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Egypt - Still going strong

October 2007
Reformist government on steady course to privatization
Egypt may have been slow to open up its political system over the past few years but it has taken steady steps to free up its economy from the shackles of bureaucracy and mitigate the lingering effects of socialism since the 2004 formation of a new reformist government under the helm of Prime Minister Ahmed Nazif, a former minister of communications and information technology.

The new government devised an economic program that focused on lowering taxes, slashing customs tariffs, abolishing antiquated laws and selling state assets. One of the cornerstones of that program is the sale of state assets, mainly to strategic investors to assist them in turning state-owned companies operating at a loss into profitable ventures. Government officials have affirmed that privatization proceeds have helped lower the country's public debt and the fiscal deficit. Some of proceeds from privatization have been used to pay off non-performing loans at state-owned banks, further giving a boost to this essential sector of the economy. The overall fiscal deficit has dwindled to 5.5% of GDP in the last fiscal year which ended on June 30 from 8.2% a year earlier.

"Privatization has allowed the government to address public finances and has been one element contributing to rising growth in Egypt," Ben Faulks, a London-based analyst with Standard & Poor's rating agency told Executive. "With regard to privatization, the fact that the government followed through on its promises, despite some complications here and there, is important for government credibility domestic and abroad. In the early part of the past decade, confidence seeped away a bit."

Consumer boom
Privatization has been accompanied with other ambitious targets, such as lifting economic growth to more than 6%, eradicating bureaucracy, and lowering unemployment. They have managed to achieve some of their goals. Growth in Egypt reached 7.1% by the end of this fiscal year the highest rate in more than two decades. In the previous fiscal year, Egypt's economic growth reached 6.9%, driven by high consumption, an increased flow of investments, rising exports and greater revenues from the services sector, such as tourism and the Suez Canal. Growth has been accompanied by an improvement in other financial indicators. The unemployment rate has fallen to 9.3% in the last fiscal year from 9.6% a year earlier, according to government figures. According to the MasterCard MasterIndex of Consumer Confidence conducted in the first half of this year, consumer expectations in Egypt are at a record high, beating expectations in Saudi Arabia.

"This is the first real consumer boom in Egypt in 50 years," said Angus Blair, head of research at Beltone Financial, a Cairo-based investment bank managing over $2 billion in assets.

The Central Bank of Egypt 's foreign reserves hit an all-time high of $29.7 billion in August. The balance of payments recorded a surplus of $5.3 billion in the last fiscal year, up by 60.6% from $3.3 billion a year earlier, according to the Central Bank of Egypt . Foreign direct investment has also surged to a record $11.1 billion in the last fiscal year, compared with $6.1 billion a year earlier.

But it hasn't been smooth sailing for Egypt's privatization program. A number of politicians, mainly members of parliament, have protested the sale of Egyptian public enterprises to foreign investors, accusing the government of colonialism and divesting state assets at low premiums. Such a furor was highlighted with the sale of Omar Effendi, Egypt's largest department store. The 82-outlet store chain had long been viewed as an Egyptian icon, having been in operation since 1856. The sale of 90% of its shares to Saudi Arabia's Amwal United Trading Company for $102.5 million was met with a slew of protests. Such question marks about privatization and the use of its proceeds have promoted both the investment minister, who is in charge of selling state assets, and the finance minister, who is responsible for spending the proceeds, to come before parliament and defend the privatization process.

The protests from members of parliament and the Muslim Brotherhood, the largest opposition group in Egypt, were accompanied by a string of strikes by laborers at state-owned enterprises slated for sale. Fear of layoffs prompted Egyptian workers to stage a wave of sit-ins this year unfamiliar to Egypt. The government has dismissed these strikes and protests and defended its program, which began to show some signs of slowdown earlier in the year. The sale of state-owned companies such as Eastern Co., the country's monopoly cigarette maker, and Egypt Aluminum, a state-owned aluminum company, which were much-talked about, was put on the backburner.

"Obviously, the government's reform policies are sometimes contentious and raise people's passions, but it is important to try to raise growth while at the same time supporting the poorer element of the population," said Faulks.

