg El Arab airport west of Alexandria. The Export-Import Bank of the United States is an independent U.S. government agency that finances the overseas sales of U.S. goods and services. Since its inception in 1934, the Ex-Im Bank has provided financing for transactions totaling more than $300 billion. Ex-Im's total actual exposure in Egypt is currently $45.9 million.

U.S.-Egypt Trade and Investment Framework Agreement (TIFA) and other Regional Initiatives: In July 1999, Egypt and the U.S. signed the Trade and Investment Framework Agreement (TIFA). The TIFA is intended to lead to freer trade between the two countries. The TIFA established a Council on Trade and Investment composed of representatives of both governments, and chaired by the US Trade Representative (USTR) and Egypt's Ministry of Trade and Supply. The Council will meet regularly to discuss specific trade and investment matters, providing a valuable mechanism for promptly addressing these and other issues that may rise between the U.S. and Egypt.

Egypt has been in negotiations with the European Union on an association agreement under the Mediterranean Initiative since 1995. In January 1998, Egypt began implementing agreements reached with Arab League members in connection with the Arab Common Market treaty of the 1960's. These agreements call for phasing out existing tariffs over a ten-year period. Egypt joined the Common Market for Eastern and Southern Africa (COMESA) in June 1998, reducing tariffs with COMESA partners by 90% in 1999 and committing to eliminate them entirely by 2000.

U.S. Economic Assistance: U.S. economic assistance to Egypt is administered by USAID, which has been working in Egypt since 1975. Assistance levels were set at $815 million per year between 1979 and 1998 as a result of the Camp David accords (1978). Since 1979, USAID has been instrumental in putting into place the foundations for economic growth, such as infrastructure (water, wastewater, power and telecommunications) and a favorable economic policy environment for private sector development.

The recent areas of concentration of the program have been job creation, economic growth and productivity, infrastructure, education, democracy and governance, population, health and nutrition, environment and natural resource management. It is currently projected that the economic assistance levels for Egypt will be reduced over a ten-year period to a new level of around $400 million. In line with this reduction in resources, USAID proposes to adopt a new strategy that will move Egypt from an assistance-based relationship to a relationship based on trade.