Analyst Omar Shenety, managing director of investment bank Multiples Group and chairman of consultancy firm Quick Wins, looks back on the nation’s investment climate over the past year and ahead at how we’ll need to overcome this year's over-optimism.[caption id="attachment_396635" align="alignnone" width="620"] Omar Shenety[/caption]
By Ahmed Goher
How do you assess Egypt’s investment climate over this past year?
2014 was a very good year for the Egyptian economy and we can also say the same for the beginning of 2015. There was good growth. People had very high expectations and economists generally respond to expectations and signals. However, during the last few months, we have seen some setbacks. This is no surprise. Back in 2014 and the beginning of 2015, people were too optimistic; I did not see any fundamental changes taking place to justify people’s exaggerated optimism. Sure, you had the announcement of national projects and the holding of the Sharm el-Sheikh economic conference, which saw amazing representation from investors, emirs and officials from the region and abroad, giving a very positive image, but these things were exaggerated and overrated and with time we eventually had to get back to reality.
Where did all of this false hope come from?
Many people supported the changes promised by the January 25 and June 30 events. These past years were basically a huge storm that no one expected. All of a sudden, a 30-year regime fell only to be replaced by some new guys that no one had heard of before. And to the influential people in Egypt, these political newcomers were making very strange moves. So there was a lot of skepticism and apprehensiveness after two and a half years of violence and protests, perhaps until the first quarter of 2014. With the beginning of 2014 you could start to see signs of stability returning. Naturally, after years of uncertainty, investors were hungry and jumped at the opportunity to finally start investing their money. People always have savings and want to invest, and by 2014 people were starting to see signs of a system they could like, perhaps not completely, but at least it was there.
The second factor is at the beginning of 2014 the country saw unprecedented support by the Gulf countries right after June 30. I mean, you got around $30 billion — enough to breathe life into a dead economy. And then from mid-2014 to the beginning of 2015 you could see good growth as a result of such generous support. This revitalized the market and people felt currency pressures were easing up and that Gulf countries will stand by Egypt and invest in the country. Moreover, Egyptian workers in the Gulf were also expected to be impacted positively by these developments and thus inject more money into Egypt. In this sense, Gulf aid played a very significant part in this optimism.
The third factor that contributed to the optimism was the promises made during presidential elections that the country would see a dramatic transformation after June 30. President Sisi enjoyed immense popularity when he came to power because people viewed him as someone special, holding promises for a better life. A new trend so to speak. He was the hero of June 30 and fostered this idea that things would transform, which in turn generated huge expectations. National projects, like the new Suez Canal, also played a part. The Suez Canal holds huge symbolism for Egyptians, kind of like the pyramids. It is something they’ve bragged about since they were children.
Ultimately, consumer behavior has much more to do with psychology than just practical business rules. During this period, the psychology was very positive. You had a president people were infatuated with, who also enjoyed support from the state, police, army, media and the business community. In just one week, he was able to collect LE 64 billion for the Suez Canal project. Even the most optimistic individuals could not have imagined such a figure: from the perspective of an average investor, it was clear that this success was the start of a better period.
Finally, the media played a big role in exaggerating things and raising expectations, making it look like it was only a matter of time before things got better. This was problematic.
Today, you have no Gulf aid due to the decrease in oil prices, and things are not very stable. The consequences of the inflated exaggerations are coming to bear. When reality finally hits people, you start seeing widespread frustration.
The government has announced a sustainable development strategy titled “Egypt 2030,” promising a growth rate of 12%, an investment rate of 30% of GDP, an unemployment rate of 5%, and an illiteracy rate of 7% by the year 2030. Does this seem feasible to you?
First off all, to be thinking as far ahead as 2030 is in itself a positive move. Regardless of the content, the idea to come up with a strategy for sustainable development and to start thinking 15 years ahead to make sure entities are working together towards a common set of goals is a very good initiative that should be supported.
