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). -------------- Summary and Introduction -------------- ¶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. -------------- Economic Reform: Pushing Up a Steep Hill -------------- ¶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. -------------- Blame the U.S. -------------- ¶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. -------------- Political Reform -------------- ¶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. -------------- Succession: The Lurking Issue -------------- ¶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