Growth and reforms have had also some adverse effects on citizens. Inflation peaked this year at 12.8% in March, which the government said was due to aftereffects of a fuel price hike through subsidy cuts, lower-than-usual agricultural output and the outbreak of avian influenza last year, which created a shortage in poultry and eggs. Inflation has since slowed down to 8.5% in August, amid government promises of further signs of lower prices. Government officials have been quick to defend the government's economic program, arguing it may take time for all Egyptians to feel the trickle-down effect of the economic boom. This view is shared with the International Monetary Fund, which has warned the government not to slow down its program.

"Reform fatigue may set in as some interest groups are adversely affected and parts of the public are disappointed with the pace at which reform benefits accrue to all strata of society," the fund said in a statement in September following consultations with the Egyptian authorities.

The privatization process had been preceded by modest steps to divest stakes in public entities as part of an economic restructuring program devised in the 1990s to resolve Egypt's financial woes, which included massive debt owed to creditors such as the 19-nation Paris Club. Mubarak and his regime came under pressure from the IMF to shape up the economy in the 1990s, prompting the state to reduce price controls, lower subsidies on consumer goods, free up trade and attract investments.

Undoing 50 years of socialism
Egypt, the largest Arab nation, had up until then the longest history of socialism. Following the military coup in 1952 that deposed King Farouk from power, the new government put big companies into state hands and appointed generals to take the helm. State grip on the economy was the cornerstone of Gamal Abdel Nasser's rule as president from 1956 until 1970. Nasser's most famous economic act was the nationalization of the Suez Canal, which prompted the tripartite aggression against Egypt.

Socialism remained strong under President Anwar Sadat's Infitah, or open door policy in the 1970s, which tried to lure foreign investment into the country. The privatization program didn't move very fast through the 1980s and 1990s as the government struggled between maintaining state control and avoiding the repercussions of sell-offs. The reform program was dealt a blow with the Asian financial crisis in 1997-1998 as foreigners shied away from emerging markets. When the Nazif government came to power in 2004, it started the sell-off program with the sale of stakes in state-owned enterprises to investors and on the Cairo & Alexandria Stock Exchanges , the nation's bourse.

"The government has been doing a lot by undoing over 50 years of socialism," said Blair.

Sales of state assets has helped the bourse surge, boosting the Case 30 Index by nearly 500%, since June 2004. The government sold assets such as a 20% stake in petrochemical company, Alexandria Minerals Oil Company , a 20% stake in Telecom Egypt , the country's fixed-line monopoly, and an 80% stake in Bank of Alexandria , the country's fourth-largest state-owned bank.

In the banking sector, the announcement of the sale of Banque du Caire , the country's third-largest state-owned lender, and the expected merger of the country's state-owned insurance and reinsurance companies into one entity, followed by privatization, have banished any thoughts that the privatization program is going to slow down anytime soon.

"In general, people were skeptical about privatization in Egypt because the process of privatizing the Bank of Alexandria was slow," said Mary Nicola, a Dubai-based economist with Standard Chartered Bank told Executive. "Now that the government is moving forward with the sale of Banque du Caire shows that it is serious about free market reform."

This sale of state assets has earned the Egyptian government kudos from the IMF. "Over the last two years, privatization has put about half of the banking sector into private hands and the government has restructured public banks, paying off nonperforming loans (NPLs) owed by state enterprises, while also fostering resolution of private sector NPLs," the fund said in a statement in September.

The government's announcement in July that Banque du Caire would be put on the block, rather than merge with the country's second-largest lender, Banque Misr , came as a surprise. President Hosni Mubarak, still going strong after nearly 26 years in power, had earlier this year said in press statements that Bank of Alexandria , which was sold in 2006, would be the last public lender to be put for sale.

Nazif has given different statements about the stakes that would be sold in Banque de Caire. Initially, he said the government would sell as much as 80% of the bank to a strategic investor, but later indicated the sale could be less.

"The government realized that the merger will not work because Banque du Caire will lose its license and also because Banque Misr and Banque du Caire 's branches are next to each other," government spokesman Magdy Rady told Executive. "Through privatization, Banque du Caire will have a higher market value."

Rady said the government plans to sell as much as 80% of the lender, with the possibility of selling a lower stake. Prime Minister Nazif has said he expected the sale of as much as an 80% stake in Banque du Caire to fetch at least $1.6 billion the sale price for 80% of Bank of Alexandria .