Having said that, looking at the contents of the strategy we can see that it suffers from the often-repeated mistake of having unrealistic goals. If you get an investor and tell them that you will give them 15% return on their money and you actually manage to get them 16% then that’s great. The investor will love you. On the other hand, if you promise 20% and only actually achieve 19%, the investor will feel lots of frustration. When you set the bar too high for yourself and miss it, people will be very frustrated.
Frustration is the difference between expectations and reality. Having a strategy is good, but to say you’re going to have a 12% growth rate is very aggressive and harmful. China, in its heyday, did not have such growth rates in a sustainable manner. You are also so far away from having a 30% investment rate. Where will the investments come from? Purchasing power is very low. People can barely afford basic needs. Where will savings come from?
A more reasonable thing to do is to re-check these numbers, especially if they were based on the availability of endless Gulf aid, FDI coming to the country, a secure environment and high tourism. Today, none of these factors are there. There is no Gulf aid, no tourism and no security. The variables that were taken into account when coming up with this plan have changed, and revising it now makes perfect sense.
Egypt’s economy is also not isolated from the global economy. You are affected by what happens in the world. You do not affect global trends but are affected by them. And the global economy today is not at its best.
Egypt’s government also seems to have adopted the idea of megaprojects as a solution for its economic woes. What is your take on this?
There are two theories when it comes to national projects and the idea of the government leading development. One theory postulates that the government should just provide infrastructure and allow the private sector to lead. The other theory suggests that during times of crisis, the private sector and investors have no desire to take risks and so the government must step in by pursuing projects that help the country and create job opportunities until the private sector can get back on its feet and lead. And here we should note that such projects do not necessarily need to be mega ones; working on smaller-scale projects may sometimes make more sense.
In Egypt, the megaprojects being pursued raise many issues, and here I’m not talking about the Suez Canal. Firstly, Egypt’s experience with megaprojects is generally not good. Toshka is, of course, a prime example of bad experience; perhaps the main example of a successful megaproject pursued by the state in Egypt’s modern history is the Aswan High Dam. Secondly, megaprojects also entail long-term returns. The returns you get on the money you put in today will only materialize 10 to 15 years from now. Today you need quick returns on investment. Thirdly, megaprojects require a lot of financing. Today, you don’t have many such sources and relying on loans or issuing investment certificates pressures market liquidity.
Finally, the bigger the project, the bigger the risk. If you have LE 10 billion and divide them over 10 different projects and one project fails, you only lose 10% of the money. If you invest the 10 billion in one big megaproject, you lose all the money. In 2015 the IMF came to Egypt and advised the government to stay away from megaprojects, so that the private sector is not crowded out, and to instead focus on developing the country’s infrastructure. Pursuing megaprojects is a huge gamble and is not the best way to invigorate an economy.
What about the new Suez Canal Project? To what extent was that a positive endeavor?
I think the Suez Canal needs to be evaluated from a number of different angles. It’s very hard to reach a single conclusion declaring it beneficial or not. What we can do is divide the different aspects of the project into three components: widening and deepening the current waterway, creating a parallel waterway and digging new tunnels.
The first component of widening and deepening raises no issues. In fact, making the canal more efficient is a necessity, as ships are getting bigger while their numbers are getting smaller. You need to expand the canal to be able to accommodate bigger ships in the future. Keep in mind that you have already been expanding the canal every few years and the returns on investment are good, maybe even overdue. Before the expansion, 100% of small ships and most medium ships could pass but almost 40% of big ships could not. Now more mega ships can pass in one day, if there is traffic.
On the other hand, creating a new parallel waterway raises many issues. First of all, why are you digging a new canal? To reduce waiting times? Only convoys coming from the north had to park and wait for the ships coming from the south to pass. Essentially, the new waterway reduces the waiting time of north convoys from 18 hours to 11. This is good and might be very convenient for some companies and may even allow you to charge a slightly higher passage fee. Still, a reduction of seven hours waiting time can only allow you to charge so much. The journey between Asia and Europe is not a short one, and a ship that has spent 15-20 days in the water will not be ready to pay double the fees just because you reduced the trip by seven hours. The economic benefit is not too clear. Before its creation, 79 ships could pass through, now 99 can pass through. On average, however, only 50 ships pass through.
