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Impressive economic transition with strings attached

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Conjoncture // July August 2017  
economic-research.bnpparibas.com  
Egypt is implementing an ambitious programme of economic reforms. Macroeconomic imbalances are being reduced thanks to the  
pound flotation and some progress in fiscal reforms. Nevertheless, households’ purchasing power is affected by a sharp rise in  
consumer prices, and the hike in interest rates is a threat for public finances.  
After five years of sluggish growth and swelling fiscal and external  
deficits, the Egyptian economy has undergone major changes over the  
past two years. Three factors have helped the economy return to  
brighter prospects. First, the decision to float the Egyptian pound lifted a  
major constraint on activity and foreign-currency liquidity, which had  
fallen to alarmingly low levels. Second, major fiscal reforms were  
implemented with the support of international donor funds, checking the  
deterioration in public finances. Third, the accelerated development of  
natural gas resources is expected to trigger a significant reduction in the  
trade deficit and ensure the country’s energy supply. Yet these  
economic adjustments have been very costly, both for the local  
population, due to record-high price increases, and for debtors – and  
above all the state – due to higher interest rates. Although reforms have  
created positive momentum for correcting macroeconomic imbalances,  
the size of the adjustments could become a source of greater  
vulnerability.  
Exchange rate: EGP/USD  
25  
20  
15  
10  
5
0
2014  
2015  
2016  
2017  
Source : CBE  
Chart 1  
International capital flows  
USD bn  
1
0
8
6
4
2
0
2
4
6
Net FDIs  
In November 2016, the decision to float the Egyptian pound ended  
several months of tensions in the currency markets, which had fostered  
numerous restrictions on trade (blocking imports) and financial  
transactions (restricting international bank transactions), and  
encouraged the development of a parallel currency market. The floating  
of the Egyptian pound (which has depreciated by 50%) coincided with a  
significant increase in domestic interest rates and a 3-year USD 5.4  
billion loan from the International Monetary Fund (IMF).  
Net Portfolio Investments  
New Commitments  
-
-
-
09/10 10/11 11/12 12/13 13/14 14/15 15/16e 16/17e  
Chart 2  
Sources: CBE, IMF, BNP Paribas  
Floating the pound, international financial support, and the acceleration Non-resident capital inflows were also substantial, estimated at about  
of public finance reforms restored confidence in the country’s economic USD 27 bn over the same period. In addition to the IMF’s USD 2.7 bn  
policy and triggered a massive inflow of foreign currency into the pay out as part of its Extended Fund Facility, there was also about  
banking system. These included currency transfers previously outside of USD 3 bn in support from other multilateral donor funds (World Bank),  
the official banking system, and foreign capital inflows. Resident capital and USD 7 bn from two government bond issues on international  
flows were estimated at more than USD 20 bn in the eight months since markets. Moreover, high yields on government bonds and renewed  
the pound was floated.  
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Conjoncture // July August 2017  
economic-research.bnpparibas.com  
confidence in the currency market attracted about USD 10 bn in transfers, due notably to the renewed confidence of non-resident  
portfolio investment.  
Egyptians in the domestic currency market. These flows are expected to  
return to normal in the short term. For the moment, the pound’s  
depreciation has not had a notable impact on the trade balance.  
Although imports are declining due to higher costs, exports have not yet  
benefited from the improved competitiveness of the exchange rate.  
A little under USD 1 bn was invested in the Cairo stock exchange. Lastly,  
remittances have been sustained (USD 4.5-5 bn per quarter). All in all,  
about USD 57 bn has flowed into the Egyptian banking system since  
the decision to float the pound (equivalent to about 35% of M2 money  
supply at March 2017). A direct consequence of this inflow of foreign  
currencies was a significant improvement in the Central Bank of Egypt’s  
Banking system net foreign assets  
1
foreign reserves. At the end of June 2017 , CBE foreign reserves  
amounted to USD 31.3 bn, equivalent to 5.7 months of goods and  
services imports, compared to the alarming level of USD 15.5 bn, or  
only 2.9 months of imports, 11 months earlier.  
