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Just what the doctor ordered.

After years of promising, Egypt has embarked on a radical economic reform programme based on liberalisation and dismantling state controls. If the changes are carried through, the foundations may at last be laid for steady and sustainable growth. Simon Bindle reports on the main features of the programme and Nadia Amin focusses on privatisation and the revival of the stock market.

IN MAY 1991, almost four years to the day after one abortive standby credit agreement was reached with the IMF, Egypt and the Fund formally concluded a hard fought over accord on another economic reform programme. The medicine may taste unpleasant and there could be nasty side effects from the treatment ordered by the IMF. But this reform programme at last shows signs of setting the patient on the road to recovery.

While some observers claim that Egypt was let off lightly because of its vital role in the international coalition against Iraq in the Gulf war, the IMF nevertheless insisted that a large part of the agreed reform programme be carried out in advance of a $372m standby credit being approved. The IMF prescription for the ailing Egyptian economy centred on three main elements -- exchange rates, interest rates and the budget deficit. Progress in all these areas has been good and, in some cases, better than expected.

Exchange rates, which for years included unrealistic official and semi-official rates that disguised the true costs of imports, have now been liberalised. With the Egyptian pound virtually unchanged against the US dollar since flotation last February (when it stood at $1=E 3.30 [pounds]) IMF expectations of a 15% depreciation over the year appear to have been confounded. Moreover, if the pound is actually undervalued as some bankers have suggested, local currency deposits will be in demand and further underscore its stability.

The response of the banking sector to the free exchange rate system has been cautious. In the past, banks have operated more as buyers of foreign currency than sellers. However, as supply and demand of foreign currency appears to be already well in balance, many banks are taking up the challenge.

The new system allows non-bank dealers to exchange cash and travellers cheques subject to certain restrictions. Licensed dealers must operate within limits on their operating accounts and are allowed no more than three branches. While some banks fear increased competition for the relatively small volume of funds will result in business failures and possibly speculation on the pound, others welcome the dealers who are often better able to operate in villages and rural areas. To date all four state-owned commercial banks and a number of joint venture banks have decided to invest in money dealing firms.

A central element of the interest rate reform, which replaced the previous fixed rate system with a free structure, was the introduction in January 1991 of Treasury bills. Demand from institutions and individuals is reported to have increased susbstantially over the first 15 months and until April 1992 the volume of bills issued totalled some $3.9bn. The bills have now effectively become the reference point for interest rates as well as a means of linking government spending to the availabe money stock.

The downside is that some banks have experienced a severe squeeze on funds. While loans issued at lower rates prior to liberalisation have had to be honoured, higher rates have had to be offered to dipositors to attract customers. In addition, the government's tight fiscal policy, the imposition of credit ceilings and the siphoning off of liquidity with the introduction of Treasury bills has had an adverse effect on the inter-bank market.

For businesses, shortages of funds have meant that credit has become more expensive. While banks have continued to offer competitive overdraft terms to favoured multinational clients to ensure that they do not take their custom elsewhere, smaller and less prestigious firms have found it increasingly difficult to secure loans.

The financial sector currently has its eyes fixed on imminent changes in banking legislation. A new banking and credit law adopted by parliament in June gives the Central Bank of Egypt (CBE) extensive new powers. The new measures allow CBE to order banks to raise new capital or to merge with other institutions, set limits on the amounts that can be lent to individual cleints and object, in certain cases, to the appointment of directors, managers or external auditors. Local banks will be required to have an authorised capital of at least $30m and foreign banks a minimum of $15m.

In line with the resolutins of the Basel Committee, capital adequacy rates have been set at 8% of capital and reserves. Foreign banks, effectively shut out of the foreign exchange market since 1987, will finally be allowed to handle local currency transactions and foreign banks not having branches in Egypt will be allowed to open representation offices. Finally, CBE will offer depositors guarantees against business failures by setting up a Deposit Insurance Fund under its direct control.

While most commercial, investment and joint venture banks have yet to release their 1991 result, the indications are that the majority have managed to show healthy profits. In the longer term, the liberalisation of exchange rates and the stability of the pound have attracted deposits, particularly from expatriate workers, which gives cause for optimism in the future.

Progress on reducing the budget deficit has largely resulted from Egypt's net financial gains from the Gulf war. Following the decision by the United States, shortly after the Iraqi invasion of Kuwait, to cancel Egypt's high interest $7bn military debt, the Paris Club and the Gulf states followed suit by writing off $10bn and $7bn rescpetively. Egypt's foreign debt has thus been reduced from $49bn to under $29bn.

The upshot is that Egypt's balance of payments has rarely looked in better shape. With an extra $1.7bn on the credit side as a result of forgiven or deferred debt service charges and an unexpectedly good performance by the principal foreign exchange earners -- workers' remittances, tourism, petroleum exports and Suez canal revenues -- foreign currency reserves are reported to have jumped to the equivalent of five months of imports.

Local currency reserves from customs dues, an improved income tax colletion system and the recently introduced sales tax are also reported to have shown a substantial increase. Add to this a significant decrease in government spending and the budget deficit for the fiscal year to the end of June could be as low as 7% of gross domestic product (GDP), well within the IMF target of 9.3% and within striking distance of the 6.5% target for 1992-93.

Progress on the macro-economic front, however, has not come without a price for the bulk of Egypt's 55m population. In a May Day speech in 1990 President Husni Mubarak spoke of an imminent agreement with what he called "the fund of misery". The president told Egyptians there was "no way out" and they would have to endure further hardships and belt tightening. According to a recent consumer price bulletin issued by the Central Agency for Mobilisation and Statistics, price rises this year averaged 15.7% on food and drink, 22.5% on transportation and 32.4% on rents, electricity and fuel. The bulletin shows a marked increase in inflation following the IMF agreement, peaking at an annual rate of 26.1% in January this year and settling at 21% in March (although some independent analysts put the rate as low as 17%).