Finally, when it comes to the tunnels, there is no denying that connecting Sinai to the rest of Egypt is good. But how many tunnels do we really need and how fast do we need to have them? Spending on infrastructure is a long-term investment. … I’m collecting money using short-term investment certificates for a long-term project when I’m in desperate need of shortterm results.
Having said all that, the ultimate goal is to develop the canal area as a logistical center and an industrial area. This is very important, but we still have not started on that and I think the current economic problems will prevent this in the short term. While some people think the new waterway should create a “buzz” and help expedite the bigger development plan, I think you could have started developing the area without new tunnels and a new waterway. Was using investment certificates to finance the project a good idea?
In terms of financing, this may actually be the best aspect of the Suez Canal Project. Through the 12% investment certificates, the government created a tax-free investment vehicle, which got it a lot of money. This was very attractive and profitable to investors.
However, time has showed that the original figures of the expected returns from the project were not realistic. The difficult state of affairs in Europe and China worsened the matter and international trade was negatively impacted, which means less ships. This was a matter of bad luck. You expected revenues would increase, although they actually decreased as international trade is going through a turbulent period.
Again, when you pursue massive projects, you cannot control the outcome and things become very risky. Even if international trade picks up, it is still hard to reach $13 billion in revenues in 8 years.
Let’s talk a bit about the upcoming parliament. What impact will its formation have on Egypt’s economic landscape?
I think that investors, in general, deal with Egypt as a presidential country where power is concentrated in the hands of the president, regardless of what the constitution says. So in terms of the business community, there are no huge expectations.
Still, the formation of a parliament would have some positive impact. This is especially true when talking about IMF and World Bank deals, where having a parliament is very important. Also, I think big investors and big oil companies will be happy to have parliament ratify executive signatures.
Locally, you won’t really see much of an impact. Internationally, however, big multinationals and lenders will view this as a positive sign —but nothing too huge.
With the challenge of terrorism on home ground, can the government achieve its ambitions while being embroiled in such a conflict?
The Sinai crisis in fact is not just a local or regional problem but a global one. We need to realize that when terrorists attack Paris and hurt tourism there, this will also impact us. The spread of terrorism globally means less FDI, tourism and even local investment. Moreover, even when it comes to government spending, we will see a huge effect, with spending mostly going toward defense and weaponry. Until terrorism is comprehensively dealt with, prospects for short-term growth are very limited for Egypt and other similar countries.
What about tourism? What are the repercussions of the Russian plane incident? Can Egypt’s tourism industry survive this blow?
During 2014 to 2015, Egypt saw a huge recovery in its tourism sector and so even more improvements were expected for 2015-16. But now this Russian plane crash just turned into this huge crisis that no one expected. Today, there is a complete travel ban from some countries. I mean the response in 1997 with the Luxor incident was less dramatic. So the outlook on tourism in the short term, specifically next year, is very bad. After that, it really depends on how the state attracts tourism and how it deals with the terrorism problem.[caption id="attachment_396637" align="alignnone" width="620"] The Russian plane crash has turned into a crisis that makes the outlook on tourism in the next year very bad, Shenety says. "After that, it really depends on how the state attracts tourism and how it deals with the terrorism problem."[/caption]
Some observers have described President Sisi’s economic agenda as “neo-liberal,” with an overt focus on attracting foreign investment, while adopting a policy of austerity. What’s your assessment of the president’s policies?
The first year and a half since June 30 would indicate that it is indeed a neo-liberal government. There is high dependence on foreign investment, and the private sector was expected to play a huge role along with fiscal consolidation. Still, it’s not a very classical version of neo-liberalism. This time government plays a stronger role, either through public-private partnerships or the intervention of sovereign institutions. So it is neo-liberalism, but with government having a strategic role in parallel.
From 2014-15 policies were pretty much like the ones followed during the Mubarak era. But Mubarak did not fail because of neo-liberalism, but because his regime neglected the redistribution of wealth and combating corruption and so on. The problem was thus a form of neo-liberalism devoid of equality or social considerations.
