With the global financial system in turmoil and prospects for economic growth looking far from rosy, it would be easy to believe that the world economy - Egypt's included - is on the verge of implosion. But, while Egypt's bourse has already been hit hard and its economy will certainly be further affected by the current crisis, it remains to be seen how, and to what extent.
The recent meltdown in global financial markets has created a palpable atmosphere of panic around the world, leaving in its wake a lot of worry about the future, as well as many investors who now have much less money in their pockets. While the global financial sector has been suffering from both a credit crunch for over a year and shocks from the subprime mortgage crisis for even longer, the effects of this turmoil have snowballed in recent weeks [see sidebar, page 61] In early September, many big-name financial institutions found themselves on the precipice, with some, such as Lehman Brothers, falling over, and others, such as American Insurance Group (AIG), being saved only by government intervention - all this occurring while capital markets watching around the world went into a tailspin.
Here at home, the Egyptian Exchange (EGX) was dealt a serious blow. While the market has been in a downtrend since May 5, when the CASE 30 index had its all-time closing high of 11935.67, the global crisis struck the Egyptian bourse fiercely. After the long holiday encompassing both Eid Al Fitr and Armed Forces Day, the market reopened on October 7 with the CASE 30 ending the day at 5896.80, down 16.5 percent from its close at 7059.16 on the previous trading day, September 29. Despite a brief resurgence on the bourse, by press time the CASE 30 index had dropped to less than 4900, almost 60 percent lower than its May 5 close.
As capital markets in both the developed and developing worlds are struggling, another crisis is looming, but an economic rather than a financial one. Worldwide growth is slowing, and it appears that many developed economies are either in recession or sliding towards it. "Global activity is being buffeted by an extraordinary financial shock and by still-high energy and other commodity prices," the IMF's October "World Economic Outlook" states. "Many advanced economies are close to or moving into recession, while growth in emerging economies is also weakening." While the EGX certainly suffered a major setback, still up for debate is the impact that this crisis - one that began in the developed world but spread to emerging markets - will have on Egypt's real economy.
Cash is king
A healthy financial system is essential for strong economic growth. Without the lubricant of cash in the system - also known as liquidity - the engine of economic growth will grind to a halt. Although Egypt's bourse has been hurting in line with the worldwide downward trend, its banking sector is another story. While banks and other financial institutions around the world are failing, undergoing nationalization and/or announcing large losses, many industry insiders argue that Egypt's banks are in a far from typical position - a result of a number of factors, including low leveraging and a lack of exposure to the bad debt emanating from the mortgage market overseas.
When people become unwilling or unable to repay their debt, leverage becomes a major liability. The act of leveraging means using borrowed money to invest in order to amplify returns either positive or negative - on equity. As the global financial system shakes, many leveraged financial institutions and even governments have found themselves without enough cash on hand. Egypt is fortunate to be in the opposite position, says Angus Blair, Beltone Financial's head of research. "Egypt is underleveraged, massively underleveraged, with lots of cash in the banking system."
Many experts also argue that Egypt's banking system has more than enough of this essential lubricant. "[Egyptian] banks are very liquid in Egyptian pounds and foreign currencies," says Gamal Moharam, CEO of Piraeus Bank - Egypt SAE. Also helping the sector is local banks' low dependency on receiving foreign currency from non-Egyptian banks through the interbank lending market, he says. "Egypt is in a better position because we are net placers [of currency]," explains Moharam. "We don't rely on money coming from abroad, [rather] it's the other way around: we are placing money outside of Egypt."
"Egypt has been saved from the financial crisis in terms of the status of our banks and investment," Minister of Trade and Industry Rachid Mohamed Rachid told Business Monthly. "We are quite confident that our banking system has been well observed in the last period not to be involved in any of the instruments that created the problem," he says. The minister notes that Egypt's banking sector has not participated in providing mortgage financing in Europe or the US, and that it is highly liquid.