USD bn  
40  
3
3
2
2
1
1
5
0
5
0
5
0
5
0
5
CBE  
Commercial banks  
CBE Forex reserves  
40  
35  
30  
25  
20  
15  
10  
5
0
7
6
5
4
3
2
1
0
USD m  
in month of G&S imports  
-
-
10  
2011  
2012  
2013  
2014  
2015  
2016  
2017  
Chart 4  
Sources: CBE, BNP Paribas  
Claims on private sector as % of deposits  
2
011  
2012  
2013  
2014  
2015  
2016  
2017  
Foreign currencies  
Local currency  
8
7
6
5
4
0
0
0
0
0
Chart 3  
Sources: CBE, BNP Paribas  
More significantly, the net external debt of the entire banking system  
CBE and commercial banks) narrowed sharply. Faced with a  
(
30  
persistently high current account deficit and insufficient capital inflows,  
the banking system had to take on debt to cover part of the Egyptian  
market’s hard currency needs. At the end of October 2016, the CBE’s  
net external debt (comprised notably of deposits from the Gulf  
countries) hit a record high of more than USD 6.7 bn. In December  
2
0
0
0
1
2006/07  
2008/09  
2010/11  
2012/13  
2014/15 March 2017  
Source: CBE  
Chart 5  
2016, the net external debt of banks reached a similar amount. By May  
017, the net external position of the CBE and the commercial banks  
2
had swung back into positive territory, at about USD 2.3 bn and USD  
.9 bn, respectively.  
0
Once foreign currency liquidity had returned to much more comfortable  
levels, the restrictions on currency transactions were gradually lifted.  
Moreover, with the rebuilding of the CBE’s foreign reserves, the national  
oil company EGPC is in the process of repaying its arrears to  
international energy companies, which have been reduced to  
USD 2.3 bn from about USD 3.5 bn at year-end 2016 (national  
estimates).  
Since 2011/12, public finances have deteriorated sharply. The fiscal  
deficit has swollen to an average of 12% of GDP over the period  
2
011/12-2015/16, compared to a 7.7% average during the five previous  
Despite higher oil prices in H2 2016, the current account balance  
improved. Yet this improvement is mainly due to a surge in private  
years. This deterioration is mainly due to the hard-to-curb and high  
current expenditures. In 2015/16, the public sector wage bill and  
subsidies (energy and food) amounted to 28% of fiscal revenues each,  
1
Fiscal year ends in June  
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Conjoncture // July August 2017  
economic-research.bnpparibas.com  
while debt service also absorbed about 30% of revenues. Significant  
efforts have been made to clean up public finances since 2015/16. In  
keeping with the IMF support programme, these efforts were  
accelerated in 2016/17.  
The very high cost of servicing public debt is a major reason for the  
increase in fiscal deficits. As a percentage of fiscal spending, debt  
service reached nearly 50% in 2015/16. The deficit is essentially  
financed on the domestic market, with high interest rates and short  
maturities. Since November 2016, despite the growing use of  
international financing in foreign currencies to contain the cost of  
financing, the sharp rise in domestic interest rates should drive up the  
apparent interest rate on the public debt.  
External accounts  
%
of GDP  
4
2
0
2
4
6
8
-
-
-
-
Fiscal balance  
-
-
-
-
10  
12  
14  
16  
4
3
0
0
% of GDP  
% of GDP  
5
3
1
Current account balance Trade balance Energy balance  
20  
10  
0
-
-
1
3
0
9/10 10/11 11/12 12/13 13/14 14/15 15/16e 16/17e  
-5  
-
7
-10  
-20  
-30  
Chart 6  
Sources: CBE, BNP Paribas  
-9  
-
-
11  
13  
The main measures include the introduction of a value-added tax,  
currently at 14% (which replaces the previous 10% tax on goods), and  
cut in energy subsidies. Although these measures should help reduce  
the fiscal deficit in the medium term, their impact on the budget is  
limited for the moment. The currency effect combined with higher oil  
prices in international markets has increased the energy bill, doubling  
the amount of energy subsidies relative to the initial budget proposal.  