No new banking licenses now
"Regardless of any problems accompanying banks, Egyptian lenders have a premium because it is simply the only way to get into the sector," said Hatem Alaa, banking analyst at Cairo-based HC Brokerage told Executive. "There are no banking licenses being issued by the Central Bank right now."

Italy's Sanpaolo IMI SpA bought 80% Bank of Alexandria in October 2006 in Egypt's first sale of a state-owned bank and the country's biggest divestment of a state asset. The sale of Banque du Caire is expected to take place over the next 12 months. A remaining 15% stake will be sold on the Cairo & Alexandria Stock Exchanges and another 5% will be sold to the bank's employees, following in the footsteps of Bank of Alexandria .

Bank reform in Egypt started in 2003 with the introduction of a new banking law that raised the minimum capital requirement for local banks to 500 million pounds and $50 million to units of foreign lenders to end excessive banking activity in the country and encourage mergers among lenders. Since then, the number of banks operating in Egypt had slid to 41 in June of this year from 61 in June 2004, according to the latest figures from the Central Bank of Egypt . The growth rate in deposits has risen by 18.7% in July this year from 12.8% in June 2004. Total deposits held in Egyptian banks have increased to LE658.2 billion in July of this year from LE463.5 billion in June 2004. Assets of banks in Egypt have increased to LE950.4 billion in July this year from LE633.4 billion in June 2004.

"The mission encourages the authorities to build on good progress to date, and continue to improve bank and non-bank supervision along the lines set out in the banking sector program launched in 2004," the IMF said. "This would involve rapidly completing the bank recapitalization program, and further improving banking sector data to enhance monitoring and stress testing of the financial sector."

These views are shared with Moody's Investors Service, which praised Egypt's reform program in a report released in August. The rating agency encouraged Egyptian authorities to carry on with the restructuring process, which nonetheless remains an arduous task.

"Rehabilitating the operations of state-owned banks will be a difficult task as the public sector mentality cannot change overnight," explained Constantinos Kypreos, a Cyprus-based analyst at Moody's told Executive.

Besides the public sector mentality, state-owned banks such as Banque du Caire face another uphill struggle. Like the rest of state-owned lenders, Banque du Caire has a high percentage of nonperforming loans. Before selling the Bank of Alexandria , the government paid LE6.9 billion to settle the lender's nonperforming loans, particularly those owed by public-sector enterprises.

"Unlike Bank of Alexandria , Banque du Caire has less exposure to state-owned public enterprises and has mainly private sector nonperforming loans, which will take longer to address," said Kypreos. "There are a number of issues involving Banque du Caire and they are not just nonperforming loans. Earnings power is very low and capital is low."

Before the Nazif government embarked on selling the big state-owned banks, it started off with divesting stakes in lenders and joint ventures. It also encouraged mergers among private lenders, who were also seeking out strategic investors to boost their profile.

Foreign lenders are buying stakes
Lebanon's Blom Bank and Bank Audi Saradar , France's Credit Agricole and Greece's Piraeus Bank are some of the foreign lenders that have bought stakes or acquired Egyptian lenders from the private and public sectors. Gulf lenders, such as the National Bank of Kuwait , have also been vying to snap up stakes in Egyptian lenders as they seek to take advantage of Egypt's booming banking industry. Only about 10% of Egypt's 75 million people have bank accounts, according to Moody's. In 2006, Abraaj Capital , a Dubai-based investment company that manages about $4 billion in assets, became the single largest shareholder in Egypt's investment bank EFG-Hermes Holding through a capital increase valued at $505 million.

The Egyptian government has also encouraged mergers among Egyptian lenders. Commercial International Bank , an Egyptian lender, and Arab African International Bank , a joint venture between the Central Bank of Egypt and Kuwait Investment Authority, the Kuwait government investment arm, are in talks for a possible merger. Both Egypt and Kuwait each own a 49.4% stake in the Arab African International Bank .

This consolidation in the Egyptian banking industry is unlikely to end soon, as Egypt continues to attract lenders. But will any of the two remaining state-owned banks be put up for sale?

"Absolutely not," said government spokesman Magdy Rady. " Banque du Caire is the last one to be sold."

© Executive 2007