The condition of Egypt's banks should help stave off a credit crisis in the domestic economy, argues Hatem Alaa, a senior researcher in HC Brokerage's research department. "I believe there are no fears of a credit crunch with high liquidity in the Egyptian banking sector [and] with the sector's loans-to-deposits [ratio] at around 50 percent."
Egypt's loans-to-deposits ratio compares favorably to those of many other economies - both developed and developing - where these numbers are significantly higher, a tremendous disadvantage in today's global credit crunch, where fear has developed among banks about the inability to repay debt and lending has suffered.
Furthermore, cash is still a primary medium for conducting business in Egypt, a fact that economist Samir Radwan argues has also helped to prevent any immediate economic impact from the crisis. "[Egypt's] is still largely a cash economy, and not a banking economy," he argues.
Credit woes
Although the Egyptian economy is still predominantly cash-based and its financial sector has remained largely intact in the face of the crisis, the credit crunch might negatively impact some local businesses. There are Egyptian companies that rely on credit to fund their operations, but not all of them do, explains Alaa. "Many big companies have high credit exposure from both local and foreign banks. Egyptian banks, however, have not expanded aggressively in lending to SMEs [small and medium enterprises]."
While he says that there is ample liquidity in the Egyptian market for domestic banks to step in to fill any gap left by the crisis abroad, Radwan does acknowledge that credit problems have seeped into the domestic system - if only slightly. "There is evidence here and there of overtightening, of people unable to transact, even people getting out of business," he says. "There are signs of that, but not at the scale at all that we see in the States or Europe."
The potential for the credit crunch to impact local businesses has not escaped the attention of the government. "Many of the businesses in Egypt today that are depending on credit coming from the outside, whether they're importers or exporters, will find all this credit disappearing, and that will mean that [foreign lenders] will have to be replaced by local banks taking over such credit positions," explains Rachid.
Mostafa El Halwagy, director of corporate projects at the Egyptian Company for International Touristic Projects (Americana), which processes food and owns the rights to operate various fast-food chains including KFC, argues that Egyptian businesses using credit to import - whether they're importing agents bringing in items for sale or manufacturing companies procuring raw materials, packaging materials and equipment - will now face worsening credit conditions. These importers will have to turn to local banks for borrowing, he says, which usually carries a higher cost because the loans are often in local currency.
Exporters will also be hurt by the current credit crunch abroad, El Halwagy argues. "[The credit crunch] is going to impose higher pressure on the Egyptian exporter to extend longer credit terms when we export to Europe or to the States," El Halwagy says. "And if the Egyptian exporter refuses to comply, we could easily lose the transaction because there is an overall decline in demand," he argues, noting that there are others who could step in to fill the orders.
Although most contend that there is sufficient liquidity in the Egyptian system, getting domestic banks to loan it out is another challenge, say some experts. "There is enough liquidity in the system," argues Radwan. "The question is how to give incentives and enough guarantees to the banks to [get them to] lend to the business sector."
In the face of this challenge, a new approach is needed, Rachid argues. "We have to find a mechanism to expand even more the credit terms of banks into the business community, small and medium [enterprises] specifically, and at the same time to inject all this liquidity [in Egyptian banks] into the market in the next few months," the minister says. "We are aware that what [was] there before is not good enough for today. We need to do something different now."
The outside caving in
As export-related businesses in Egypt are adjusting to new credit conditions, they have another significant challenge to deal with: slowing growth in the world economy. "There will be some slowdown in the global economy, and I think the best scenario existing today for the US and Europe is that they will be almost at zero [percent] growth," Rachid says.
The economic aspects of the global crisis are likely to far outlast the financial side, the trade and industry minister says. "I think the financial crisis will resolve itself in the next few weeks, because it's a matter of confidence and it is very clear that governments outside will have to take whatever [measures] it takes to stabilize [the situation]," Rachid argues. "But I think [regarding] the economic crisis itself, we need to take the conservative view that this will not take less than two, three years to be resolved."