The amount of subsidies will continue to be extremely vulnerable to  
external factors, given the spread between consumer energy prices and  
market prices (currently estimated at 65%). Moreover, the need to  
increase social measures to offset the impact of higher prices is another  
factor driving up public spending. In terms of revenues, however, the  
introduction of VAT as of Q2 2016/17 helped boost fiscal inflows, which  
increased by about 30%. The increase in the total wage bill remained  
mild (+4%). The primary fiscal deficit has improved significantly in  
-40  
-15  
Total revenues  
Subsidies  
Tax revenues  
Total expenditures  
Budget balance  
Chart 7  
Sources: MoF, IMF, BNP Paribas  
General government debt  
Interest expenditures (% of revenues)  
45  
1
20  
00  
General government external debt (% of GDP)  
4
3
30  
2
2
15  
1
5
0
0
5
1
8
0
5
0
2
016/17. We estimate that narrowed by the equivalent of 1 point of GDP  
60  
to 2.7% of GDP.  
4
0
0
0
0
2
General government domestic debt (% of GDP)  
In fiscal year 2017/18, the government expects these trends to  
continue: higher fiscal revenues, a mild increase in the total wage bill  
and an increase in social expenditures and subsidies, due in part to the  
increase in some social transfers. The decline in energy subsidies,  
which took effect in early July for fuel (prices rose by about 40%) should  
continue with the rise in electricity prices. These measures should help  
reduce the primary deficit, which we estimate at 1.3% of GDP in fiscal  
year 2017/18. However, the government’s target of reducing the total  
deficit below 10% of GDP seems to be optimistic. Debt service is  
expected to rise sharply, which would call this target into question.  
Chart 8  
Sources: MoF, IMF, BNP Paribas  
Since September 2016, the CBE’s key rate has increased by 885 basis  
points (bp) to 19.25%. Interest rates were raised for two reasons: to  
combat inflationary pressures, and above all, to continue improving  
foreign currency liquidity in the banking system, by attracting currency  
still outside of the official banking system into bank deposits offering  
higher remuneration.  
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Conjoncture // July August 2017  
economic-research.bnpparibas.com  
The latest 200 bp key rate increase, which caught numerous analysts  
by surprise, is only a temporary measure according to the CBE. Yet  
such a steep increase in the cost of debt threatens the goal of fiscal  
consolidation. Even though the CBE’s key rate increase is not carried  
over in full to the yield on government securities, it sharply increases the  
cost of domestic debt for the government.  
Government debt has swollen to a high level (97% of GDP in 2015/16  
according to the IMF). The majority is comprised of bonds issued on the  
domestic market with rather short maturities. The IMF loan and two  
bond issues in 2017 (USD 7 bn) have helped increase the percentage  
denominated in foreign currency, which currently accounts for about  
As a result, the interest rate on 3-month treasury bonds has increased  
from 15% in October 2016 to 22.5% during the latest auction on 9 July.  
Given that the government is expected to resort less to international  
financing this year (about USD 4-5 bn), a 200 bp interest rate hike  
increases the government’s interest charge over a full year by about  
EGP 40 bn (1% of expected GDP in 2017/18). However, the net cost of  
interest rate hike for public finance will be lower. We have to take into  
account the various maturities of the debt portfolio and the fiscal income  
provided by the activity on the debt market. In 2015/16, the tax on T-bills  
and bonds’ payable interest yielded EGP 23 bn.  
15% of total debt. In fiscal year 2017/18, given the expected sharp  
increase in nominal GDP, we forecast debt to reach 94% of GDP, after  
peaking at an estimated 113% of GDP in 2016/17. The privatisation of  
some state-owned companies could further reduce the country’s debt.  
