Egypt Country Report-18May08

8/3/2019 Egypt Country Report-18May08

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Egypt Economy Also available at www.hc-si.com

General Information

Egypt Capital Market Indicators

Market Cap USD121bn

% of FY07 Nominal GDP 89%

Equity Turnover in 2007 USD44bn

Equity Turnover YTD USD46bn

HCMI Performance

2005 127%

2006 4.6%

2007 51%

2008 YTD -5.5%

Corporate Earnings Growth

2006 37%

2007 35%

2008 (expected) 16%

Market P/E

FY07 18.2x

FY08(forecast)

15.3X

Summary

AchievementsEgypt managed to grow at 7.1% in FY07 versus 6.9% in FY06 and 8.1% in 2Q07/08against 6.6% in 2Q06/07. This gave Egypt several reasons to rejoice as it managed to

draw foreign investors' attention and managed to place itself on the map of worldinvestments. Foreign direct investments (FDI) almost doubled reaching USD11.0 billionin FY07 in comparison to USD6.1 billion in FY06 and it expected to reach USD15.0 billionin FY08 on the back of vast interest coming from the west and the Arab world, coupledwith the expected sale of a 51%-67% stake in Banuqe du Caire scheduled to take place

by the end of fiscal year 2008.

US sub prime crisis and its impact on EgyptFY08 is not expected to be hit by the slowdown in the US and the expected slowdown in

Europe. Results might be seen in FY09 on trade, workers remittances, and tourism.However, we expect investments to pour in emerging markets that are rich in naturalresources and have potential for growth in the primary sector, especially sincecommodity and oil prices are skyrocketing, and so Egypt might attract more foreigninterest. Egypt has potential in the oil and gas, petro-chemicals, gold mining, and the

agriculture sectors.

SetbacksEgypt has a setback arising from an increasing budget deficit on the back of heightenedinflation rates that hit 16.4% in April 2008. The government plans to increase thesubsidy and wages bills to accommodate the surge in local prices. In that respect, the

government's plan of an annual reduction of 1.0% of budget deficit to GDP has beenput aside. Also, the hikes in the overnight deposit rate seems to have had little if not

any impact on the three months and the one year deposit rates offered at local banks.The government is thus resorting to other methods to curb inflation such as banningexports of cement and rice. This in itself, if continued, might depress foreigninvestments and free trade.

Table 1: Economic Indicators (FY02-FY07)

FY02 FY03 FY04 FY05 FY06 FY07

Real GDP Growth (%) 3.2 3.2 4.1 4.6 6.9 7.1

Nominal GDP (EGP bn) 378.9 417.5 485.3 538.5 617.7 731.2

Inflation-CPI (%) 2.4 3.2 4.9 11.4 4.2 11.0

Inflation-WPI (%) 2.1 11.7 17.4 10.1 4.0 10.1

Total Domestic Debt (% GDP) 87.0 88.8 89.6 94.9 96.1 87.1

Gov. Domestic Debt (% GDP) 58.4 60.4 60.3 64.8 62.8 65.3

3- Months T-Bills Avg Yield (%) 7.8 8.3 8.4 10.4 8.8 8.6M2 Growth YoY (%) 15.4 16.9 13.2 13.6 13.5 18.3

Government Exp. (EGP bn) 115.5 127.3 145.9 161.6 204.5 222.0

Government Revenues (EGP bn) 78.3 89.3 102.0 110.8 149.5 180.2

Overall Budget deficit/GDP (%) 10.2 10.5 9.5 9.6 8.2 7.5

NIR (USD bn) 14.1 14.8 14.7 19.3 22.9 28.6

Reserves (import months) 11.6 12.0 9.7 9.6 9.0 9.1

*Egypts fiscal year ends in June.Source: CBE, MOF, HC Brokerage

Disclaimer

AnalystReem Mansour, MA ECID &

Yasmin El Batrawy

Tel + 2 02 3749 6008 (ext. 368 & 362)

e-mail

[email protected] ,

[email protected]

SalesTel + 2 02 3749 6008Fax + 2 02 3749 6051

This memorandum is based on information available to the public. This memorandum is not an offer to buy or sell, or a solicitation of an offer to

buy or sell the securities mentioned. The information and opinions in this memorandum were prepared by HC Brokerage from sources it believes to

be reliable and from information available to the public. HC Brokerage makes no guarantee or warranty to the accuracy and thoroughness of the

information mentioned in this memorandum, and accepts no responsibility or liability for losses or damages incurred as a result of opinions formed

and decisions made based on information presented in this memorandum. HC Brokerage does not undertake to advise you of changes in its opinionor information. HC Brokerage and its affiliates and/or its directors and employees may own or have positions in, and effect transactions of

companies mentioned in this memorandum. HC Brokerage and its affiliates may also seek to perform or have performed investment-banking

services for companies mentioned in this memorandum.

Research Department

Egypt Country Report

24 April 2008

Update Report Glory Tinted With Rust


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Egypt - Economy 2

Table of Contents

I. Summary 3

II. Who can help? 5

III. Fiscal Policy 8

IV. Monetary Policy: Inflation Under A Microscope 15

V. Investments, the Name Of The Game 19

VI. Balance of Payments 21

VII. US Sub Prime Crisis & Egypt 26

VIII. The Map of Investments 28

IX. The Egyptian Stock Market 32

X. Appendix: Key Macro Indicators 34

XI. Appendix: Main CBE Banking Regulations 35


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Egypt - Economy 3

I. Summary

Playing Devil's Advocate

Fiscal Policy

Egypt celebrated two years of a falling deficit to GDP but this has now come to an end. AlthoughEgypts budget deficit fell from 8.2% in FY06 to 7.5% in FY07, this trend is not expected to betaken forward, with the government expenditures far surpassing revenues due to raisingsubsidies and wages to accommodate for rising inflation rates. Tax revenues grew by 16.6% inFY07, which can be considered pretty high. Only when compared to FY06s growth rate of29.7%, do we realize that the government may not be able to sustain such high levels of taxrevenues over the years. We expect the growth rate of tax revenues will continue to fallgradually over the next few years, and then stabilize eventually, along with a gradual reductionin privatization proceeds over the years since it is viewed as a non recurring source of income.

As a result, our outlook over the countrys future deficit is a skeptical one. In its attempts totame escalating inflation rates, the government has been increasing subsidies substantially,whether it is on food or energy, as well as raising salaries and wages. This only strains thegovernments budget further, resulting in a widening deficit. Moreover, growth in government

expenses is not matched by revenue growth at the same rate. on May 1st, 2008, the governmentapproved (a) 30% raise in salaries to the public sector amounting to EGP6.2 billion (b) a 20%increase in pensions where a floor limit of EGP100 per month is set this should cost thegovernment EGP3.5 billion (c) a 25%-75% boost in incentive payments to local council workersthat would at amount to EGP1.3 billion (d) subsidies of basic goods, including sugar, rice andcooking oil which will cost EGP1.6 billion. These increases will cost the government a total ofEGP14.0 billion. Later in the month on May 6th, 2008, the government announced the followingplan to raise revenue to be able to cover the aforementioned costs (a) free zone incentivesoffered to energy intensive companies are removed (b) extraction fees on clays and quarries areimposed (c) vehicle license fees are raised to 2% of the total amount of cars above 2000cc (d)sales tax on cigarettes increased (e) tax exemptions on treasuries and educational institutionsare removed (f) the prices of 90, 92 and 95 octane gasoline, industrial natural gas, diesel andkerosene increased. This should generate 12.0 billion to the government. We are concernedabout the government's ability to decrease budget deficit to the announced 4.5% to GDP by2010.

Monetary Policy & InflationDue to the Egyptian economy seeing rapid growth, inflation has also seen unprecedenteddouble digit rates; up from 4.2% in FY06, to 11.0% in FY07 and reaching 16.4% in April 2008signaling negative real interest rates. Reasons behind skyrocketing inflation rates range fromrising international food prices to increased domestic demand and consumption, surging oilprices which hit record highs of USD122 per barrel in May 2008, and skyrocketing cement andsteel prices that fed into rising real estate prices.