The IMF's October report projects that globally, growth will slow to 3.9 percent this year, down from 5 percent in 2007, and that the slowdown will continue into 2009, when growth will decelerate even further to 3 percent.
While Egypt will be impacted by a global economic slowdown, the financial crisis has not hit the country as it has others, Radwan argues. "The immediate impact on the economy was not felt as in other economies," he says, attributing this to a number of factors including a high percentage of Egyptian versus foreign investment in the economy. But, Radwan asks, answering his own query: "Does that mean that Egypt will be immune forever from the impact of the crisis? The answer is certainly no."
The current turmoil will impact Egypt insofar as it relates to the global economy, explains Wael Ziada, head of Egypt research at EFG-Hermes. "From a macro perspective, the way that Egypt's going to be affected [or] could be affected over the coming period is where Egypt relates to the external world, and this is through the export of services and goods."
The 'real' impact
Rachid argues that a number of different segments of the Egyptian economy will be hurt by the global economic crisis. "It will have a negative impact on our ability to attract foreign direct investment, it will have a negative impact on the growth of our exports, and it will have a negative impact on the tourism [sector]," Rachid says. "It will have a negative impact possibly on trade routes [such as] the Suez Canal, [as well as] Egyptian remittances."
Many of the sectors likely to be adversely affected showed significant growth from FY 2006-07 to FY 2007-08, according to provisional balance of payments (BoP) figures released by the Central Bank of Egypt (CBE) for the latter, which state that Egypt had a BoP surplus of $5.42 billion in FY 2007-08, up from $5.28 billion in FY 2006-07.
Like Rachid, many experts say that as global economic activity slows, foreign direct investment (FDI) is likely to be hurt. According to the CBE's provisional estimate, FDI increased to $13.24 billion in FY 2007-08, from $11.05 billion in FY 2006-07.
While Blair acknowledges that some foreign direct investment could be reduced, pointing to real estate as an example of a sector that may have a harder time attracting FDI, he is optimistic regarding foreign investment in manufacturing. "I think manufacturing FDI will actually improve," he says, arguing that companies will take advantage of both the low cost of operating in Egypt and comparatively lower transport costs for export into Europe.
This may bode well for manufacturing exports growth. Egypt registered strong growth in non-petroleum exports from FY 2006-07 to FY 2007-08, according to the CBE's BoP figures, going up 25 percent to $14.88 billion, from $11.91 billion. But growth in these exports will not be as fast as in the past, Blair argues. "You've had very strong export growth in the last few years," he says. "It's not going to stop, [but] you'll find a slowing of the growth."
Exports of food products have already not been as strong as expected in 2008, says Hani Berzi, chairman of the Food Export Council. He says that food exports were 6 percent below the council's target for the period from January to September 2008, and he anticipates a further drop due to the global crisis in the final quarter of this year, saying that exports may end up falling as much as 15 percent below the target amount for the year as a whole. "If I'm going [to be] a little bit pessimistic, it will be 20 percent," Berzi acknowledges, although he does note, "people have to continue to eat."
While he points out that the food and beverages sector is largely a cash industry, Berzi explains that a significant number of food export businesses use credit, a fact that he says will hurt exports to the US and Europe, where there are credit and liquidity issues.
El Helwagy expects Americana's exports to Europe and North America to suffer as a result of the current downturn, but not those to the Gulf, where he argues that the credit and banking systems are still in relatively good shape. He juxtaposes this with the situation in North America and Europe, citing some European banks' calls for additional guarantees and refusals to accept letters of credit.
Mohamed Sultan, general manager of Procter & Gamble Egypt Ltd., says that the global economic situation may impact the fast-moving consumer goods company's exports to other P&G subsidiaries, but not for three to six months, explaining that the Egyptian subsidiary's practice is to lock in orders for the future. "Global consumption should go down," Sultan says. "We would anticipate some decline in the markets that we export to," he explains, noting that this may cause a fall in P&G's exports.