The state-owned company Enppi is expected to float part of its capital in  
the short term. The government expects to raise USD 150 m, which  
would only have a marginal impact on public debt.  
Under these conditions, it will be difficult for the government to meet its  
target of reducing the fiscal deficit below 10% of GDP. We are  
forecasting a slight decline in the deficit, to 10.2% of GDP in FY 2017/18.  
The energy sector is crucial for macroeconomic stability. It contributes  
to fiscal and external balances and is a factor driving economic activity.  
5Y Sovereign CDS  
basis points  
9
00  
00  
00  
00  
00  
00  
00  
00  
00  
0
8
Egypt’s energy sector boomed in the early 2000s, driven by strong  
domestic demand and Liquefied Natural Gas (LNG) exports. Gas  
production increased more than three-fold to 6bcf/d between 1999 and  
7
6
5
4
3
2
1
2
009. Since 2010, however, sharp macroeconomic deterioration and  
structural natural resource trends have pushed the sector into difficulties.  
The first hit was the decline in offshore Mediterranean gas production  
as a result of reservoir maturity and stalled investments. The production  
of four of Egypt’s major offshore gas fields started to decline in 2012 as  
they had been discovered and developed at the same time in the mid-  
2
011  
2012  
2013  
2014  
2015  
2016  
2017  
1990s. The second hit was the accumulation of Egyptian General  
Chart 9  
Source: Thomson Reuters  
Petroleum Corporation (EGPC) arrears to upstream investors peaking  
at USD 6.3 bn in 2012 (2% of GDP) as a result of mounting fiscal  
deficits and deteriorating external liquidity during the political transition.  
The third hit came from the decline in crude prices in 2014-15, thereby  
discouraging foreign investment especially in high-risk deepwater  
exploration.  
Interest rates  
%
25  
20  
15  
10  
5
0
CBE Discount rate  
T-Bills 364 days  
Egypt became a net gas importer in FY 2015/16 with a hydrocarbon  
external deficit of USD 3.6bn compared with a surplus of USD 5.1 bn in  
FY 2009/10. During that period, the current account deficit was largely  
driven more by the negative hydrocarbon balance than by the decline in  
tourism. Real economic activity was also impacted as households and  
energy-intensive industries suffered from occasional fuel and power  
shortages.  
2
015  
2016  
Sources: CBE, MoF, BNP Paribas  
Chart 10  
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Conjoncture // July August 2017  
economic-research.bnpparibas.com  
Energy balance  
2000-15) is one of the highest in the MENA region, a trend that is likely  
to last beyond the medium term due to Egypt’s youth boom (one-third of  
total population is under 14). Another source of gas demand is gas-  
intensive industry (steel, fertilizers), which is expected to return to full  
utilisation in step with the economic recovery. Here, Egypt has to  
choose between exporting surplus gas in either LNG in order to  
accumulate fx reserves or industrial forms in a way that maximises  
factors of economic development such as employment and industrial  
integration.  
Index 100=2003  
250  
200  
150  
100  
Pursuant to demand management, Egypt is challenged to manage gas  
supply. Some producing legacy gasfields suffer from high rates of  
decline in production (12% annual average). While the four key offshore  
discoveries are being fast-tracked, they have varying production  
plateaus ranging from 11-18 years (Atoll, Zohr) to much shorter 3-5  
years (Noroos, West Nile Delta). Replacing declining offshore  
production necessitates further exploration investments to proactively  
sustain Western Desert production that should start naturally declining  
in 2-3 years, albeit at smoother rate.  