In response to higher inflation, the Central Bank of Egypts Monetary Policy Committee hikedboth overnight deposit and lending rates in three consecutive meetings by125bps, from anearlier 8.75% and 10.75% to 10.0% and 12.0% respectively. This upsurge, however, was not

reflected in the three month deposit rates of commercial banks, thus having practically no effecton inflation rates. We believe that an appreciation of the EGP against the faltering USD may bepursued as a strategy to limit imported inflation, and can be maintained in the short term,however, we expect the fair value of the EGP to USD to depreciate in FY09.

Foreign CurrencyWith the Fed cutting interest rates in an attempt to rectify the economic situation in the US, andthe CBE raising its overnight deposit and lending rates in hopes of lowering inflation rates, thecurrent nominal spread between the two currencies comes in at a remarkable 800 bps.

Moreover, Egypts shadow exchange rate, which determines whether or not it is trading at a fairvalue, shows that the EGP is currently trading at its fair value. And with a huge stack of FXfortunes standing at USD33.8 billion as of April 2008, the CBE has the luxury to allow the EGP toappreciate against the USD without having to worry about dollarization over the short-medium

term.


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Egypt - Economy 4

Balance of PaymentsIn FY07, the Egyptian economy boasted a positive balance of payments expanding by 62.4%

YoY, due to surpluses in both the current and capital accounts. Oils share in Egypts exports fellthis year, while non-oil exports rose remarkably, signaling profitable prospects in non-oil sectors.Nevertheless, imports also increased considerably, with non-oil imports booking the lions share,

on the back of soaring oil prices. Tourism receipts and private transfers continued to boostEgypts current account, and are expected to carry on the trend over the coming years. A hugeinflux of FDI, which almost doubled from FY06 to FY07, was the main driver behind Egyptscapital account surplus in FY07, with investment inflows expected to rise even further duringFY08, as Egypts emerging market may seem more appealing to foreign investors than the USand Euro region tainted with the sub prime crisis.

Looking AheadEgypt aims to lower its inflation rate back to a previous range of 6.0%-8.0%, while maintainingreal growth rates around 7.0%, and a budget deficit to GDP of 6.9% in FY08. We believe thatthe chances of lowering inflation rates in such a short period of time are rather slim. However,given the substantially increasing levels of FDI and the expected privatization proceeds for theyear, we think that Egypt may be able to attain its planned growth rate. Over the long term,Egypt needs to utilize its investment inflows in an optimal manner that does not put the countryat a risk of FDI and portfolio reversal.The US sub prime crisis is expected to benefit emerging markets and the Middle East in terms ofinvestments. We believe investors' decisions would be influenced to a great extent in favor of thecommodity and energy sectors on the back of skyrocketing international food and oil prices. Inthat respect, and in comparison to other emerging markets, Egypt's main competitors areMalaysia, Indonesia and the Gulf area where there are good macro indicators, positive sovereignratings, and there is a considerable amount of proven oil and natural gas.


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Egypt - Economy 5

II. Who can help?

PoliticsSince 2004, political and economic reforms has topped the Egyptian governments agenda, asPresident Hosny Mubarak appointed an economically progressive cabinet. Former

Telecommunications Minister Dr. Ahmed Nazif was made Prime Minister, and other cabinetpositions were filled by business leaders. They were charged with creating a business friendlyenvironment to encourage investments and enhance growth through a reform process.

In March 2007, Egypts national referendum on constitutional amendments saw severalalterations in the Egyptian constitution, aiming to create a more stable social and politicalenvironment to encourage sustainable economic growth. These amendments included banningthe creation of political parties based on any religious position and the application of an anti-terrorism law to replace the emergency law passed in 1981, which gives the President the rightto refer terrorism criminals to court.

As of December 2007, a Cabinet Committee has been set up to draft a new anti- terror law,

which should be debated in parliament soon. Officials emphasize the importance of this bill inthe transitional process towards democracy.

Another significant amendment entailed eliminating direct judicial supervision over elections,which would instead be supervised by an independent Higher Committee. Moreover, issues suchas poverty, healthcare, education, and overpopulation were all discussed, but with no clearoutcome as to how they will be dealt with.

Even though these constitutional amendments aim towards paving the way to democracy andsocial and political stability, they still fail to adequately address fundamental issues of politicalreform, at the heart of which is the question of presidential succession. With the persistence ofsuch political concerns, future progress may be constrained by fears of potential politicalinstability.

Political unrest has recently emerged on the back of social discontent due to rising food prices,especially bread prices, with Egypt being one the worlds largest consumers of bread. Thisplaces huge financial burdens on the Egyptian population, 20.0% of which are currently livingbelow the poverty line. According to the UNDPs latest Human Development Report, Egypt ranks48th in the Human Poverty Index out of 108 developing countries. The governments attemptsto solve the problem include raising the subsidy bill, increasing pensions, incentive paymentsand 30% increase in the wages bill, which will probably have negative implications in the future,further widening the budget deficit.

We believe that it is now time to shed more light over the role of civil society in rectifying thesocial situation which gives rise to political instability. Currently, a total of approximately 22,470NGOs are operating under the Ministry of Social Solidarity, with activities ranging from

supplying the poor with food and shelter, education, employment services, and health facilities.Egypt suffers from unequal distribution of wealth, with the rich getting richer and the poorgetting poorer. Egypts Gini coefficient, an index measuring the equality of wealth distribution,came in at 0.34 in FY07, indicating that wealth in Egypt is to a great extent unequally distributed(a value of 0 represents total equality and a value of 1 indicates total inequality). The role ofcharitable organizations, although many believe is marginalized, can actually make a remarkabledifference in the redistribution of income among the society, by gathering donations from richersocial segments, whether in the form of funds or in kind, and allocating them towards feedingthe poor and raising their standards of living. This would, in a way, remove part of the loadplaced on the governments shoulders, and perhaps ease political unrest stemming from theaggravated inflationary situation. After all, there is a limit as to the extent the government cancontinue expanding its subsidy bill.Nevertheless uncertainties about growing inflation rate still poses a risk of political unrest.


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Egypt - Economy 6

Progress and ConcernsEgypts economic progress did not show any signs of slowdown in FY07, with the governmentexpecting the positive note to be taken on into FY08. The governments five year plan 2007-2012 targets many ambitious goals that continue to work on implementing market liberalizingstrategies. In FY07, GDP growth rates hit 7.1%, up from 6.9% in FY06, with the government

targeting future growth rates of 8.0%-9.0% over an unstated time span. Gross domesticconsumption was ruled by private consumption, comprising 82.5% of GDP in FY07.Expansionary fiscal policies have induced domestic demand and thus growth. All the while,public consumption represent only a small portion of GDP due to the government's policy topromote private consumption, which stood at 71.0% of GDP in 1H08, as opposed to 78.6% in1H07.

Investments came to light in the recent years. Although local investments share in totalinvestments is high, representing 71.8% of total investments, and 21.2% of GDP, growth wasmainly stimulated by foreign direct investments accounting for 8.4% of GDP, and taking GDPgrowth rates up to 7.1% in FY07. The importance of FDI is growing and there goes with it therisk of an FDI reversal. Foreign direct investments were unleashed, skyrocketing to USD11.1billion in FY07 against USD6.1 billion in FY06 and targeted to reach USD15.0 billion in FY08. FDIto GDP as of 1H08 stood at 10.7%, compared to 11.8% in 1H07. Net exports of goods andservices represent 4.1%. We expect growth in FY09 to stem from (a) public consumptiongrowing on the back of increased government expenditure due to social concerns and (b)investments coming from the Gulf and Europe. Net exports are expected to dip further into thered on a growing trade deficit. We expect GDP to grow by 7.1% in FY08 and 7.0% in FY09.