While it may not be much consolation to Egypt's struggling population there is a general feeling of optimism among policy makers and economists that the worst may already be over and that the inflationary pressures brought about by the price rises required by the IMF have been more or less contained.

The government's decision at the end of May to remove import restrictions has also been welcomed. Previous legislation banned the import of many basic commodities such as live sheep, meat, fish, cheese and dairy products, tomato paste, sugar, flour, sesame, lentils and beans. The new legislation lifts the ban and allows importers to set their own prices, except for sugar and flour which are still subsidised by the state. The hope is that free market forces will eventually lead to price reductions to the consumer.

While the IMF programme has generally got off to a good start regarding reforms on exchange rates, interest rates and measures to reduce the budget deficit, the government appears to be draggin its feet over the most controversial of reforms, privatisation, amid concern about the social and political fallout. A first cautious step to dispose of state assets was taken at the end of 1990 when governorates were given the go-ahead to sell off their small businesses. Numbering about 1,700, these include poultry units, dairies, and even retail outlets. State assets in several joint venture companies have also been auctioned and floated on the stock market in what have been described as "pilot privatisation projects".

More recently, loss-making public sector companies and businesses in which the state has a major share are being reorganised under the control of holding companies (see page 39). Their responsibility will be to restructure and improve the efficiency of the firms under their control and bring them into profit or, if necessary, sell them or close them down. While the private sector is well represented, it is not clear who will have ultimate control.

Slow progress has prompted some observers to question the government's real commitment to privatistion. Many are not convinced that the same people in the higher echelons of the bureacracy who have been committed to central planning are willing or able to lead Egypt towards a free market economy. Businessmen say they are frustrated by inconsistent behaviour by officials who have done little to encourage or inform them about a programme that is dependent on their participation.

With an estimated $45bn worth of state assets in the balance, the need for a radical reform of capital markets is paramount. Other changes are needed to unify taxation rates for Securities and to remove existing restrictions on the levels of yields allowed for financial instruments such as commercial paper and corporate bonds.

A draft law on capital markets has been put before parliament. While the government has proposed that intermediaries and brokers be allowed to participate in the sale and purchase of shares, that computerised trading be introduced on the Cairo and Alexandria stock exchanges and that bearer shares be issued to promote secondary trading, it is clear that much still needs to be done to create an appropriate infrastructure and legal framework for the expected levels of investment (see page 43).

In sharp contrast to other sectors of the economy, privatisation in the tourism sector is moving ahead quickly. Following the sale last year of the Cairo Meridien for $75m and the Hurghada Sheraton for $50m, two foreign consultants, Citicorp and Coopers and Lybrand, have been appointed to evaluate the investment portfolio and assets of the Egyptian General Organisation for Tourism and Hotels (EGOTH). This will pave the way for the sale of other prestigious hotels such as the Cairo and Luxor Sheratons, Mena House Oberoi, Aswan Oberoi and Sheraton Floating Hotels.

According to the minister of tourism, Fuad Sultan, himself a former investment banker, privatisation in the tourism sector has become a major element of the economic reform programme and includes not only changes in the ownership of projects but the liberalisation of the entire admnistrative and investment decision-making system.

For the future, the main devidends of the IMF agreement, apart from the massive debt reductions, are a $372m 18-month IMF standby credit, a $300m World Bank structural adjustment loan, $250m worth of loans from the African Development Bank and the European Community and the opening of new lines of credit by individual donors.

In addition, a Social Fund for Development has been set up to help offset the negative impact of economic reforms by channelling welfare and other state assistance to those most affected. The aims of the fund are to create 150,000 jobs over the next four years, provide training to the unemployed, currently estimated at three million, and address the complex issue of transportation in Egypt's two most crowded cities, Cairo and Alexandria. The main components of the fund relate to municipal services, improvements to public transport, community development, enterprise development, mobility and institutional development.

The size of the fund has mushroomed from the original $400m pledged by the World Bank and the European Community to $610m as a result of donations by various Gulf Arab countries and individual member of the EC. Although it has taken more than a year to negotiate agreements with donors, pass relevant legislation through parliament and recruit qualified staff, $190m has already been received and since February short and medium-term loans at special interest rates of 10% have been disbursed to individuals wishing to start up small businesses. A $20m "productive families programme" will enable an estimated 7,000 families to set up cottage industries such as weaving, knitting and food processing, while a $21m public works project will provide jobs for 30,000 workers on a project to protect and develop the Nile river.

The current IMF standby agreement comes to an end in November this year, by which time the two sides should have completed negotiations on another. Whether the longer-term IMF programme achieves its stated aim of brining about sustainable economic growth will depend on how effectively the detailed management of the reforms is implemented.

Previous disagreements have usually been about the pace of reform, between reforming on a grand scale like certain East European countries or adopting a gradualist approach taking social and political considerations into careful account. The latter, favoured by the Egyptian authorites, appears to have won the day. However, by agreeing to the IMF programme, Egypt has effectively embarked on a 180-degree turn from the past that involves a massive reduction of state controls and a radically different approach in setting the economic agenda for the future.
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Title Annotation:Special Report on Banking and Finance in Egypt; economic reforms in Egypt
Author:Brindle, Simon
Publication:The Middle East
Date:Jul 1, 1992
Previous Article:Come in, the door is open.
Next Article:Shock to the system.

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