Oil consumption  
Oil production  
Natural gas consumption  
Natural gas production  
5
0
0
0
3
04 05 06 07 08 09 10 11 12 13 14 15e 16e  
Sources: BP, BNP Paribas  
Chart 11  
In the short term, the government secured concessional fuel supply Under the conservative assumption that gas consumption will grow by  
agreements with GCC sovereigns and launched LNG imports fulfilling 4% per annum on average in the medium term and a production to peak  
around 25% of domestic demand. In the medium term, the government in 2021 and decline afterwards, Egypt’s capacity to export gas may not  
repriced gas offtake from new blocks by 40-120% and upwards to last beyond 2022. Even if such production forecasts are considered  
incentivise production and auctioned large exploration acreage at conservative, we believe that Egypt can sustain gas exportation only if  
competitive terms to accelerate reserve replacement. On the financial further discoveries are made and subsequently developed. That is  
side, the government allowed some onshore producers to increase partly achievable if EGPC arrears are repaid on a regular basis to  
exports in order to decelerate the build-up of arrears. That, combined provide the needed certainty for private E&P investments.  
with a series of material payments to targeted E&P operators, has  
indeed halved EGPC arrears to USD 3.5 bn (Dec 2016). However,  
outstanding receivables continue to be a major constraint for new E&P  
investments primarily in gassy portfolios.  
CPI inflation is structurally high. Average inflation reached 10% on  
The turning point was the discovery of the Zohr jumbo gasfield (Eni) in  
average during 2005-15. This is mainly due to several constraints on  
August 2015. This gasfield, with its recoverable reserves of 22tcf, has  
supply chains, to vulnerability to commodity prices (Egypt is the first  
not only replenished Egypt’s total gas resources by one third, but has  
also been fast-tracked to start production in H2 2017. Egypt is currently  
world wheat importer) and exchange rate.  
replenishing most of its gas production with new discoveries and is  
likely to achieve self-sufficiency by 2019. These new discoveries are  
comprised of two large offshore projects, Zohr and West Nile Delta (BP),  
in addition to the smaller Noroos (Eni) and Atoll (BP) fields that should There is significant exchange rate pass-through to inflation. Analysis of  
jointly produce around 5bcf/d at plateau representing 1.1x Egypt’s the period from 2003 to 2015 by faculty members of Cairo University  
2
current total gas production.  
and the CBE showed that relatively little of this happens through a  
direct effect on the price of imported goods; more significant  
transmission occurs through an indirect effect via the increase in the  
prices of semi-finished goods and commodities, which feeds through  
into production prices and then consumer prices. This mechanism is  
particularly due to the existence of few sizeable domestic manufacturers  
across consumer goods segments. According to the authors, this  
transmission is not immediate, and persists over a two-year period.  
Moreover, the level of transmission is considered as incomplete, due to  
the existence of numerous goods for which prices are controlled.  
The first and foremost constraint is large domestic demand that caps  
the gas surplus available for export. The prime consumer of gas is  
electricity generation, which burns 60-65% of Egypt’s gas output. Gas  
consumption is dependent on both structural trends in demand and  
availability of energy for end-users. While gas consumption markedly  
rose during the first half of the 2000s (+12% CAGR in 2000-05), it has  
been almost stable since 2011 given shortages (+1% CAGR in 2011-  
15). The key factor driving electricity consumption is population growth  
because two-thirds of power output is consumed by residential and  
commercial customers. Population growth (+2.2% annual average in  
2
Omneia Helmy, Mona Fayed, Kholoud Hussein, 2017, Exchange rate Pass-through to  
Inflation in Egypt: A Structural VAR Approach, 37 Annual meeting of the Middle East  
Economic Association.  
th  
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Conjoncture // July August 2017  
economic-research.bnpparibas.com  
From November 2016, the increase in consumer prices has been mainly distributing through traditional circuits (local shops) in which they  
incremental rather than immediate, but it has been substantial. The have higher control over selling prices. The modern retail sector (e.g.  
scale of the EGP depreciation is clearly a decisive factor. After the super- and hypermarkets) is expanding rapidly as demonstrated by  
3
pound was allowed to float in 2003, its depreciation relative to the USD recent entry of major regional supermarkets to Egypt . However  
was fairly modest (13% after one year, and 25% after twenty months), producers tend to favour traditional distribution channels. Their products  
whereas it immediately fell 50% following the decision to let it float in are present in supermarkets, but there is a real desire to limit the share  
November 2016.  
that this represents, in order to protect pricing power. This strategy is  
made possible due to relatively low competition in the domestic market.  