Fiscal spending on the other hand has become one of the Egyptian governments top concerns,considering the inflationary situation at hand. The government, trying to alleviate financialburdens arising from rising international commodity prices, is in fact adding more pressure on itsbudget. This is conveyed in the government's decisions to relocate the usage of subsidies. As aresult, the subsidy bill in FY08 is expected to reach EGP70.0 billion, up from EGP58.4 billion inFY07. Effective from September 2008, natural gas prices paid by manufacturers are set to risefrom a current USD1.85 per MBTU to USD2.65 per MBTU, according to the CEO of the General

Authority of Petroleum. This price increase will be applied on 40 factories, which consume about

66 million cubic meters of natural gas on a yearly basis and 60% of total government subsidies.Consequently, this move is anticipated to reduce energy subsidies by approximately EGP15.0billion over the coming five years, easing the weight placed on the governments budget. Thefiscal expansionary policy which took effect in 2005 proved its success for the second year in arow where tax revenues have continued its upward ride, up 16.6% in FY07 although this isdown from 29.7% in FY06.

The good news for FY07 was that GDP growth was led by the manufacturing sector followed bytrade, financial intermediaries, construction, hotels and restaurants, and real estate sectors.Growth generated from all those sectors grouped together decreases reliance on newdiscoveries of oil and natural gas fields which are ultimately unsustainable sources of growth.This is one of Egypt's advantages that makes it a diversified economy resilient to externalshocks. This, however, does not undermine the oil and gas extractions sector's importance; forboth are part and parcel of the economy of Egypt, raking fourth after manufacturing, agriculture

and trade industries and constituting 9.0% of GDP and especially since we expect heavyinvestors to flood into oil sectors in the Middle East to benefit from high international oil prices.The private sector continues to lead the economic growth, generating 62.3% of GDP in FY07 asopposed to 61.4% in FY06.


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Egypt - Economy 7

Chart 1: GDP by Sector (FY06 & FY07)

FY06

Extractions

15%

Agriculture

14%

Social solidarity

2%

Education, Health &

Personal Activities

3%

Insurance

0%

Restaurants & Hotels

3%Financial Intermediaries

5%

General Government

8%

Communication

2%

Water

0%Transportaion

4%

Manufacturing

17%

Real Estate

4%

Trade

12%

Construction

4%

Suez Canal

3%

Electricity

1%

FY07

Electr icity

2%Extr actions

9%

Agr icultur e

15%

Socialsolidar ity

2%Insur ance

0%

Education, Health &

Per sonalActivities

3%

Restaur ants & Hotels

3%FinancialInter mediar ies

6%

Gener alGover nment

9%

Communication

2%Water

0%Tr anspor taion

5%

Manuf actur ing

19%

RealEstate

4%

Tr ade

12%

Constr uction

5%

Suez Canal

4%

Source: CBE, HC Brokerage

Other goals have been met with budget deficit going down second year in a row by roughly 1.0% toGDP standing at 7.5% in FY07 as opposed to 8.2% in FY06. Investments are also going up, reaching29.6% of GDP as of FY07 against 24.4% of GDP in FY06. This is to remind the reader that the targetedlevel of investments by 2012 is set at 30.0% of GDP.

Staking Fortunes yet Absolute Poverty RisingWith ongoing economic progress, the unemployment rate dropped to 9.0% in FY07 as opposed to11.0% in FY03, said Dr. Ahmed Nazif, the Prime Minister. This might give Egypt a reason to rejoice;that not only economic growth is accelerating, benefiting only the rich, but also the middle and lowincome groups get the chance to reap part of the fruits. But the fact still lies that absolute poverty hasrisen where for every five Egyptians, one is suffering from a lack of basic necessities, according toUnited Nations (UN) operations in Egypt.Needless to say that job creation still lags behind population growth where 31.8% of total population isbelow 14 years old. This still cries out for the need to accelerate job creation (RE: No Time forComplacency).

The Prices and the Populace

The unemployment and poverty problems are intensified with inflation rates rising in FY07 hitting11.0% for the fiscal year against 4.2% in FY06. Prices are still going up, hitting 16.4% in April 2008.This in itself corners the government in an awkward situation where it had to sacrifice budget deficitreduction and market liberalization to make living easy for the populace. Only this is still not asustainable solution as a rising budget deficit eventually leads to higher inflation rates. The solution thuslies in collaborative actions coming also from civil societies to help pass the dilemma with the leastpossible costs. Civil societies have been recently active in Egypt and are working on solving the recentbread problem, developing under-developed areas and helping the impoverished. Though this is still notenough, it creates the basis for the government to build on. Inflation, political stability and budgetdeficits are fabrics that weave Egypt's current problems. Though FDI is high, hitting 8.4% of GDP and

helping unprecedented growth rates, investors might shy away over those concerns.


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Egypt - Economy 8

III. Fiscal Policy

The Ministry of Finance has been implementing an expansionary fiscal policy since 2007, with individualand corporate tax income going down to 20.0%, and customs and tariffs dropping to 6.9%. Beating allodds, this helped the government to generate more tax revenue than it used to in the past. It is worth

noting that the government has been broadcasting campaigns to induce transparency, which in turnenhanced tax payers trust and encouraged payments. This helped in pushing tax revenue up 29.7% inFY06 and 16.6% in FY07. In our ''No Time for Complacency'' report published in April 2007, in the bestcase scenario for budget deficit we highlighted that for the government to work on reducing the budgetdeficit by 1.0% per year and with GDP growing at 7.0%, revenue had to increase by at least 15.0%,which the government managed to exceed. Nevertheless, moving in line with our expectations, thegovernment has delayed the budget deficit to GDP reduction plan on rising subsidy burden. Not justthat but also, we believe that it is rather challenging for the government to raise high revenue growthrates, like the past two years, especially that the tax revenue growth rate has dropped by almost halffrom FY06 to FY07.

Expenditures All the while, government expenditures have expanded: In FY07, government expenditure to GDPdropped from 33.0% to 31.8%, mainly due to a substantial increase in nominal GDP from EGP617.7

billion in FY06 to EGP731.3 billion in FY07. When comparing government expenditure to GDP, even withthe most recent increase in the subsidy bill, expenditure still maintains the 30%-31% to GDP trend.However, in absolute terms, government expenditure is on the rise, driven by higher subsidies spendingto accommodate oil and food price hikes; and increasing wages and salaries to accommodate inflation.

(i) Subsidies: In FY07, subsidies amounted to EGP58.4 billion, making up a hefty 24.3% of totalexpenditure and 7.4% of FY07 GDP. This is compared to EGP54.60 billion in FY06, which constituted26.7% of total expenditure and 8.8% of FY06 GDP. The subsidy bill includes food, housing, and otheritems, but is top heavy with EGP40.0 billion of energy subsidies (74.1% of subsidy bill), constituting18.0% of total expenditure and 5.5% of FY07 GDP as opposed to EGP41.6 billion (76.2% of the subsidybill) in FY06, which stood at 20.3% of total expenditure and 6.7% of GDP. As of FY08, thegovernments planned subsidy bill is stated at EGP55.7 billion, however, government officials announcedthat it will be further increased to EGP70.0 billion to accommodate for rising oil prices and inflation.

(ii) Wages & Salaries: Egypt has a long standing social policy of promising employment to all college

graduates. In FY07, wages and salaries stood at a massive EGP52.1 billion, or 23.5% of totalexpenditure and 7.1% of FY07 GDP, up from EGP45.9 billion in FY06, which made up 22.4% of totalexpenditure and 7.4% of GDP.

(iii) Interest: With the pace of borrowing increasing to fund a growing cash deficit, interest paymentsexpanded to EGP47.7 billion in FY07 (21.5% of total expenditure and 6.5% of GDP), up dramaticallyfrom EGP36.7 billion in FY06 (17.9% of total expenditure and 5.9% of GDP), making up a huge portionof current expenditures. Local interest amounted to 93.7% of total interest, up slightly from 92% inFY06, while interest payment of foreign debt made up only 6.3% of the total as opposed to 8.0% inFY06.

(iv) Other: The Ministry of Finance provides a breakdown for public expenditure as a percentage of allspending (see chart 1), but does not assign monetary values to the categories. Among the largestcomponents of public spending include general public services (30.0%), social security (26.0%) andeducation (13.0%).


