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Global Economic Outlook
Egypt: September 2010 Outlook Update
By Ayah El Said
- Domestic demand remains the most important growth driver for 2010 and 2011.
- Higher food prices could feed through to core inflation and put pressure on the government’s fiscal accounts, which may delay fiscal consolidation.
- Political and policy uncertainty from the election cycle may constrain capital inflows, but we do not expect any major regime or policy change.
Outlook Update: Domestic Demand Driven
Egypt’s economy continued to outperform its regional peers, accelerating to 5.9% y/y in H1 2010. RGE now forecasts growth of 5.7% in 2010, marginally higher than posited in our July Outlook update as domestic consumption and continuing—if easing—fiscal support will offset uncertain external demand. Growth will slow in H2 on a y/y basis, as base effects wear off, fiscal stimulus wanes and the external environment weakens. In 2011, robust domestic demand, stabilizing external demand and increased investment (especially in the gas sector) will boost growth rates to around 5.8%. However, RGE does not expect a return to the 7% pace of 2006-07, given the lack of structural reforms as well as the uncertainties in the global and regional environment.
Higher global food prices are exacerbating pre-existing price pressures, but RGE believes that the focus on supporting growth and more modest increases in core inflation will facilitate an expansionary monetary policy until early 2011.
Growth Dynamics: Domestic Demand to Drive Economic Growth
In line with RGE’s expectations, robust domestic demand will continue to be the main driver of Egypt’s economic growth for H2 2010 and 2011. Stronger electricity demand, improved credit growth and better labor market conditions in H1 2010 should continue through 2011. The unemployment rate fell to almost 9% in H1 2010 from 9.4% at the end of 2009, and stronger remittances are supportive of private consumption. On a sectoral level, the construction, real estate, tourism and telecommunication sectors were particularly strong in H1 2010 and should be robust through the forecast period.
Credit growth should support domestic demand. Leading indicators, including building permits, suggest that real estate should be a major support, shored up by increased mortgage extensions. Credit to private businesses grew by an average of 2.3% m/m in Q2 2010 from 1.2% in Q1 2010 and a 0.8% contraction in Q4 2009. RGE expects average private sector credit growth of around 2.7% in H2, continuing to support activity but only marginally boosting inflation.
Increased investment in the hydrocarbon sector—especially gas—is likely to boost fixed investment activity, which tends to be correlated with FDI. Waning external demand and greater imports will weigh on net exports, detracting from growth. Non-oil export growth will ease slightly from the robust 19% y/y in Q2 2010 as base effects and global restocking wear off.
Figure 1: Revenues Picking Up
Source: CBE, Ministry of Finance and EFG Hermes
Risks: Unrest and Uncertainties on the Rise
RGE’s forecast of 5.5% growth in 2010 already assumes a significant slowdown in the U.S., Chinese and global economies in H2 2010, which could weigh on demand for Egyptian goods and keep global credit more constrained. An even more sluggish growth rate or a global double dip would have a more pronounced effect on Egypt’s growth through reduced exports, tourism, remittances and Suez Canal revenues.
As the elections for the People's Assembly (the lower house of parliament) in 2010 and the presidential elections in 2011 approach, the risk of policy implementation delays increases. We do not expect major initiatives to narrow the budget deficit or ease investment before the elections. President Hosni Mubarak’s persistent health issues have again brought Egypt’s succession question into the spotlight, which may adversely affect capital inflows. RGE holds to its view that the next term will be a continuation of the current regime with few if any major policy changes.
Higher food prices—especially grain—have exacerbated social tensions while stressing the government’s fiscal accounts through higher subsidies. As noted in a recent Analysis, Egypt’s reliance on imports from Russia (50% of its imports in 2009) increases its vulnerability. Purchasing alternate supplies could almost double the government’s food subsidy bill to about US$700 million for the fiscal year 2010-11—raising the budget deficit by about 0.2-0.4% of GDP. The persistence of subsidies could reduce funds available for infrastructure, including the strained power sector.
Policy Implications: Inflation Under Watch
Despite 20% credit growth in 2009 and strong domestic demand, inflationary pressures should remain contained. The Central Bank of Egypt (CBE) has kept interest rates on hold at a four-year low of 8.25% (deposit rate) and 9.75% (lending rate) since September 2009. The divergence between core and headline inflation in H1 2010 may persist in early H2 as the Ramadan effect on headline prices kicks in. Stronger domestic private demand and investment—and the phasing out of energy subsidies—will boost inflation both headline and core with the two rates likely to converge at closer to the upper level. Higher grain prices are likely to be absorbed in the budget rather than passed on to consumers. RGE holds to the view that the CBE will keep interest rates on hold in 2010, with modest rate hikes to come only in H1 2011 as inflationary pressures rise. If higher food prices pass through to core inflation, the first hike could come in Q1, but the stance remains expansionary.
Figure 2: Core and Headline CPI to Converge
Elections in 2010 and 2011 will constrain the government’s ability to implement planned fiscal consolidation. These pressures could swell the deficit above 8% of GDP even though stronger growth has boosted revenues. Higher subsidy costs (likely exacerbated by more costly food imports) and continued infrastructure spending will combine with slower growth to keep the fiscal gap wide. Political pressures will delay implementation of new taxes until mid-2011 at the earliest.
Figure 3: Consolidation Far in the Future (Spending as % of GDP)