As the evidence mounts that the recently downed airliner filled with Russian travelers is a result of a terrorist attack, a chill is permeating through the economically vital Egyptian tourist industry. This sector of the economy, provides 11% of the GDP (Gross Domestic Product). President Sisi of Egypt desperately needs the revenue from foreign visitors, in an economy that is still recovering from the turmoil of the Arab Spring and the brief tenure of the Islamist Mohammed Morsi.
The decision by the United Kingdom to suspend flights from Sharm el-Sheikh, is a devastating blow to one of the most popular tourist destinations in Egypt. This one location attracts 900,000 British tourists alone,in addition to countless more from both Germany and Russia. If Westerners abandon Egyptian historical sites as well, it will be devastating for the domestic economy of Egypt.
Sharm el-Sheikh, Egypt
Since 2000, a number of structural reforms moved Egypt from a centrally planned economy to a more market oriented one. These efforts included new legislation to promote business, a movement towards privatization, reduced taxation, and better fiscal and monetary policies. This would lead to a dramatic increase in foreign investment in subsequent years, up to the 2011 revolution.
Growth averaged around 8% annually between the period from 2004 to 2009. When the global economic downturn arrived in Egypt as a result of the financial meltdown, it laid bare the wealth inequity that had been exacerbated by the previous boom. Unemployment and underemployment had become a major drag on the potential growth of the economy. The percentage of the population living below the poverty line in 2013, was 26.5%.
Celebrations in Tahrir Square after Omar Suleiman’s statement announcing Hosni Mubarak’s resignation
The revolution interrupted the pace of reform and brought the economy to a virtual standstill. Within a year, foreign exchange reserves fell from the equivalent of $36 billion USD (United States Dollar) to $16.3 billion. By February of 2012, the long term credit rating of Egypt was being reduced by Standard & Poor (S&P) from B+ to B. The following year, it would be reduced further from B- to CCC+.
The concern among creditors in the increasing political turmoil, was how Egypt would meet financial targets and still grow the economy with a restive population of nearly 90 million.
The Egyptian GDP in 2015, is estimated to be $324.267 billion USD. The GDP per capita is $3,724 USD. In Purchasing Power Parity (PPP) the GDP is $989.886 billion with a per capita of $11,194 USD. The Egyptian economy has come within striking distance of overtaking South Africa, before the latest developments. Egypt is now the third largest economy in Africa, after Nigeria surpassed South Africa in 2014.
In an effort to support the Egyptian pound, the government has taken steps in capital controls. However with foreign investment declining and the threat now poised to tourism it will be increasingly challenging, for domestic businesses to secure the American dollars needed for imports. The rapid depletion of foreign exchange reserves, will only magnify the present situation.
The present path of the government support for the pound is also unsustainable. Once this assistance is removed, expect a devaluation of at least 20%. This would substantially help Egyptian exports.
The hard currency crunch has pervaded throughout the economy. Energy shortages the consequence of the lack of fuel, have resulted in frequent power cuts. This in turn is having a detrimental effect on manufacturing and industry. The government has made the situation worse by diverting gas supplies intended for factories to households, in an attempt to forestall further political unrest.
The recent gas discovery and the movement towards building capacity to handle LNG (liquified natural gas) so it can be converted back for industrial and consumers uses, will alleviate some of these short term problems.
Suez Canal
The Egyptian pound because of government intervention,has only dropped 11% in valuation to the United States dollar. The currency has become one of the most overvalued in the emerging markets.
President Sisi has provided political stability for the time being and there are a few bright spots for the Egyptian economy. The Suez Canal expansion has recently been completed. In August of this year, there was the discovery of the giant gas field in the Nile Delta off the coast of the Mediterranean Sea. This resource once fully developed,would not only allow Egypt self sufficiency, but actually permit exports of sizable quantities to neighbors in the region.
Cairo is the financial capital of Egypt.
The plan to build a new capital for the country 28 miles (45 kilometers) east of Cairo, can provide an enormous opportunity for investors in the region. Yet despite this huge construction project, economic growth as projected by the government in the next year is a mere 1.5%. This was before the recent probable terrorist event. The scarcity of foreign currency, lack of exports, suspended factory production, investment disputes and an intractable budget deficit, all weigh heavily on economic growth.
Plans by the government in reducing government spending, widening the tax base and dealing with the high cost of energy subsidies is politically unpopular, but economically necessary. A scant $3 billion USD loan from the World Bank to be received over the next 3 years, will make have a minimum impact on these fiscal state of affairs. Neither will a emergency $1.5 billion combination loan from the African Development Bank and the World Bank.
It is the lack of cash, that is preventing an economic normalization in Egypt. It has turned the country from a major draw of foreign investment two years ago, to a state of stagnation in 2015. The present foreign exchange reserves now at a minimum as recognized by the IMF (International Monetary Fund), will be exhausted in 3 months.
In March of this year, the Egyptian government had been given an emergency grant of cash equal to $12 Billion USD, from the Gulf states of Kuwait, Saudi Arabia and the United Arab Emirates. There is unlikely to be another bailout of this magnitude soon, since these benefactors have their own problems with the price of crude 50% lower than last year.
Already the international credit rating of Saudi Arabia has been reduced, because of the rising budget deficit in the kingdom which is set to be 20% in the coming year. The IMF has projected that the Saudis will run out of financial reserves in five years, if crude remains near the $50 USD level.
The Egyptian stock market was already down 12% this year and that was before the downing of the plane. This compares to the 30% gain last year and the near sprint rate of 50% in 2012. The cost to insure government bonds are now at their highest level, since May of 2014. That was when President Sisi was elected into office.
Egypt will need to quicken reforms, if there is any hope of luring investors back given the present environment. There is a vital need for more spending on education, healthcare and most importantly infrastructure, but this will be difficult in the existing fiscal crisis.
Foreign direct investment (FDI) had declined to just $6.4 billion USD, in the fiscal year that ended this past June. Now that the tourist industry has become a target, this sum is likely to plummet further. It totally derails the government hope for FDI of $10 billion USD in the current fiscal year.
Egyptian exports
Egypt was able to export goods that were worth a total of $22 billion USD in 2014. Although the price of imported oil is much lower now, the bill last year amounted to $12.3 billion. An additional $48.5 billion, was spent on other imports that include everything from commodities to foodstuffs. The annual trade deficit which has been rising for over a decade, has now become unsustainable. The current account deficit is likely to top $20 billion USD this year alone.
The government is also promoting a program that will permit the sale of land in the country to Egyptians living abroad. Even if all goes as planned, the most that can be raised would be $2.5 billion. It will not be enough nor can it be replicated in subsequent years.
Egypt will have no choice, but to allow their currency to devalue below the 11% that has already occurred. The government did match the black market exchange rate earlier this year and will be forced to do so again. There now exists a 5% differentiation once again. It will be a slow process, to prevent a massive round of inflation within the Egyptian economy.
In 2014, the Egyptian government limited transfers abroad to the equivalent of $100,000 USD. This year in an attempt to shut down the black market in currency deposits to foreign accounts, there was a $10,000 a day limit placed, which was capped at $50,000 for any given month. These kind of actions make investors wary of Egypt.
The continued government manipulation of the currency and the current state of the economy now magnified by the spread of terrorism, is making potential investors unlikely to come to the rescue of Egypt at the current time. Any investment made now, must be done with the thought of a much longer term payoff.