According to the latest World Economic Forum report on global  
In addition, the level of transmission has varied since 2003 due to more  
structural factors. The share of imports in GDP is currently much higher  
at 21% compared to 14% in 2003 in real terms. We can also assume  
that over the medium term this figure will be higher, given the tight  
restrictions on the availability of foreign currencies that hampered  
importers over the quarters preceding the EGP liberalisation in  
November 2016.  
th  
competitiveness, Egypt ranks 112 (out of 138) in terms of the efficiency  
th  
of the market for goods and 127 on the “intensity of domestic  
competition” sub-component. In a certain number of markets for  
consumer goods, particularly food, local producers hold the bulk of  
market share and the role of multinationals remains fairly marginal.  
Following the EGP depreciation there is anecdotal evidence that some  
Another factor affecting the degree of transmission is the reaction of price hikes in certain consumer good categories may have gone beyond  
companies to the currency depreciation. Schematically, faced with covering the rising cost of intermediate imported goods allowing  
higher import costs they need to choose between maintaining their producers to make up lost ground after several years of relative price  
margins or their market share. One determiner of this choice can be the stability. Limited competition in the consumer retail market may also  
scale of any depreciation. A modest change would be easier to absorb explain the persistence of high inflation over a long period, even when  
in terms of costs, and the depreciation in March 2016, of around 13%, production capacity is not fully utilised. The expansion of modern  
did not result in a significant rise in inflation. After the depreciation in supermarkets in Egypt may therefore promote competition and relieve  
November 2016, on top of the increase in prices for imported factors of inflation, but also threaten producer margins.  
production, most private corporates in the formal sector raised wages  
(
by 10-20%), making an increase in selling prices necessary. Another  
more structural factor influencing inflation relates to market organisation,  
and specifically the level of competition in the consumer goods sector.  
In H2 2016, the reduction in energy subsidies was another important  
factor of consumer inflation. Petrol prices were more than 100% higher  
than in 2014, whilst increases in electricity prices ranged from 29% to  
Contributions to CPI inflation  
124% depending on the consumption tier. The monetisation of the  
budget deficit, by expanding the money supply, may be inflationary, but  
this factor does not appear decisive. This monetisation was fairly  
substantial in 2015 but was reduced in 2016. In more general terms, we  
are not seeing an uncontrolled expansion of money supply. The M2  
aggregate as a percentage of GDP rose only slightly – from 76% to  
%
4
Regulted items  
Fruits and vegetables  
Core inflation  
2
2
1
1
5
0
5
0
5
0
8
0% – between late 2014 and March 2017.  
In the short term, consumer price inflation is likely to remain elevated.  
CPI inflation reached 23.7% in FY2016/17 and almost 25% is expected  
in FY2017/18. Further subsidy cuts, the persistence of imported inflation  
and a possible upturn in domestic demand are all likely to continue  
driving inflation. Higher energy and farm product prices on international  
markets should also be considered, although oil price recovery is likely  
to be subdued in the medium term. The resources available to the  
government and the CBE to tackle inflation are currently limited. The  
effectiveness of the interest rate lever is limited by the low adult  
bankability ratio (less than 15%), whilst, up to now, the CBE’s exchange  
rate policy focuses on building up forex reserves in order to protect  
against possible tensions. The recent EGP appreciation could signal a  
change in this policy.  
