SCENESETTER FOR SECRETARY SNOW

C O N F I D E N T I A L CAIRO 002991

SIPDIS

SIPDIS

E.O. 12958: DECL: 05/18/2016
TAGS: PREL PGOV ECON EFIN EAID ETRD EG SU IS KPAL
SUBJECT: SCENESETTER FOR SECRETARY SNOW

Classified by DCM Stuart Jones for reasons 1.4(b) and (d).

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Summary and Introduction
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1. (C) We look forward to welcoming you to Sharm El Sheikh.
You come at a tense time for Egypt. The Mubarak regime has
come under criticism for its heavy-handed response to
demonstrations supporting jailed opposition leader Ayman Nour
and judges who criticized corruption in the last election.
The demonstrations were part of wider pressure both domestic
and foreign, for greater democratc and economic reform.
Mubarak's succession is te key issue overshadowing all other
political cocerns. On the economic front, although the
econoy is growing at six percent, average Egyptians hav yet
to benefit in terms of jobs or improved ecoomic prospects.
The Prime Minister and his Cabint are soldiering ahead with
liberalization of th economy, but face stubborn resistance
from nationalist-statist quarters in and out of government,
especially on Egypt's third rail ) public subsidies.
Widespread concern over inflation compounds the GOE's
reluctance to reduce food and energy subsidies, the latter
constituting the biggest drag on the GOE budget.


2. (C) On the bilateral track, your confirmed senior GOE
interlocutor will be Prime Minister Ahmed Nazif, and we have
a request in to see Mubarak. You may wish to re-state our
concern over the momentum on reform with Nazif and other GOE
officials. Nazif will push back hard and may complain about
USG/Congressional political conditioning of economic and
military aid and the death of the FTA. End summary.

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Economic Reform: Pushing Up a Steep Hill
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3. (C) Nazif's economic team has made significant progress on
economic reform, but now the hard part begins. The banking
sector remains inefficient, and public borrowing tends to
crowd out credit to the private sector. Moreover, public
banks hold the lion's share of the banking sector and are
burdened with bad loans to state-owned companies that will be
costly to eliminate. In line with benchmarks in the
U.S.-Egypt Financial Sector MOU, some progress has been made
re-organizing the Central Bank and creating an interbank
market system for foreign exchange and a Primary Dealers
System for public debt. The GOE has also divested its shares
in the four largest joint venture banks, and the public Bank
of Alexandria (BOA) has been put up for sale. We have heard
informally that the Ministry of Investment (MOI) received 14
expressions of interest in buying the 75-80 percent of BOA up
for sale. Additional progress has been made on consolidation
of the banking sector, and foreign banks are beginning to
enter the market, mostly through purchases of small private
banks. U.S.-based Ripplewood Investments recently led a
consortium that purchased the GOE's shares in Commercial
International Bank, Egypt's most successful private
commercial bank.


4. (C) Egypt's stock market was the best performing
emerging-market exchange in the world for the past two years,
but is now slumping, mainly as a reaction to drops in other
regional exchanges. The Egyptian exchange has recovered
somewhat from its low point in March, but the market is still
not very deep and offers limited services to investors. The
insurance sector is dominated by public companies, but MOI
has announced plans to restructure all of the companies and
privatize at least one. Although we had hoped privatization
would happen quickly, MOI indicates the first company will
not be privatized until 2007. Mortgage finance is minimal,
but the GOE is taking steps to streamline real estate
sale/purchase procedures and facilitate the banking sector's
increasing interest in offering mortgage services.


5. (C) Regarding privatization, MOI has re-invigorated the
program, privatizing 81 companies since July 2004 and
generating approximately LE 20 billion (USD 3.49 billion) in
revenues. Notably, MOI has not shied away from privatizing
companies in sectors previously considered "strategic," such
as construction and petroleum. Several companies have been
sold to foreign buyers, another change from previous
privatization policy. Despite the favorable response to
privatization from foreign investors and the business class,
workers in some of the privatized companies have gone on
strike and/or resigned en masse. This clearly has the
Cabinet concerned, as the pace of privatization has slowed
somewhat in recent weeks. The MOI has also taken pains to
emphasize that workers rights and concerns will be taken into
consideration in all current and future privatizations.


6. (C) Subsidies, particularly for energy, are a heavy
burden on the GOE's budget, constituting almost 40% of public
expenditure. The budget deficit grows even as the economy
grows, dampening Egypt's prospects for an improvement in its
credit rating or outlook. Official figures for the deficit
place it at 10 percent of GDP, but we think it is closer to
15 percent. Concern over public reaction seems to be the
main factor keeping the GOE from reducing subsidies or
accepting job losses from closure of state owned enterprises,
particularly in light of Egypt's high unemployment rate.
Official figures for unemployment stand at 10 percent, but we
think it is closer to 20 percent. Approximately 700,000 new
job seekers enter the labor market each year, requiring the
economy to grow at over 6 percent just to keep unemployment
at current levels.

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Blame the U.S.
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7. (C) With their momentum stalled by political realities,
Nazif and his team are inclined to blame the United States
for, they say, "back tracking" on FTA talks, which they hoped
would drive the next stage of reform. Mubarak has apparently
instructed his ministers not to raise the issue of military
and economic assistance with USG counterparts. The U.S.
provides $1.3 billion in military assistance and about $500
million in development aid annually. Mubarak resents any
political linkage or conditioning of assistance towards
reform. But several members of Congress have expressed
reservations on the size and impact of the Egyptian programs,
especially on the military side. The GOE dismisses these as
irresponsible voices who wish to weaken Egypt to bolster
Israel and insists that the Administration demonstrate its
loyalty to Egypt by standing firm. The U.S. Administration
is committed to current assistance levels, but we need
something positive to take to Congress.

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Political Reform
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8. (C) Gamal Mubarak, Nazif and other reformers insist the
GOE is on track for substantive political reform, despite
recent extension of the Emergency Law for two years,
postponement of local elections for two years, and
state-influenced media attacks on reform advocates. They
tell us that before the current parliamentary session ends
(in late June) new legislation will be passed granting new
press freedoms and greater judicial autonomy. More
significantly, the GOE is working on a package of up to 20
constitutional amendments, to be ratified by mid-2007, and
then submitted to referendum. This package is intended to
drastically change Egypt's political landscape and will
reportedly distribute powers from the executive to the
legislature and contribute to the empowerment of provincial
and local councils.

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Succession: The Lurking Issue
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9. (C) Mubarak's current (and presumably final) six year term
will end in 2011, but many observers expect the transition
sooner. The public fears that Mubarak's domestic
machinations are calculated to establish his son, Gamal, as
his successor. Gamal remains coy and now avoids the
limelight. No real contenders stand in his way ) Arab
League Secretary General Amre Moussa is the only often-named
alternative -- and the existing legal framework clearly
favors Gamal's candidacy. It is not yet clear that the
Egyptian military establishment ) Mubarak pere's traditional
base ) will tolerate the pharaonic succession of decidedly
un-military Gamal. And the idea of Gamal's succession
remains unpopular with the press and public, on principle.
RICCIARDONE