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Egypt - Economy 9

Chart 2: Average of Public Expenditure (FY03-FY07)

Social security

26%

Economic Affairs

6%

Education

13%

Public Order & Public

Security

5%

Housing & Public Utilities

2%

Environment Protection

1%General Public Services

30%Defense & National Security

8%

Health

5%

Youth, cutlure & religious

affaris

4%

Source: MOF, HC Brokerage

RevenuesTotal revenue grew by 19.2% in FY07 versus 36.4% in FY06. In our ''No Time for Complacency'' report

published in April 2007 we questioned the ability of revenues to grow by 15.0% especially sincehistorically the government has been raising revenues by an average of 9.0% per year excluding thespree of income seen in FY06 triggered by income tax rate reductions. In FY07, the increase in totalrevenue came from a 24.2% surge in non-tax revenue which was boosted by a 156.5% jump inproperty income.

i) Taxes: Egypts most crucial source of income is taxes. Tax revenues rose by 16.6% in FY07, to standat EGP114.3 billion, or 63.4% of total revenues and 15.6% of FY07 GDP, up from EGP98.0 billion inFY06 which constituted 65.5% of total revenues and 15.9% of FY06 GDP. Taxes on goods and services,or sales tax, stood at EGP39.4 billion in FY07, increasing by 14.5% from last years EGP34.4 billion.Sales tax composed 34.5% of tax revenues in FY07 as opposed to 35.1% in FY06.

ii) Tariffs: Customs and tariffs, or Taxes on International Trade, are a fundamental source ofrevenue for Egypt, earning EGP10.4 billion in FY07, up from EGP9.6 billion in FY06. The ratio of customsto total revenues has been decreasing regularly in recent years, down from 11.9% in FY04 to 6.3% in

FY06 and 5.7% in FY07, as tax revenues have captured a greater share of total revenue. Tariffsconstituted only 1.4% of FY07 GDP, slightly down from 1.6% of the FY06 GDP. And, recent newssuggests that they may decline further; Egypts Finance Minister announced on February 6th, 2007, thatthe Egyptian government would lower the average import tariff rate to 6.9%, a 25% decrease. Now90% of all tariff clauses are in a 10%-or-less import duty bracket. This move may be a boon to theeconomy, by putting downward pressure on inflation and making certain components of Egyptianproducts cheaper. But, according to the Ministry of Finance estimates, the reductions will cost thegovernment an estimated EGP1.4 billion in lost revenues to the Treasury. However, as imports rise dueto the lower tariff scheme, total revenue collected may actually rise, surpassing the amount lost as aresult of lower tariffs.

Chart 3: Breakdown of Tax Revenue by Type

FY06 Taxes onInternational

Trade

10%

Taxes on

Goods &

Services

35%

Other Taxes

4%

Income

Taxes

50%

Property

Taxes

1%

FY07 Taxes onInternational

Trade

10%

Taxes on

Goods &

Services

28%

Other Taxes

5%

Income

Taxes

56%

Property

Taxes

1%



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Egypt - Economy 10

The Never Ending Deficit

Given that expenditures far surpass revenues, Egypt runs both a fiscal deficit, which includes theconsolidated operations for the general government: the budget sector, National Investment Bank (NIB)and social insurance funds; and a budget deficit, which includes the operations of the budget sector:the central government, local governments and public service authorities.

Table 2: Fiscal Deficit (FY04-1H07/08)EGP billion FY04 FY05 FY06 FY07 1H07/08

Budget

Sector

Consoli-

dated

Budg

Sect

Consoli-

dated

Budget

Sector

Consoli-

dated

Budget

Sector

Consoli-

dated

Budget

Sector

Consoli

-dated

Total Revenues 102.0 124.1 110.8 133.1 151.2 174.5 180.2 205.7 64.3 73.7

Tax Revenues 67.1 67.1 75.7 75.7 97.7 97.7 114.3 114.3 44.4 44.4

Taxes on Income 27.2 27.2 31.5 31.5 48.3 48.3 58.5 58.5 17.3 17.3

Taxes on Property 0.7 0.7 1.0 1.0 1.2 1.2 1.8 1.2 0.8 0.8

Taxes on Good & Servi ces 26.5 26.5 31.4 31 .4 34 .4 34.4 39.4 39.4 20.1 20 .1

Taxes on Inte rnational Trade 9 .2 9 .2 7.7 7 .7 7.7 9.6 10.4 10.4 5 .7 5 .7

Other Taxes 3.2 3.2 3.9 3.9 3.9 3.9 4.2 4.2 0.5 0.5

Grants 5.0 5.0 2.8 2.8 2.4 2.4 3.9 3.9 0.7 0.7

Other Revenues 29.8 51.9 32.2 54.5 54.3 75.7 62.0 87.4 19.2 28.6

Returns on F inancial Asse ts 14.5 19.9 17.7 23 .3 23 .6 43.4 45.1 50.6 13.3 14 .8

Sale of Good & Services 9.4 9.4 7.1 7.1 7.8 7.8 9.8 9.8 2.6 2.6

Financing Invest. 2.6 2.6 3.1 3.1 3.7 3 .7 4.4 4.4 0.6 0.6

Other 3.0 19.8 4.0 20.0 3.1 20.7 2.7 22.7 2.7 10.6

Total Expenditures 145.9 153.3 161.6 170.8 207.8 223.2 222.0 244.0 96.2 106.3

Compensations of employees 37.2 37.6 41.5 42.0 46.7 47.3 52.1 52.7 28.1 28.4

Purchases 9.3 9.4 12.6 12.7 14.4 14.4 17.0 17.1 6.1 6.1

Interest Payment 30.7 27.5 32.7 29.8 36.8 34.5 47.7 38.4 18.9 13.6

Foreign Interest 2.9 2.9 3.0 3.0 2.8 2.8 3.0 3.0 1.6 1.6

Domestic Interest 27.7 24.5 29.7 26.8 33.9 31.7 44.7 35.4 17.3 11.9

To NIB 10.4 - 10.0 - 8.7 0.0 17.3 0 8.8 0

To others 17.2 24.5 19.7 26.8 25.1 31.7 27.4 35.4 8.5 11.9

Sub. Grants & Social Bene fi ts 24 .7 34.8 29.7 41 .2 68 .7 85.9 58.4 88.7 22.8 38.0

Subsidies 10.3 10.3 13.7 13.7 54.3 54.3 54.0 54.0 17.2 17.2

To GASC 8.1 8.1 11.2 11.2 9.4 9.4 9.4 9.4 9.1 9.1

To Pe tro leum 0.0 0 .0 0.0 0 .0 41.7 41.7 40.1 40 .1 3.9 3.9

To others 2.1 2.1 2.5 2.5 3.1 3.1 4.5 4.5 4.2 4.2

Grants 1.5 1.5 1.8 1.8 2.1 2.1 2.6 2.6 2.1 2.1

Social Benefits 12.8 22.9 14.0 25.0 12.3 29.5 1.6 31.9 3.3 18.5

To SIF 12.0 22.0 13.0 24.0 11.0 28.1 0 0 2.0 0

Other 0.8 0.8 0.9 0.9 1.4 1.4 1.6 31.9 1.3 18.5

Other 0 .0 0 .0 0 .002 0 .002 0 .014 0.014 0 .272 0 .272 0 .094 0 .094

Other Expenditures 21 21 21.6 21.7 19.7 19.7 21.2 21.6 10.6 10.6

Defense 14.4 14.4 14.5 14.5 15.7 15.7 17.7 17.7 9.1 9.1

Other 6.6 6.6 7.1 7.1 3.9 3.9 3.5 3.9 1.5 1.5

Investments 22.8 22.8 23.2 23.2 21.2 21.2 25.5 25.5 9.6 9.6

Cash Def ici t* 43.9 29.2 50.7 37.7 56.5 47.6 41.8 38.4 31.8 32.6

Cash Deficit (Surplus)

% of GDP

9.1% 6.0% 9.4% 7.0% 9.2% 7.7% 5.7% 5.3% 3.8% 3.8%

Net Acquisition of FinancialAssets (%GDP)

