EGYPT: FINANCIAL SECTOR MOU UPDATE, PART I

UNCLAS CAIRO 005001 SIPDIS SIPDIS SENSITIVE STATE FOR NEA/ELA, NEA/RA, EB/IDF AND EB/OMA USAID FOR ANE/MEA MCCLOUD AND DUNN USTR FOR SAUMS TREASURY FOR NUGENT AND HIRSON COMMERCE FOR 4520/ITA/ANESA/TALAAT E.O. 12958: N/A TAGS: ECON EFIN ETRD EINV EG SUBJECT: EGYPT: FINANCIAL SECTOR MOU UPDATE, PART I Sensitive but Unclassified. Not for Internet distribution. REF: A. Cairo 1838 ¶B. Cairo 3746 -------------- Summary and Introduction -------------- ¶1. (SBU) Since the last update on the status of the Financial Sector MOU (Ref A),the GOE has met all of the benchmarks for disbursement of USD 25 million in DSP-II funds tied to Policy Item 1 - Central Bank Management. The GOE has indicated that it expects to complete, by September 2006, all of the benchmarks for disbursement of USD 25 million tied to Policy Item 2 - Government Securities Market, and USD 100 million tied to the first part (public bank audits and joint venture bank divestment) of Policy Item 3 - Financial Sector Reform. Once all of these benchmarks have been met, the GOE intends to request one large disbursement of funds. ¶2. (SBU) The GOE and the USAID Mission are close to finalizing a Monitoring Program for the MOU that will specify the documentation needed to certify that benchmarks have been met and funds can be disbursed. Agreement on the Monitoring Program, however, awaits the outcome of discussion between the USG and GOE regarding use of the term "full financial due diligence" versus "audit" for the financial assessments of the public banks required by benchmark 3.1. The Ambassador has conveyed to the Minister of Finance the U.S. position that the 2006 report may be called "full financial due diligence," but subsequent annual reports required by the MOU must be called "audits." Post will report septel when GOE agreement has been confirmed. End summary and introduction. -------------- Policy Item 1 - Central Bank Management -------------- ¶3. (U) USD 25 million in DSP funds are tied to completion of the following three benchmarks for Policy Item 1: Benchmark 1.1 - The Central Bank of Egypt (CBE) will establish and appropriately staff units for: - Monetary Policy: Completed - CBE established a Monetary Policy Unit in October 2005. The unit provides support for the Monetary Policy Committee (MPC), which was established in June 2005 and is composed of members from various GOE ministries and CBE. The MPC is responsible for setting overall monetary policy, including key interest rates. - Foreign Exchange Management and a Foreign Exchange Dealers System: Completed - An inter-bank market for foreign exchange was set up in September 2004 and the convention governing inter-bank foreign exchange trading was formally adopted in December 2004. CBE also established a Foreign Exchange Unit in December 2004 (an extension of the previously-existing Foreign Exchange Dealings Chamber). A foreign currency clearing mechanism was created in October 2005. - Non-performing Loan (NPL) Management Unit responsible for setting a national policy of dealing with NPLs, setting up and NPL data base, monitoring recovery efforts and introducing an arbitration/conciliation mechanism for NPLs: Completed - CBE set up an NPL Management Unit in October 2005. The unit supported efforts by the CBE, Ministry of Finance (MOF) and Ministry of Investment (MOI) to develop a national NPL policy, which was first announced in January 2006. Further details of the policy were announced earlier this month (see para 8). The unit has also set up an Arbitration Committee to conduct settlement negotiations and a monitoring program to track implementation of negotiated resolutions. Benchmark 1.2 - CBE will hire the required competent advisors. Completed - CBE has completely restructured bank management and hired numerous private sector bankers to work in the new units established at the bank. USAID has funded the hiring of some of these advisors. Benchmark 1.3 - CBE will introduce an optional early retirement policy and compensation scheme for the CBE. Completed - CBE announced its optional early retirement policy and compensation scheme in two stages, the first in May 2006, for employees aged 51 to 55, and the second in June 2006 for employees aged 46 to 50. According to CBE Deputy Governor Tarek Amer, over 1000 employees (approximately 20 percent of CBE's workforce) have taken the early retirement option and left CBE's personnel rolls. -------------- Policy Item 2 - Government Securities Market -------------- ¶4. (U) The U.S will disburse USD 25 million in DSP funds upon completion of the following three benchmarks for Policy Item 2: Benchmark 2.1 - Implement a Primary Dealers System with dealers underwriting new government debt issuance through auctions and trading of government securities on the open market. Completed - The Primary Dealers System was launched in July 2004. It allows 13 financial institutions registered with the MOF, including banks and bond dealers, to underwrite primary issues of government securities and activate trading in the secondary market through sale, purchase and repurchase agreements of government securities. Information on the Decree and Executive Regulations establishing the Primary Dealers System can be found at: www.mof.gov.eg/debt. Benchmark 2.2 - Initiate trading of government bonds off the stock exchange in an open market where buyers and sellers may directly trade. Completed - The Primary Dealers System was restricted, in the first quarter of FY 2004/05 (July - September 2004),to