The question now is whether this neoliberal track will continue. I don’t think so. Neo-liberalism can only flourish in an environment conducive to FDI. This is currently not the environment we are in due to the global recession. Our biggest investor is Europe, and it is in pretty bad shape. Gulf countries are suffering from low oil prices and won’t come to invest. The private sector may be doing fine in the short term because of the external cash flows of lasty year, but can’t operate alone and needs help from foreign banks and entities.
With the Russian plane crash and so on, we need to realize that if countries are afraid to send tourists, they definitely won’t send investments. In this sense, I think reliance on the private sector will decrease and the government will have a bigger role during the coming period. We have already started seeing this with interventions to regulate prices and the current emphasis of the military as an economic tool at a time of crisis.
You say that the problem was not neo-liberalism per se, but rather neo-liberalism that does not take into account social considerations. But isn’t not taking account of social considerations an inherent feature of neo-liberal policies?
Neo-liberalism indeed does not really take social aspects into account. It is based on the idea that the market will adjust itself and that the trickle-down effect will happen in the long run. Still, this is oldschool neo-liberalism. Over the past six years, after the financial crisis, the IMF itself announced that social aspects will need to be considered, and so we are essentially seeing neo-liberalism with social considerations as a school of thought lately. For example, in a recent report the IMF talked about income inequality as a major barrier to development. You would have never seen this before. There is now a new direction worldwide to focus on the inequality problem. I believe you can have a more fine-tuned version of neo-liberalism that can take social aspects into account.
How do you see Egypt’s move to negotiate a $3 billion loan from the World Bank?
As far as I understand, part of this loan is built on the idea that the World Bank supports countries that are developing and pursuing serious reform agendas. The WB is different from the IMF. In its terms, if a country is undergoing economic transition, then credit lines can be made available to it to expedite reforms. From the perspective of the government, we are currently liberalizing the economy, by depreciating the currency and reducing subsidies and so on, as the IMF and WB recommend.
Accordingly, per WB customary practice, Egypt can be eligible for direct support to the tune of $1.5 billion toward liberalization reforms and another $1.5 billion to specific developmental projects. Overall, I think the loan is good and important, but I don’t think it will attract too much FDI. Instead, it will bring in cheap dollars at a time at which they are heavily needed. This will help alleviate pressure on the pound to some extent.
Egypt’s monetary policy, specifically the recent announcement of the replacement of the Central Bank’s governor and the Bank’s response to the dollar crisis, have raised controversy. What is your take on these developments?
I think there is a realization as of late that we as a country are desperately looking to attract foreign investors and are thus trying to depreciate our currency toward that end. However, the region is on fire so to speak, with terrorism and political instability afflicting Egypt. With that in mind, FDI is not coming rapidly, the balance of payments problems put pressure on the pound and the fact that you are losing Gulf investors does not help. We need to stop dreaming that depreciating the pound will attract investors.
We now need to deal with our currency comprehensively. Classic policy would suggest you increase the interest rate on the pound to push individuals to convert their money to it and benefit from higher interest rates. So for instance, getting 12.5% over five years on your pound deposits versus keeping your saving in dollars at home means a 60% increase, and the pound will probably not depreciate 60% in five years. In fact, despite the turbulence of the past five years, you saw only a 35% depreciation in the pound.
The Central Bank of Egypt is trying to fight dollarization and the purchasing of luxury goods and thus put a limit on dollar deposits. Yet this showed itself to be more harmful than beneficial. People respond to signals. When people see the CBE fighting dollarization and being unable to protect the pound, they figure it’s better to keep their dollars. In effect, this increases dollarization. Moreover, such moves by the CBE hit not only those who dollarize, but also importers who had to reduce their import of basic services, which made everyone unhappy.
Now, however, the policy has changed. Instead of hitting demand, it is hitting supply and encouraging people to save in pounds with the 12.5% interest rate. I think we can expect the interest rate to increase to 13.5-14% by mid next year to further dissuade people from dollarization.
