IS THE EGYPTIAN GOVERNMENT READY FOR A GLOBAL SLOWDOWN?

UNCLAS CAIRO 002221

SIPDIS

SENSITIVE

STATE FOR NEA/ELA, NEA/RA
USAID FOR ANE/MEA MCCLOUD AND RILEY
USTR FOR FRANCESKI
TREASURY FOR PARODI AND BAYLIN
COMMERCE FOR 4520/ITA/ANESA

E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV EG
SUBJECT: IS THE EGYPTIAN GOVERNMENT READY FOR A GLOBAL SLOWDOWN?

Sensitive but unclassified. Please handle accordingly.


1. (SBU) Summary: Egypt's stock market, like nearly all globally,
has been significantly down this year and the global financial
crisis has only accelerated that decline. The index is down 50
percent from its April historic highs, and in October, the most
intense period of global financial crisis, the local index shed more
than 20 percent of its value. That said, just a small percentage of
Egyptians are invested in the stock market, Egyptian banks are very
conservative, and Egypt enters this volatile period with strong
growth, so Egypt's real economy has seen relatively little specific
impacts from the financial crisis. However, the Government would
probably like to believe that it is more immune than it is.
President Mubarak has held two Cabinet meetings with his economic
team recently, and several members of the economic team have spoken
publicly about planned reforms and other initiatives to ease the
economic impact of ongoing financial turmoil, including an October
12 press conference by Prime Minister Nazif and an October 19 speech
at the AmCham by Minister of Trade Rachid. The message has been
that Egypt's financial system is safe, that the GOE is monitoring
the situation, and that even in a global recession Egypt will
weather the storm better than others. While we are not aware of any
comprehensive assessments done by the GOE on the specific risks
Egypt faces in this global crisis, some ministers have mentioned
some "new plans" and "incentives" in the press, none of which
contain specificity. End Summary.


2. (U) At a speech to the Amcham on October 16, Minister of Trade
and Industry Rachid warned that although the Egyptian banking sector
is sound, Egypt is nonetheless likely to suffer from the global
economic crisis that he predicted would inevitably follow the
current period of financial turmoil. Following the lines of the
IMF's World Economic Outlook he said, that as OECD countries slow,
growth in 2009 will come from emerging markets, including China,
India, Indonesia and Egypt. He expressed concern, however, that a
protectionist trend may emerge and said that WTO's Lamy had called
him about an emergency meeting. The financial crisis, he said, is a
"hurricane that must pass" but noted that it would create
opportunities for some companies and countries. On the positive
side, for Egypt, the drop in commodity prices would lead to a drop
in inflation, which, at 20-plus percent year-on-year, has been one
of Egypt's biggest economic concerns.


3. (U) In the case of Egypt's banking sector, which Central Bank
Governor El Okdah publicly described last week as "highly liquid,"
Rachid observed deposits are safe and lending continues. This
stability has meant that the GOE's economic team has been able to
focus on the looming economic slowdown which Rachid predicted would
affect Egypt's exports, and other significant sources of forex,
including tourism, foreign direct investment, remittances and Suez
Canal revenues. Egypt has been spared the financial crisis, he
said, noting that the GOE now needs to be forward thinking on
sectoral initiatives to "at least minimize the damage" if not take
"full opportunity of the disruption."


4. (U) Rachid said that under current economic conditions, the
appropriate policy response in Egypt is "a higher level of
engagement" on economic reform. To continue at the same pace, he
said, would be to lose ground and see GDP growth rates fall to 3-5
percent. Egypt needs 7 percent GDP growth to control unemployment
and address poverty. His goal, he said, is full manufacturing
utilization rates, no layoffs, and completion of the 1000 factories
now under construction. To meet these goals, he said, the GOE will
design a set of reforms and measures for every sector, with an
overall strategy of: ensuring adequate access to finance, continuing
to attract private investment, including by Egyptians, and
maintaining the government's infrastructure investment program.
This will include pushing Egyptian banks to increase their lending
activities. He also suggested that he will engage more actively
with emerging markets such as Turkey and China, and maintain trade
and investment flows with India and Africa.