2012  
2013  
2014  
2015  
2016  
2017  
Chart 12  
Sources: CBE, BNP Paribas  
We believe that limited competition in the consumer goods market, and  
specifically food retail, is a major driver of inflation. Food is a crucial  
item as it represents circa 34% of average household expenditure as  
well as 31% of the inflation basket (excluding seasonally-fluctuating  
fruits and vegetables). It appears that control over distribution channels  
3
In 2013-2016, leading MENA supermarket groups entered Egypt such as Lulu, Panda, Al  
(
up to and including a certain level of integration) is a key determining  
Othaim and BIM in addition to the expansion of existing foreign players such as Carrefour  
and Spinney’s.  
factor for producers in setting their pricing strategies. Companies may  
have direct control over part of their distribution channels and/or be  
4
CBE gross claims on the government reached 70% of GDP in 2015/16 against 52% in  
2
012/13. They currently reach 66% of GDP  
2
1
Conjoncture // July August 2017  
economic-research.bnpparibas.com  
investment (even though it has picked up as a share of GDP since  
014) and the significant decline in total factor productivity. Reforms to  
2
the business climate are currently underway, including a new  
investment law, and major capital expenditures have been made,  
notably in infrastructure and energy production. Even so, some key  
factors for boosting productivity, such as improving employability  
through spending on education, seem to be missing, at least for the  
moment, from the economic reform programme.  
In a restrictive fiscal environment, economic activity in the second half  
of fiscal year 2016/17 was driven by the positive dynamics created by  
economic reforms. According to the government, real GDP growth is  
expected to reach about 4% in 2016/17, compared to the previous  
year’s performance of 4.3%. One growth engine was investment,  
bolstered notably by foreign investment in the energy sector, and by a  
very buoyant construction sector. Private consumption, the main growth  
engine, remained rather resilient, even though it was curbed by high  
inflation.  
Contributions to real GDP growth  
Net exports  
Investment  
Public consumption  
%
1
1
2
0
8
6
4
2
0
2
4
Private consumption GDP  
This momentum is expected to be confirmed in the short term, albeit  
without fuelling a real acceleration in activity. Although the impact of  
inflation on the disposable income of low income households can be  
partially offset by social welfare transfers, it severely erodes the  
purchasing power of the middle class. This category of the population is  
a big spender on imported consumer goods (such as cars), but also on  
education and healthcare services in the private sector, the costs of  
which are rising rapidly. This means they will have to hedge their  
purchases, which could end up having a negative impact on the overall  
level of consumption.  
-
-
Chart 13  
Sources: Ministry of Planning, BNP Paribas  
As to investment, sharply higher interest rates will scale back the  
investment decisions of national companies, at least in the short term.  
For the moment, the increase in foreign direct investment is still  
concentrated in the energy sector. Excluding the energy sector, non-  
resident investment decisions are generally made by companies that  
are already present in the Egyptian market, and many foreign  
companies are taking a wait-and-see approach. An increase in public  
investment, which is one of the government’s priorities, could provide  
additional support. Investment expenditure accounts for only about 10%  
of total fiscal spending, or 3.5% of GDP. Lastly, the net export  
contribution could provide non-negligible support for activity in 2017/18.  
Non-oil sector exports should regain competitiveness, but above all,  
imports are likely to contract for three reasons: 1) the unfavourable  
currency effect, 2) government restrictions on importers, and 3) the  
start-up of production at natural gas fields, which should reduce  
hydrocarbon imports. All in all, we expect growth to accelerate to more  
than 5% in the medium term.  
The year 2017 is a transition year for the Egyptian economy. Through  
major economic reforms, the authorities are aiming to foster a sustained  
recovery in a stabilised macroeconomic environment. Three factors  
threaten this scenario: persistent political risks, the difficult coordination  
of economic policy, and international market fluctuations.  
Egypt, like the Middle East region as a whole, is plagued by political  
tensions. The tourism sector has virtually collapsed since 2011. The  
number of tourists has plunged from 15 million a year in 2010 to 5.4  
million in 2016. We can see a timid recovery in this sector (+11% at an  
annualised rate in Q3 2016/17), thanks notably to the reopening of  
certain air routes. Some routes have not reopened yet (Russia, for  
example), and the development of new tourism business (China) is a  
very gradual process.  