0.4% 2.2% 0.1% 1.9%(0.95) 0.6% 1.8% 2.4% 0.0% 0.8%

Overall Fiscal Deficit 45.9 40.0 51.6 47.9 50.3 56.6 54.7 56.2 31.8 35.8

Overall fiscal balance

(%GDP)

9.5% 8.3% 9.6% 8.9% 8.2% 9.2% 7.5% 7.7% 3.8% 4.2%

*The cash deficit is the overall deficit excluding net acquisition of financial assets.Source: MOF, CBE, HC Brokerage


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Egypt - Economy 11

Government's plan to reduce budget deficit is on hold

Egypt has been striving recently to lower its budget deficit as a percentage of GDP, and while it hasbeen successful in doing so over the period FY05-FY07, a few concerns have risen in FY08. On thebrighter side, the (consolidated) fiscal deficit of the general government was reduced from 9.2% of

GDP in FY06 to 7.7% of GDP in FY07 and the deficit of the budget sector amounted to 7.5% of FY07GDP, down from 8.2% of FY06 GDP. This decline came on the back of rising tax revenues by 16.6%year on year, as well as a 24.2% increase in the other revenues balance on the back of thegovernment sale of licenses for the Third Mobile License.

On top of that, the governments plan to raise the subsidy bill to EGP70.0 billion in FY08, and the factthat energy and food subsides alone in FY09 will reach EGP70.0 billion and USD20.0 billion, respectively,up from expected EGP57.0 billion and EGP15.0 billion in FY08, gives us more reason to doubt thesustainability of the decline in budget deficit to GDP neither in FY08, nor over the coming years unless itresorts to privatization proceeds or receives a spree of incoming revenue from non-tax income.

According to the Ministry of Finance, the subsidy, grants, and social benefits are expected to amount toEGP64.3 billion in FY08 while total revenue would amount to EGP187.2 billion, up only 4.0% from FY06which accounts for 6.9% of budget deficit to GDP.

However, on December 31st, 2007, Prime Minister Ahmed Nazif stated that the subsidy bill would go up

to EGP70.0 billion in FY08; hence we expect the cash deficit (which excludes the privatization proceeds)to climb to EGP62.8 billion or 7.3% of GDP, up from EGP41.8 billion in FY07, 5.7% of GDP. Theseexpectations are based on the government's planned revenue of EGP187.2 billion. It is worth notingthat according to the Central Bank of Egypt (CBE), 1H07/08 revenues reached EGP64.3 billion, which isless than half of the planned total revenue.

However, it was recently announced in a news item that eight months results for tax and tariffsrevenues stand at EGP107.0 billion. And based on historical evidence, tax revenue amounted to anaverage of 65.0% of total revenues over the past four years, therefore non-tax revenue should standnow at EGP57.6 billion. In that respect an additional EGP30.6 billion is required so that budget deficit toGDP would drop to the planned 6.4%. The government is targeting Egypt's budget deficit-to-GDP toreach 4.5% by 2010.

In line with our skepticism, the Ministry of Finance announced that the budget deficit is expected todrop only to 6.9% of GDP. We believe that this may be an obtainable target if only based on theannounced 8-month results of FY08. On top of the 8-month results, an additional EGP25 billion isrequired to take the deficit down to 6.9% of GDP.

I'm coming, I'm comingnowhere to run to, no where to hide

Standing on a dusty pile of accumulated deficit and preserving a legacy of government expenditure,though plans have been set to breakthrough those bar walls and rise a free market era, an increasingdeficit still seems to be Egypt's inevitable destiny. First half results for FY08 indicate a relapse aftercelebrating two years of budget deficit reductions. It is true that in FY06 budget deficit to GDP wentdown to 8.2% from 9.6% in FY05, but this was due to an unprecedented GDP growth rate and stake/licenses sale (as it will be discussed further below), and it was not only limited to that as total revenue

jumped 36.0%, boosted by a 29.0% growth in tax revenue. This was a result of restructuring policieswhich induced transparency and encouraged tax payments.

In 1H07/08, however, the picture seems less bright as revenues stood at less than half the plannedincrease in total revenue, with a considerable chunk. It even dims when noting that the plannedincrease in government revenue in FY08 is only 4.0% versus a planned 26.0% increase in FY07; thoughactual revenue increased in FY07 by 19.0% which indicates that the government is not evenconservative in its projections.

Expenditures stood at 3.8% of GDP in 1H07/08 versus 1.5% of GDP in 1H06/07, mainly generated by a17.0% increase in wages and salaries, which underscores the government's concern of political unrest.Subsidies, grants and social benefits, however, in 1H07/08 grew by only 12.0%, amounting to EGP22.8billion versus a planned total of EGP64.3 billion excluding Ahmed Nazif's Prime Minster announcementthat subsidies will reach EGP70.0 billion in FY08.

Behind The Scenes: Declining Deficit to GDP

Looking at the budget deficit in absolute terms and comparing it to a ratio of budget deficit to GDP

explains better the main engines behind a declining trend. Budget deficit to GDP fell from 8.2% in FY06to 7.5% in FY07, yet in absolute terms it actually increased by 11.9% from EGP50.4 billion in FY06 toEGP54.7 billion in FY07 (See chart 5).


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Egypt - Economy 12

Therefore, we can conclude that the declining trend in the overall budget to GDP is attributed toincreasing GDP and not a decreasing budget deficit, mainly due to expanding government expenditures.In FY07, government expenditure to GDP dropped from 33.0% to 31.8%, mainly due to a substantialincrease in nominal GDP from EGP617.7 billion in FY06 to EGP731.3 billion in FY07. Despite this drop, itcontinues to stand within its average range of 30.0%, which is still a pretty high figure. However, in

absolute terms, government expenditure is on the rise, driven by higher subsidies spending toaccommodate oil price hikes and increasing wages and salaries to accommodate for inflation. Accordingto Minister of Finance Youssef Boutros Ghali, the government plans to raise public sector salaries by15.0% over the next fiscal year, adding on to government expenditure. Sequel to that on May 1st, 2008,the government approved (a) 30% raise in salaries to the public sector amounting to EGP6.2 billion (b)a 20% increase in pensions where a floor limit of EGP100 per month is set this should cost thegovernment EGP3.5 billion (c) a 25%-75% boost in incentive payments to local council workers thatwould at amount to EGP1.3 billion (d) subsidies of basic goods, including sugar, rice and cooking oilwhich will cost EGP1.6 billion. These increases will cost the government a total of EGP14.0 billion. Laterin the month on May 6th, 2008, the government announced the following plan to raise revenue to beable to cover the aforementioned costs (a) free zone incentives offered to energy intensive companiesare removed (b) extraction fees on clays and quarries are imposed (c) vehicle license fees are raised to2% of the total amount of cars above 2000cc (d) sales tax on cigarettes increased (e) tax exemptionson treasuries and educational institutions are removed (f) the prices of 90, 92 and 95 octane gasoline,industrial natural gas, diesel and kerosene increased. This should generate 12.0 billion to thegovernment. In addition to that the government has been and will be resorting to stake sales income tokeep the budget deficit to GDP at 6.9%, let alone take it down to 4.5% of GDP as planned by 2010.

On the other hand, it is worth pinpointing that the restructuring plan for reducing governmentexpenditure is still being taken forward. The government is undergoing pension restructuring, in whichit capped the increase in pensions at 7.5% in July 2007. It is also studying the possibility of investingpension funds in assets, rather than keeping them tied in bank deposits. This should help generateextra income for the pension fund, as well as help develop the fixed income market.

In FY07, the drop in budget deficit as a percentage of GDP came mainly from a shoot up in non taxrevenue, primarily due to the sale of the third mobile license, which according to government officials,was worth EGP3.34 billion. Chart 4 shows the governments cash deficit and overall deficit to GDP, whilein FY07 we exclude the sale of the third mobile license. Not accounting for the income generated by the

sale of the third mobile license, the cash deficit came in at 7.5% of GDP, instead of 5.7%, while theoverall deficit came in at 9.2% of GDP instead of 7.5%. This shows how the Egyptian government reliesgreatly on sales in reducing its budget deficit, which seems to be working fine on the short and mediumterm. However, in the long term, this might not be a sustainable source of income for the government,as it may be non recurrent.