5. (SBU) Rachid's remarks followed an October 12 press conference by
Prime Minister Nazif, Central Bank Governor El Okdah and Minister of
Investment Mohieldin in which they recited many of the statistics
which indicate Egypt's financial stability and safety. El Okdah
reviewed the strong position of the Egyptian financial system, in
part due to reforms begun in 2004; noting that net international
reserves (NIR) are safe and are in Treasury bonds in safe countries;
the NIR is diversified; Egyptian banks have a relatively small
amount invested overseas; and loan-to-deposit ratios are much lower
in Egypt than in other countries.


6. (SBU) All of these things are true. Egypt has been relatively
slow to introduce new financial products, which in the current
environment, makes them appear wise. Also, the CBE's bank reform
program of the last few years has contributed to the improved asset
quality and the more cautious approach towards lending of most
banks. While this has led to low credit availability and a slow
credit growth, it leaves the banks in good stead in this
environment. However, while starting from a very low base, the last
several years have seen growth in some new financial instruments
like mortgages, credit cards, and consumer credit. While this type
of credit is still a relatively small portion of overall credit, and
it is primarily concentrated in a small handful of banks, some
analysts are already warning that given the lack of familiarity with
a credit culture and absent better financial literacy, that even
this small amount of new credit could begin to pose some system
risks.


7. (U) In the period between the Nazif press conference and the
Rachid speech, several sectoral ministers hinted at the kind of
reforms the GOE may be contemplating. Transport Minister Mansour,
for example, hopes to attract more investment in ports and road
projects. Housing Minister Al Mahgrabi said a new plan will be
announced to boost activity in the building materials sector. In
addition to announcing delays in removing energy and other subsidies
in the industrial zones, and eliminating the export tax on cement,
Rachid has said that Egypt's Export Guarantee Company will receive
additional capital. He also said new incentives could be offered to
license industrial projects, and credit for industrial projects
could be enhanced. Rachid told the Ambassador on the margins of the
Amcham speech that he hoped to use the urgency of the crisis to
accelerate additional economic reform.


8. (SBU) Additionally, the Ministry of Investment (MOI) will use
financial crisis to push implementation of an existing plan to
create a single regulator for the Capital Markets Authority, the
Mortgage Finance Authority and the Insurance Authority. MOI has
been working on this key reform measure for some time. Mohieldin
told us over the weekend that the ministry will cite the financial
crisis when it submits the draft single regulator law to parliament
in November. According to the minister's advisor, MOI will argue
that the draft law is a key part of the GOE's response to the
financial crisis, and ask parliament to pass the law expeditiously.
MOI is targeting January 1 for passage of the new law, but the
minister's advisor said it could possibly happen by the end of
November.


9. (SBU) Comment: There are few specifics of any of the "new
proposals" being discussed, and given an absence of analysis about
how slower global growth will affect Egypt, it is hard to know
exactly where Egypt should focus any "new efforts." Clearly Egypt's
economy is linked to external developments, so reductions in
tourism, Suez Canal receipts, and foreign direct investment could
all contribute to slower growth. Clogged credit markets have
reportedly already started affecting exporters who depend on letters
of credit in order to ship goods. Anecdotally, we have heard
bankers mention that the L/C market has been affected, something
that will impact Egypt's export-dependent growth strategy. That
said, Egypt has a large domestic demand, an increasingly diversified
manufacturing base, a huge government sector which continues to
employ huge masses, so even if growth drops off, it will still be
above historical norms. And, while oil prices are falling, and Gulf
countries may have less to invest, they still are relatively well
off to continue to invest in Egypt.


10. (SBU) Comment (cont): Egypt's reformers have been riding a wave
of global praise in recent years, so in some ways may think of
themselves as infallible. Global financial crisis or not, the
economic team needs to redouble its efforts to keep Egyptian growth
at a high and sustainable level and to fix the inequitable growth
which has worsened with years of inefficient subsidies. While
subsidy reform was a part of Mubarak's lexicon after last year's NDP
party conference, it has disappeared in the current environment;
Rachid refused to answer a question at the AmCham on removing
subsidies. Given the declining cost of commodities and lack of
political will to take on tough reforms, we expect that the GOE will
continue to use subsidies as its principal way to help the poor.
While this may help with public perceptions, it ignores long-awaited
reforms needed for long-term economic growth in the areas of the
education, land ownership, housing, the civil service and the
welfare system. It is worth noting that Finance Minister
Boutros-Ghali has not yet weighed in publicly. It will be
interesting to see if any "incentives" which are rolled out run
counter to his goal of fighting the deficit.
SCOBEY