But, of course, prices are rising. Today, inflation is caused by the CBE printing too much money to buy treasury bills, so this won’t really eliminate inflation, but just limit it. In this sense, Egypt’s monetary policy is largely directed toward protecting the pound. One negative repercussion from higher interest rates is that interest rates on loans taken by companies will also increase. This will deepen the recession and increase unemployment.
In terms of the move to strengthen the exchange rate against the dollar, the CBE essentially saw that its moves to fight the black market also impacted clients who had taken loans in dollars (due to lack of dollars in the market) and intended to pay back loans in pounds, but were hit by the pound’s several rounds of depreciation. So by strengthening the exchange rate against the dollar, the CBE basically figured that FDI is not coming anytime soon anyways, but clients are at risk of overdraft. So they injected dollars into the banks directly to help banks cover the dollar overdrafts, while strengthening the pound. Through these actions, approximately 25% of overdrafts were covered.
Even so, further devaluations of the pound will need to take place. There are two types of foreign investment that come to Egypt. One is direct and the other is in government treasury bills. Today, we are trying to bring this second type of investments back. Accordingly, we can expect further devaluations of the pound in a few months to bring these in. What is your outlook on Egypt’s economic conditions during the coming year?
Well, there were big expectations that next year will be the year Egypt finally passes through the bottleneck. Yet it now seems that next year will be the bottleneck. I expect a very tight year with higher energy prices and more moves by the government to lower pressures on the budget. The Civil Services Law will be implemented to achieve efficiency and reduce government salaries’ growth from year to year. So from the standpoint of fiscal policy, we can expect more austerity.
When it comes to monetary policy, we are likely to see further increases in interest rates, at least twice, by about 1-2%. Moreover, by mid-2016 we will probably see another round of devaluations, maybe by 4-5% or 6-7% after solving the overdraft problem.
In terms of growth in 2016, economic activity will likely not pick up as expected. There will be no substantial FDI and interest rates on loans will increase, which will slow down growth and exacerbate the recession. That said, I don’t think we will see economic ‘collapse.’ This is just not applicable to a country with such a high consumption base.
What advice would you give to the government and, alternatively, to investors who are eyeing Egypt?
To the government I would say that it is extremely important to share the real economic outlook with people in a realistic format. Do not do what you did a year and a half ago by making all these unrealistic promises. I mean, do not give a very bleak view of things either, but just actually say how things really are and how you plan to get out of this mess. People will definitely appreciate that. Also, stay away from megaprojects, like the one for a new administrative capital and the other one of the million feddans. Instead, work on developing infrastructure across governorates. This is an urgent need, as demonstrated by the consequences of the recent floods. By focusing on infrastructure, you can both avert potential crises and increase economic activity. Additionally, understand that FDI and tourism rates are decreasing and that we should now look toward achieving growth domestically. External flows are not so high anymore.
To investors I would say that while Egypt has become a risky venture as of late, some sectors are characterized by being very stable, like defensive sectors built on local consumption. Egypt has 90 million people and they all eat, require health and education services and so on. Investing in these sectors now will allow you to gain a strategic position in the market that you may not be able to attain later on.
In the coming period, austerity measures will push the government to offer many public-private projects that could be very rewarding for long term investors. Now is the time to invest in food and beverages, education, and health sectors. These sectors are all very consumer-oriented, very lucrative and offer massive returns. However, investors coming here should be looking for a long-term position. Exit and entry into the Egyptian market is not easy, unless you are coming for the long-term where you benefit from very cheap infrastructure. Indeed, this is what multinationals are doing today.
This article is part of Egypt Today's five-part series looking at the nation's road to economic recovery. Despite the uncertainties, this past year has seen investors eyeing Egypt's market quite favorably, predicting that in the long run the country's economic outlook will turn positive. In this package, we ask investment gurus to weigh in on the current investment climate, including interviews with the MENA CEO of DHL in addition to Philips to get their take on the state of Egypt's economy. We also spotlight one investment in the country's attractive education sector: the scheduled opening of prestigious British school Malvern College.
Read the full series now in the December issue.