Chart 4: Cash Deficit and Overall Deficit to GDP Excluding Sale of Third Mobile License in FY07

9.10% 9.10% 9.40% 8.90%

7.50%

10.50%

9.50% 9.60%

7.90%

9.20%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

FY03 FY04 FY05 FY06 FY07*

%of

GDP

Cash Deficit

Overall Deficit

*FY07 cash deficit and budget deficit excluding the sale of the third mobile license worth EGP3.34 billion.

Source: HC Brokerage


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Egypt - Economy 13

Chart 5: Budget Deficit and Cash Deficit* of Budget Sector

% of GDP

9.1 9.19.4

8.9

5.7

10.5

9.5 9.6

7.9

7.5

5.00

5.50

6.00

6.50

7.00

7.50

8.00

8.50

9.00

9.50

10.00

10.50

11.00

FY03 FY04 FY05 FY06 FY07

Cash Deficit

Overall Deficit

Absolute Terms (EGP bn)

37.9

43.9

50.7

54.9

41.843.6

45.9

51.6

48.9

54.7

0

10

20

30

40

50

60

FY03 FY04 FY05 FY06 FY07

Cash Deficit

Overall Deficit

*The cash deficit is the overall deficit excluding privatization proceeds, i.e. acquisition of financial assets


Planned budget deficit FY08/09

Looking forward, the planned budget deficit for FY08/09 is expected to come in at EGP88.1 billion,according to the Ministry of Finance, on the back of government expenditures amounting to EGP365.2billion, and revenues coming in at EGP277.1 billion. Among the components adding on to governmentexpenditures is subsidies, grants and social benefits expected to stand at EGP128.4 billion, wages andsalaries projected at EGP72.8 billion, and total interest payments of EGP52.9 billion, among otherexpenses. Government revenues, on the other hand, are expected to include EGP152.9 billion in taxrevenues and EGP10.0 billion in privatization proceeds, among other sources of income. As a result, thebudget deficit to GDP is estimated to come in at 8.8%, according to IMF estimates which assume anominal growth rate of 17.2% and a real growth rate of 7.1% for FY08/09 (Nominal GDP is projected to

come in at EGP1,005.4 billion in FY08/09). This confirms the notion that the government will not beable to go along with its previously stated plan of reducing its budget deficit by 1.0% on a yearly basis,despite rapid growth in GDP. This however was prior the recent planned announcements of theEGP14.0 billion increase in the expenditure bill versus EGP12.0 billion boost in revenues. This raisesgovernment expenditure to GDP to 37.7% from a current 30%-31% to GDP as well as it takes budgetdeficit up to 8.9% of GDP in FY09. This confirms the notion that the government will not be able to goalong with its previously stated plan of reducing its budget deficit by 1.0% on a yearly basis, despiterapid growth in GDP as it also raises doubts over the government's ability to reduce budget deficit toGDP at 4.5%.

Government relies on local debt

A growing GDP and a declining budget deficit to GDP has saved total net domestic debt (which includesthe net debt of the government and economic authorities, and net dues of the NIB) to GDP frommultiplying in FY07. It went down from 96.1% in FY06 to 87.1% in FY07 and finally to 79.2% in

1H07/08. Gross domestic debt (which includes balances with the banking system, including deposits)amounted to 100.0% of GDP in FY07 against 113.9% in FY06 and 123.3% in FY05.

Government debt, which is the largest contributor to total debt, amounts to 75.0% of total net domesticdebt while NIB and economic authorities net debt amounted to 6.9% and 17.9%, respectively, in FY07.

T-bills and bonds still gained the lions share, amounting to 88.3% of total domestic debt against 70.0%in FY06, although this is an indication that the government is increasing its borrowing from the marketand inhibiting investments, loans to deposits ratio in banks amounted to 54.5% in December 2007. Thisis still a large figure, however proves that funds are available for investors to invest. The government isalso a net depositor to the banking system, which strengthens the argument. But even thoughgovernment debt is now proven not to be guilty in inhibiting investments, it can not escape beingblamed for fuelling inflation since the amount of borrowing in absolute terms is actually growing, whichsuggests that the government has two options: 1) to raise taxes, or 2) to resort to seignorage to payback its debts.


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Egypt - Economy 14

Chart 6: Total Domestic Debt (% GDP)

0

10

20

30

40

50

60

70

80

90

100

2002 2003 2004 2005 2006 2007 1H07/08

NIB Debt

Econ. Authorities Debt

Government Debt


Breakdown of Domestic Debt in FY07 and 1H07/08Government debt accounts for 75.0% of total domestic debt representing EGP478.2 billion; economicauthorities 6.9%, or EGP44.6 billion; and NIB 17.9%, or EGP114.5 billion.

Table 3: Total Domestic Debt of the Government, Economic Authorities and NIB (FY05-FY07)EGP Bil. FY05 FY06 FY07 1H07 1H08

(1) Government 349.0 387.7 478.2 453.4 502.2

Balances of Bonds & Bills 340.8 349.9 562.9 549.5 596.8

Notes & Bonds 215 246 444.2 443.2 450.8

Treasury Bills 124.9 103.1 118.7 106.4 146.0

Borrowing from NIB 143.7 142.6 -- -- --

Net balance with banking (135.5) (104.4) (89.2) (96.1) (98.3)

Facilities 17.9 5.0 23.6 12.5 21.1

Deposits (-) 153.4 109.9 112.8 108.7 119.4% GDP 64.8% 62.8% 65.4% 62.1% 59.3%

(2) Economic Authorities 47.2 47.3 44.6 50.2 49.2

Net balance with banking (11.1) (2.8) (7.2) (1.6) (3.7)

Facilities 23.4 23.3 28.9 26.0 37.1

Deposits (-) 34.5 26.0 36.1 27.6 40.8

Borrowing from NIB 58.2 50.1 51.7 51.9 53.0

% GDP 8.8% 7.7% 6.1% 6.9% 5.8%

(3) NIB(net)

Resources 316.5 351.2 166.2 155.2 172.2

Social Insurance Fund for Civil Servants 122.9 135.7 27.5 25.0 27.4

Social Insurance (Public & Private) 96.1 105.7 20.6 18.7 20.6

Post Office saving accounts 33.9 39 43.6 38.9 43.8

NIB account balances with banking (net) (4.9) (3.7) (3.0) (2.5) (1.6)

Investment certificate Proceeds 68.5 74.3 68.5 66.3 73.1

Accumulated interest on invest. certificates 6.6 7.0 7.6 7.2 7.7Uses 316.5 351.2 166.2 155.2 172.2

Government 143.7 142.6 -- -- --

Economic authorities 58.3 50.1 51.7 51.9 53.0

Public & private sectors 114.5 158.3 114.5 103.3 119.2

% GDP 21.3% 25.6% 15.6% 14.2% 14.1%

Total domestic Public Debt (1+2+3) 510.8 593.4 637.2 607.0 670.6.0

% GDP 94.9% 96.1% 87.1% 83.2% 79.2%


Foreign borrowing a safe haven

Growing foreign reserves, which reached a high of USD33.8 billion in April 2008, has blessed Egypt withthe opportunity to raise its short-term foreign debt without having to worry about external shocks thathave led to financial crises in other countries such as the Asian crisis. Short-term to foreign reserves stoodonly at 6.9% in December 2007, which indicates a safe haven for foreign investors to invest in Egypt.Though Egypt can borrow from abroad it prefers a localized debt strategy to spare exposure to foreignexchange rate volatility.