Treasury Bills in order to ensure efficient functioning of the system. In October 2004 it was extended to bonds. A secondary market for government securities, working through the Primary Dealers System, has developed and trading is taking place off the stock exchange, i.e., over the counter, but the Capital Market Law requires that all over the counter transactions be reported to the Capital Market Authority. Benchmark 2.3 - Establish the legal status of and launch operation of Repurchase Agreements for government securities consistent with international best practices. Pending - A Repurchase Agreement template was drafted by the Ministry of Finance and circulated to banks for comment via the CBE. Amendments to the Capital Market Law to allow short selling are still pending but are expected to be issued by September. -------------- -------------- Policy Item 3: Financial Sector Reform/Privatization -------------- -------------- ¶5. (U) The U.S. will disburse USD 100 million in DSP funds for completion of the following two benchmarks for Policy Item 3: Benchmark 3.1 - Auditing of the four largest state-owned banks by an internationally recognized impartial institution in accordance with standards set by the International Accounting Standards Board (IASB). Pending - The audit of Bank of Alexandria (BOA) was completed in late 2005, and according to CBE Deputy Governor Tarek Amer, auditing of National Bank of Egypt, Banque Misr and Banque du Caire has been completed by BDO-Seidman International, KPMG International and Deloitte, Touche and Tohmatsu, respectively, but the reports have not yet been released publicly. Benchmark 3.2 - Divestment of GOE shares in the four largest joint venture banks. Completed - The GOE divested all of its shares in the four largest JV banks, i.e., Misr-International Bank; Egyptian-American Bank; National Societe Generale Bank and Commercial International Bank. ¶6. (U) The U.S. will disburse USD 150 million in DSP funds upon completion of the following benchmark for Policy Item 3: Benchmark 3.4 - Privatization of the candidate bank (BOA). Pending - As reported in Ref B, on August 2, CBE and MOI announced a short list of six candidates who will be allowed to carry out their own due diligence on the bank. Final financial and technical offers from the short listed bidders are due at the end of September. The GOE audit and due diligence on BOA was completed in late 2005. In accordance with the national NPL policy, the bank's NPL portfolio (LE 6.9 billion) was settled in February 2006, using proceeds from the Telecom Egypt IPO in December 2005. As noted in Ref B, GOE contacts have given various estimates, ranging from September to December 2006, for completion of the sale. ¶7. (U) The U.S. will disburse USD 200 million in DSP funds, on an annual pro rata basis, upon completion of the following benchmark for Policy Item 3: Benchmark 3.5 - The private sector banks' share of new loans made in the banking system during the previous calendar year will be equal to at least 62.5 percent. Intermediate progress toward this goal will be measured from the baseline determined by the initial audit referenced in benchmark 3.1 and calculated each year by annual audits of banks according to IASB standards. Pro-rata disbursements against this benchmark may be made for annual increases in the private sector banks' share. Pending - Progress on this benchmark can only be measured when the 2006 full financial due diligence reports on the public banks are issued. ¶8. (U) The U.S. will disburse USD 250 million in DSP funds, on an annual pro rata basis, upon completion of the following benchmarks for Policy Item 3: Benchmark 3.6 - The share of NPLs as a proportion of all loans in the banking system will be reduced by 50 percent from the baseline determined by the audit of the four largest state-owned banks and the annual audit of private sector banks. Pending - Progress on this benchmark can only be measured when the 2006 full financial due diligence reports on the public banks are issued. However, according to IMF, NPLs declined from approximately 26 percent of total loans in April/May 2005 to 25 percent by December 2005. Beginning in June 2005, provisioning also increased as a percentage of NPLs from around 53 percent in June 2005 to 55 percent in December 2005. Earlier this month, CBE Governor El Okdah held a press conference to announce details of the national NPL policy. El Okdah claimed that 46 percent of total NPLs in the banking sector had already been resolved. After settlement of BOA's NPLs in February 2006, the remaining NPLs held by public banks totaled approximately LE 26.1 billion. These NPLs would be settled with proceeds from the GOE's privatization program, including sale of BOA, and revenues from issuance of a third cellular phone license. El Okdah also noted that about one half of private sector NPLs held by public banks had been resolved by individual bank settlement units, supported by CBE's Arbitration Committee. Benchmark 3.7 - The cash recovery on NPLs will equal at least 20 percent of the book value of NPLs to be disposed of under the previous benchmark. Pending - Progress on this benchmark can only be measured when the full financial due diligence is completed on the remaining public sector banks. However, according to CBE, of the 46 percent of total NPLs that have been settled, 27 percent were collected, including cash recoveries of 24 percent of the overall debts resolved. ¶9. (U) Post will report on GOE progress on Policy Items 4-6 septel. RICCIARDONE