Significant earners of foreign exchange such as the Suez Canal and tourism are likely to be hit by the current turmoil, experts say. "As far as the Suez Canal and tourism are concerned, they will suffer as a result of the decline in demand," says Radwan.
According to the CBE's BoP figures, tourism earned $10.83 billion in FY 2007-08, up 32.3 percent from $8.18 billion in FY 2006-07, and Suez Canal revenues rose to $5.16 billion in FY 2007-08, up 23.6 percent from $4.17 billion in FY 2006-07.
Not everyone is convinced that tourism will necessarily be hurt badly. "There will be some people who might not come from Europe," says Blair, who has "the feeling that you're going to have [tourists coming to] Egypt as the holiday substitute, rather than [people] going to the Gulf and going to Dubai in particular, because the value's much better in Egypt." He adds that Egypt's location is another asset in this equation. "Egypt's on the Mediterranean rim, so I think it's relatively safe from a major downturn."
Another area that will possibly be impacted is remittances from Egyptians overseas - a major source of foreign currency. These transfers brought $8.56 billion into the economy in FY 2007-08, according to CBE provisional numbers. "Remittances may not be influenced in the short term, because there's a lot of cash in the Gulf, which is the main destination for Egyptian workers," Radwan says.
While many exporters of goods and services will be hurt by a decline in the global economy, the importance of maintaining domestic consumption to drive growth cannot be understated. "Local market consumption has been the most significant contributor to our growth in the last few years," Rachid said in a speech on October 16. "We need to see that continue."
Rajeev Chaba, chairman and managing director of General Motors Egypt SAE, says that the company - which sells exclusively to the domestic market - is still in a growth mode, despite the current turmoil. The company sold approximately 40,000 locally manufactured and imported vehicles last year, and expects to sell around 60,000 this year, he says. "We are in a growth mode, and right now our challenge is growth management."
While Sultan anticipates a fall in exports, he is less sure what effect the crisis will have on P&G's domestic sales. He expects future liquidity problems in the local market to impact consumption to some degree, and also argues that reduced commodity prices should leave Egyptians with more disposable income. "We can look at all the theory and say, 'this will help us, this will hurt us,'" he says. "But so far, we have not seen signs of reduced demand [in the domestic market]."
A silver lining
While many segments of Egypt's economy will be affected by the general downturn in global growth, the economic crisis currently unfolding may work to Egypt's advantage in some respects. Perhaps the most important example of this is the impact of falling commodity prices, a trend that will hurt many other emerging markets, but seems likely to benefit Egypt.
High commodity prices helped drive inflation to record levels in 2008, creating one of the biggest challenges for the Egyptian economy this year. "It's food pricing and fuel pricing that's helped push inflation up," argues Blair. "That said, there's been a very significant drop in commodity prices globally over the last few weeks, which should work its way into the system and help bring down inflation quickly in Egypt - if you have efficient mechanisms for people to cut prices." He adds that the government should step in if local prices are not cut in conjunction with falls in global commodity prices.
Urban inflation has already begun to slow, reaching 21.5 percent in the year to September, a 2.1-percent drop from the 23.6-percent inflation in the year to August. Minister of Investment Mahmoud Mohieldin said at the Euromoney conference in Cairo last month that inflation in Egypt could fall to as low as 12 percent in the current fiscal year, and even further in FY 2009-10.
Coming on the heels of a global food crisis, when high prices for staples including bread caused popular discontent here at home, falling inflation and food commodity prices are likely to be a boon for Egypt. LE 14.4 billion was allocated for food subsidies in the budget for FY 2007-08.
The declining price of energy should also work to Egypt's advantage, experts say. At press time, oil was trading at around $65 per barrel, down from over $147 per barrel in July. "Egypt is beginning to be a net importer of petroleum and even gas," says Radwan. "So if the price [of petroleum] increases Egypt will suffer, but there are no signs that this is happening. Exactly the opposite is true."