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Egypt - Economy 15

IV. Monetary Policy: Inflation Under A Microscope

Egypt's most distressing challenge for the time being lies in inflation. It was dormant for a year before itstarted unleashing again in 1Q06/07 when the government decided to raise the 90 Octane Fuel by 30.0% in

July 2007 accompanied with the external supply shocks that hit some of the administered items on theconsumer price index coming from the Avian flu. The inflation rate hit a high of 16.4% in April 2008. Thesituation was controlled as the effects were fading out, but only for a short while, until food prices ininternational markets started climbing. Being directly linked to the inflation situation in Egypt, as it imports70.0% of total wheat imports from the US, prices of wheat has gone up to EGP2,740 per ton in mid March2008, up from EGP2,380 per ton in early March 2008. Food items constitute 43.9% of the Consumer PriceIndex (CPI). The correlation between rising food prices and the inflation rate since the inflationary trendstarted erupting in the local market is illustrated in chart (7). Although the graph shows positive correlation,the reasons behind the hike in inflation rate back then was attributed to the energy subsidy cut that tookplace in summer 2006 and the supply shocks of the Avian flu. We expect that the recent energy priceincreases will take inflation further up.

Chart 7: International Food Prices (2005-2008)

0

2

4

6

8

10

12

14

Jun-05 Jun-06 Jun-07 Feb-08

0

4

8

12

16

20Inflation

Flour

Rice

Cooking Oil

Beans

Poultry

Milk

Cheese Whit e

* Cooking oil value is per 1 litre

Source: Al Alam Al Youm, HC Brokerage

But, we believe that there is more to the story then just that. Unprecedented economic growth ratesspurred domestic consumption pushing demand to exceeded supply. It encouraged investments which fedinto the construction and real estate sectors. Both sectors demand bigger quantities of steel and cementwhich pushed their prices up 50.0% and 44.0%, respectively, from FY07 to March 2008. Also, the increasein demand on housing units from the Arab world due to excessive petrodollar money and the Arab World'sdesire to diversify their portfolios played a role. Like a domino effect, real estate prices started shooting up.Housing, water, gas, electricity and other fuel constitute 13.5% of CPI. Gas and fuel did not witness anyprice increases in 2007. (Please update with latest developments)

Table 4: Construction materials Prices (F2005-2008)

2005 2006 2007 2008 2008% AVG % (2005-2007)Construction Materials

Steel (ton) 2,750 3,200 3,600 5,400 50.0% 14.4%

Cement (ton) 300 340 360 520 44.4% 9.6%

Source: Al Alam Al Yom, HC Brokerage


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Egypt - Economy 16

Risk averse investors have little to rejoice forFor the first time in a year, the Central Bank of Egypt (CBE) raised the overnight deposit and lending rateson three consecutive meetings to reach 10.0% and 12.0%, respectively, on May 8th, 2008. The jump in theinflation rate from a steady 6.9% in November and December 2007 to 10.9% in January 2008, 12.1% inFebruary 2008, 15.8% in March 2008 and 16.4% in April 2008 left the Monetary Policy Committee board

members no choice but to hike interest rates. Local banks did not respond by raising their interest rates ondeposits, as the three months-deposit rate hovers between 5.5% and 6.5%. The last reading for inflation in

April 2008 recorded 16.4% which when compared to interest rates indicates negative real interest rates.Depositors are thus encouraged to invest in other high interest baring investments which are in naturemore risky. All the while, risk averse investors might thus be encouraged to buy funds investing in T-bills,bonds, or even post office savings which offer higher interest rates yet sell lower than the current inflationrate. Post offices offer 9.25% for one year deposits against 6.75% for one year deposits in commercialbanks With inflationary pressures expecting to persist, we tend to believe that the MPC might resort totaking rates upwards.

Table 5: T- bills, Bonds, and Post Office Savings Interest Rates and Maturities

Risk Free Investment March 2008

T- Bills

91 day bills interest rate (3 months) 6.1%

182 day bills interest rate (6 months) 7.1%

364 day bills interest rate (1 year) 7.4%

T- Bonds

Average Interest rate (2-20 years) 8.0%-11.6%

Post Office Savings

Interest rate ( 1 year) 9.5%

Source: CBE, MOF, HC Brokerage

The following table shows government issued stocks, matured stocks, and outstanding stocks of T-bills andbonds up until the period July 2007 to March 2008.

Table 6: Government Securities Issuance

EGP bn FY03 FY04 FY05 FY06 FY07 July- MarchFY08

Issued 127.3 150.5 137.8 179.1 180.7 178.8

T-Bills 127.3 146.5 123.8 146.1 174.7 154.3

T- Bonds 0.0 4.0 14.0 33.0 6.0 24.5

Matured 112.0 142.0 107.7 124.9 166.2 129.0

T-Bills 112.0 138.0 107.7 122.9 159.2 127.0

T-Bonds 0.0 4.0 0.0 2.0 7.0 2.0

Net Issues 15.3 8.5 30.1 54.2 14.5 49.8

Outstanding stock(End of

period)

68.3 76.8 106.9 161.1 175.6 225.4

T- Bills 55.3 63.8 79.9 103.1 118.6 145.9

T-Bonds 13.0 13.0 27.0 58.0 57.0 79.5

Average Interest Rates

91 Day T-Bills 8.3 8.4 10.4 8.8 8.6 6.5182 Day T- Bills 8.8 8.4 10.6 8.8 8.9 7.1

364 Day T- Bills -- 8.9 10.4 8.8 9.1 7.4



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Egypt - Economy 17

Table 7: Recent Changes in Monetary Policy

CBE Deposit Rate Fed Funds Rate ECB Rate

Date Rate Date Rate Date Rate

April 9, 2006 8.00 June 29, 2006 5.25 June 8, 2006 2.75

November 2, 2006 8.50 September 18, 2007 4.75 August 3, 2006 3.00

December 14, 2006 8.75 October 31, 2007 4.50 October 5, 2006 3.25

February 10, 2008 9.00 December 11, 2007 4.25 December 7, 2006 3.50

March 24, 2008 9.50 January 21, 2008 3.50 March 8, 2007 3.75

May 8, 2008 10.0 January 30, 2008 3.00 June 13, 2007 4.00

March 18, 2008 2.25

April 30, 2008 2.0

Source: CBE, FED & ECB

How else can the government curb inflation?

In an attempt to control rising steel prices, the Ministry of Foreign Trade and Industry is considering makinguse of an article in the antitrust law which enables the Prime Minister to fix the price of strategiccommodities for a limited period of time after consulting with the Antitrust Council. In the mean time, the

Ministry of Foreign Trade banned exports of cement until October 2008 to ensure its availability in the localmarket and thus tame prices, and removed import duties on some kinds of steel and cement. Also, steeltraders have agreed to sell at announced factory prices, plus additional transportation costs and taxes,which would fall within a range of EGP5,100.0-EGP5,150.0 per ton.Limiting basic commodity price hikes and increasing subsidies, as it was previously discussed, are allcollective attempts to contain inflation. Moreover, the Egyptian Government has banned rice exports for aperiod of six months starting from April 2008 in order to ensure an adequate supply of rice in the marketand stabilize surging prices, while also waiving import duties on rice, dairy products, and edible oils.

Also, an appreciation of the EGP against the USD might be sought after, as another strategy that limitsprice increases since Egypt imports 70.0% of its total wheat imports from the US. This is backed by a trendof a depreciating USD against all other currencies coupled with the CBE hiking its overnight deposit rates.However, we do not expect this trend to last over the medium term, especially if speculators realize thatthe shadow exchange rate, which is a reflection of the real value of the EGP:USD, is expected to hoveraround USD1:EGP5.5-5.7 in FY09 with trade being negatively affected by the US slowdown. In due cause,

we tend to believe that the government has the luxury to appreciate the EGP against the USD in theremaining months of FY08 with the shadow exchange rate hovering in-between EGP5.3-5.4 to USD1 if notless. If speculators realize that the value of the EGP:USD should actually depreciate in FY09 to hoveraround USD1:EGP5.7, demand on the dollar will rise.Indeed, Egypt has a backlog of foreign reserves amounting to USD33.8 billion in April 2008 to preserve itsmanaged float system, but even that did not save the EGP from being severely battered by speculators in2002-2003 and taking it close to its shadow exchange rate. The government, in the late 1990's, with a fixedexchange rate system, resorted to injecting foreign reserves into the economy to maintain the USD:EGPrate at USD1:EGP3.4. However, pressure pushed it to eventually leave the EGP to depreciate very close toits real effective exchange rate at USD1:EGP6.1. Hence, with expectations of a further increase in demandof FX in the years to come, the real value of the EGP against the USD might only depreciate, forcing thegovernment to eventually leave the EGP to free market forces and speculation. In that respect we believethat the government might only resort to appreciating the EGP as an immediate solution to help alleviatethe bread problem, but more weight should be put on commercial banks hiking their interest rates and

controlling local commodity prices. This in our opinion is the safest haven for the government to resort to.Persistent increases in subsidies and appreciating the EGP might have uncalled for repercussions on themedium and long term.