Yet, looking beyond short-term trends and the rebound in growth since For the moment, the political crisis between the Gulf States (Egypt is a  
2
011, there are reasons to doubt the Egyptian economy’s capacity to partner in the coalition behind the Qatar embargo) is having only a  
reach sustainable growth strong enough to create sufficient jobs and to limited impact on the Egyptian economy. Yet the crisis represents a  
reduce the role of the informal sector. According to the International potential economic risk given Egypt’s strong presence in Qatar (about  
5
Institute of Finance (IIF) , Egypt’s potential growth rate has been 250,000 Egyptians work in Qatar, mainly in skilled jobs). Tighter  
declining for the past ten years, to 3.5% presently, from 4.4% over the sanctions could trigger retaliation from Qatar. Yet the relative  
period 2007-10. This decline can be attributed to both the slowdown in dependence of the two economies limits such an outcome: Qatar is  
present in certain key sectors of the Egyptian economy (industry,  
5
G. Iradian, Y. Yakhshilikov, B. Markovic, 2017, Egypt research note. “Major adjustment  
is underway", IIF.  
2
2
Conjoncture // July August 2017  
economic-research.bnpparibas.com  
banking), and needs Egypt’s skilled workforce to keep parts of its  
economy running smoothly.  
Faced with an increasingly alarming macroeconomic situation, the  
Egyptian authorities have opted to launch massive, rapid reforms with  
the support of the international financial community. The first goals have  
been met: to restore the country’s foreign-currency liquidity and reverse  
the deterioration of public finances. Yet other imbalances have  
emerged: in an economy with a low level of bank penetration, the  
massive increase in interest rates did not bring down inflation, but  
increased the cost of servicing the public debt.  
Over the course of fiscal year 2017/18, it will be no easy task to  
coordinate short-term monetary policy goals (boosting bank liquidity and  
reducing inflation) with medium-term fiscal reforms. The fiscal situation  
is still fragile, and a sharp increase in CBE interest rates could have a  
very negative impact on debt service, and in turn on the dynamics of  
consolidating public finances in the medium term. For the moment,  
foreign investors are attracted by higher yields on government securities.  
But 2018 is an election year, which tends to encourage the easing of  
fiscal consolidation, as can be seen in numerous countries under similar  
circumstances. It will be important to monitor the duration of monetary  
tightening, which a priori should be only temporary.  
During this transition year, there is a risk that too many incompatible  
reforms will be launched all at once. The key is to strike the right  
balance between monetary policy goals and fiscal reform targets. For  
the Egyptian economy, the way out of this delicate situation is to return  
to sustainable, diversified growth. This can only be achieved through the  
combination of strong household consumption and accelerated  
productive investment.  
Tourism activity  
Completed on July 13, 2017  
pascal.devaux@bnpparibas.com  
1
1
year sum, thousands  
60000  
1 year sum, thousands  
16000  
1
1
1
40000  
20000  
00000  
1
1
1
8
6
4000  
2000  
0000  
000  
8
6
4
2
0000  
0000  
0000  
0000  
Number of tourist nights  
Number of tourist arrivals  
000  
4000  
2010  
2011  
2012  
2013  
2014  
2015  
2016  
Chart 14  
Sources: CBE, BNP Paribas  
Egypt’s vulnerability to fluctuations in global hydrocarbon prices has  
ebbed due to the big increase in natural gas production and  
investments in electrical power generation, which has improved its  
energy efficiency. Moreover, the reduction in energy subsidies, with the  
goal of recovering costs in the medium term, will reduce the vulnerability  
of public finances to oil price fluctuations.  
Yet, floating the pound and raising interest rates expose external  
accounts to the volatility of international capital flows. Currently, Egypt is  
the second most attractive country for carry trade operations, after  
Argentina. These flows could become more volatile if the pound  
continues to appreciate in the quarters ahead, or if interest rates begin  
to decline.