The decline in oil prices will benefit the Egyptian government, says Khaled AbuBakr, managing director and chairman of the executive committee of TAQA (The Arab Company for Energy). "Any energy saving will reduce the subsidy that the government is paying from the treasury." Amid an atmosphere of high oil prices, according to the CBE's provisional numbers the trade balance for petroleum products registered a surplus of $4.91 billion in FY 2007-08, a drop of 17.9 percent from $5.98 billion in FY 2006-07. In FY 2007-08, the amount the government spent on energy subsidies was LE 2 billion.
Even as Egypt benefits from falling oil and other commodity prices, the global economy's slowdown will nonetheless present a challenge to maintaining economic growth the government is aiming for GDP growth of 6 to 7 percent for FY 2008-09.
Many anticipate that this growth 7.2 percent in FY 2007-08 will slow as a result of the general downturn in the global economy. "I think in Egypt, you're not going to have a recession," argues Blair. "You'll have slower growth."
But in trying to maintain growth, Egypt is once again in a fortuitous position, Rachid argues. While other countries' financial systems are being wrenched apart - and their governments are focusing on keeping them intact - Egypt is in a different situation, he says. "We have a head start," the minister told Business Monthly. "We have the luxury today of focusing on the economic negatives, instead of being totally immersed in the financial crisis that other countries are facing."
"We need to do something to ensure that all these negative impacts are going to be balanced," Rachid argues. "We are sitting the business community with the financial institutions, banks and the government, and putting together a package of stimuli and reforms [for investment, exports and local consumption]." Numerous components of the government are working to minimize the impact of the crisis. The Ministry of Trade & Industry, for example, has removed export duties on steel, iron and cement in order to stimulate growth in these sectors. How effective these and other government measures will be is another story. "We are still aiming for 6- [or] 7-percent [GDP growth,] but obviously it will only happen if we do some extraordinary things."
Origins of a crisis
The roots of the current financial crisis lie in the US mortgage market, explains Beltone Financial's head of research, Angus Blair, who says mortgages were given to people who weren't qualified to receive them a situation that depended on rising housing prices to sustain itself." You then had all of this mortgage debt, in effect, which was sold on and repackaged by global investment banks to a variety of parties," he explains.
Low interest rates set by the US Federal Reserve earlier this decade were key in setting the stage for the current turmoil, argues Wael Ziada, head of Egypt research at EFG-Hermes, who says that these rates contributed to the development of a bubble in the real estate market. "[This] situation, where you have cheap money and an asset-pricing bubble forming, coupled with investment banks getting really creative and getting really ahead of themselves in creating very exotic products - some of [which were] kept off the balance sheets - was, briefly, a recipe for disaster."
For this situation to sustain itself, Ziada argues that three factors had to remain constant - low interest rates, a "buoyant" economy and control over inflation. "If any of these three things goes wrong, then basically the whole thing comes down," Ziada argues. And amid rising interest and inflation rates, it did just that.
As the US economy began to slow down, this put pressure on the ability of the American people to pay off their debts, says Blair. "You had larger and larger numbers of people who were becoming delinquent in their mortgage payments, so that then had a repercussion [on] a whole variety of other instruments across a whole number of institutions."
With many financial institutions reporting losses from investments in the mortgage market and fear of bank failure reducing willingness for interbank lending, liquidity in the global financial system started to dry up. In a defining moment highlighting the frightening potential of the credit crunch, in August 2007 BNP Paribas suspended the ability of investors to withdraw from three of its funds involved in the US housing loan market.
The credit crunch continued to shake both US and European financial institutions. Arguably the largest shocks from the credit crisis came in September 2008, when Lehman Brothers, one of the biggest names in investment banking, went bankrupt within a short period that also included the bailout of Fannie Mae and Freddie Mac, as well as American Insurance Group (AIG) - all while European institutions continued to suffer.
Capital markets worldwide have plunged since September, and governments and central banks around the world have been trying to pick up the pieces ever since.
By Louis Wasser
© Business Monthly 2008