Foreign Exchange

Shadow Exchange RateGiven that the CBE helps maintain stability in the exchange market it should be asked whether or not thecurrent price of USD/EGP reflect its fair value. The shadow exchange rate is one metric which can be usedto determine whether or not a currency is trading at its fair value.The shadow exchange rate reflects an equilibrium between supply and demand for a currency.


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Egypt - Economy 18

Table 8: (Demand and supply of FX table)USD Million FY03 FY04 FY05 FY06 FY07 FY08*FX Demand

Imports of Goods 14,820 18,286 24,192 30,441 37,834 47,000

Imports of Services 5,492 5,663 7,187 9,247 8,957 14,100

Capital Out 45 42 1,635 1,446 1,153 1,700

Smuggling (20% of imports) 2,964 3,657 4,838 6,088 7,567 12,220Total FX Demand 23,321 27,648 37,852 47,221 55,511 75,020

FX Supply

Exports of goods 8,205 10,452 13,833 18,455 22,018 24,900

Exports of services 10,441 12,981 15,029 17,438 20,408 27,100

Capital In 3,909 4,159 10,160 19,397 17,177 23,000

Total FX Supply 22,555 27,592 39,022 55,290 59,603 75,000

Change in FX Demand andSupply** 1.03 1.0 0.97 0.85 0.93 1.0* HC estimates**If the change in supply and demand from year to year is close to, or equal to one, then a currency is priced appropriately.Source: CBE, HC Brokerage

Supply and demand for foreign currency for FY07 suggests that the Egyptian pound was undervalued, andthe fair value for USD/EGP was actually around USD1/EGP5.2. This came as a result of strong exportsperformance and floods of FDI. This is expected to be taken forward in FY08 with the market actually

reflecting the real value of the EGP to USD.The picture only gets murkier in FY09 with the expected widening of the trade deficit, which weakens theEGP strength against the USD.

Chart 8: Market Exchange Rate versus Shadow Exchange Rate

6.36.1

5.52

4.86

5.235.43

6.1 6.1

5.7 5.7 5.625.43

4.5

5.5

6.5

USD

:EGP

FY03 FY04 FY05 FY06 FY07 FY08*

Market fx rate

Shadow exchange rate

Market fx rate

Shadow exchange rate

Source: HC Brokerage


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Egypt - Economy 19

V. Investments, the Name of the Game

Money? No problem. Pocket full of that now, but.Huge amounts of foreign direct investments (FDI) inflows and sales proceeds were among the drivers ofEgypts economic growth in 2007. Sales proceeds (if it be licenses or stake sales), although helping the

government to reduce its budget deficit, are an unsustainable source of revenue which the governmentcannot continue to rely on. In addition, FDI inflows, if not properly utilized, can lead Egypt to becomingover reliant on outside sources of financing instead of generating its own sustainable sources of revenue.However, it is clear that both sources of funds have significant effects on the economys growth, resulting inthe Egyptian economys continued progress.

Although privatization proceeds in FY07 came in 6.8% lower than in FY06, they still recorded an impressivefigure of EGP13.6 billion, down from EGP14.6 billion in FY06. FDI on the other hand, surged dramatically inFY07 to USD11.1 billion (8.35% of GDP), up from USD6.1 billion (5.96% of GDP). As of 1H08, FDI stood atUSD7.8 billion, growing by 8.3% from USD7.2 billion in 1H07. In FY08, we expect FDI inflows to exceedFY07s USD11.1 billion, on the back of growing interest in Egypt fuelled by economic development andgrowth, and the trend is expected to be sustained in FY09 with global investors diverting their funds awayfrom the US due to global economic turmoil, and into emerging markets like Egypt. Potential opportunitieslie in the possible sale of Egypts second fixed line license to a foreign investor, and Egypts real estate

sector is attracting large amounts of investments from Arab countries, with the UAE becoming one ofEgypt's largest investors. The Ministry of Finance expects privatization proceeds to come in at EGP10.0billion, primarily on the back of the sale of Egypts third largest publicly owned bank, Banque Du Caire, andthe sale of the remaining 20.0% stake of Bank of Alexandria. However, looking at 1Q08 figures, withprivatization proceeds coming in at a minor EGP334.0 million, it seems that the trend is not expected tocontinue on the long term. This illustrates the unreliability of privatization proceeds as a sustainable sourceof government revenue.

Table 9: Asset Sales (number, value and percentage of GDP) FY01-1Q08 Year Companies,

Lines Sales and

Land Sales

Joint Venture

Sales

Public CompanySales

Total Sales GDP % of total

sales to

GDP

Number Value

EGP mn

Number Value

EGP mn

Number Value

EGP mn

Number Value

EGP mn

LE bn

FY01 12 263 7 118 - - 19 381 391 0.10

FY02 7 73 3 879 - - 10 952 465 0.20

FY03 6 49 1 64 - - 7 113 478 0.02

FY04 9 428 4 115 - - 13 543 509 0.11

FY05 16 824 12 4,819 - - 28 5,643 553 1.02

FY06 41 1,843 18 7,647 1 5,122 60 14,612 618 2.36

FY07 45 2,773 7 1,559 1 9,274 53 13,606 684 2.00

1Q08 5 334 0 0 0 0 5 334 -- --

Total* 308 22,450 53 15,215 3 14,410 363 52,075

*Cumulative total from 1991- 1Q08Source: MOF, HC Brokerage

Sources of FDIThe largest share of FDI came from the US (35.0%), followed by the EU (31.0%), the Arab region (26.0%)and other countries (8.0%). Investments coming from the Euro region and from Arab countries areexpected to sustain high figures in FY08, with the UAE becoming Egypts foremost foreign investor after theUS, with total investments worth USD3.0 billion in FY07 (23.3 % of FDI inflows), up from a meagerUSD63.0 million in FY06 (0.7% of FDI inflows). Investments from the UAE are pouring into Egypts realestate, hospitality, telecommunication, and maritime sectors, with real estate developer Emaar Propertiesinvesting EGP31.7 billion in real estate and tourism projects, Etisalat investing in creating a state of the arttelecom infrastructure worth USD1.4 billion, and DP World, a Dubai based global marine terminal operator,investing USD1.3 billion in several maritime projects, among others.European investments experienced a substantial growth of 37.5% in FY07, reaching USD4.06 billion, upfrom USD2.95 billion in FY06.Investment inflows from China, though still small, but also witnessed growth following the agreementsigned on September 20th, 2006, between the Egyptian and Chinese Governments regarding a Chinese-Egyptian industrial zone in Ismailia. Chinese investments in FY07 amounted to USD8.4 million, compared toUSD0.8 million in FY06. In 1H08 alone, investments from China recorded USD12.0 million, growing by48.0% YoY.


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Egypt - Economy 20

Chart 9: FDI by Country FY07

Arab Countries

26%

Other Countries

8%

USA

35%

EU

31%


The largest share of FDI inflows is directed towards the establishment of new entities, and the expansion of

already existing ones (47.3% of total FDI in FY07 and 44.5% of total FDI in 1H07/08). Followed by that isthe petroleum sector, attracting 27.3% of total FDI in FY07 and 37.6% in 1H08. The sale of assets to non-residents came in third, booking 25.1% of total FDI inflows in FY07, and 17.5% in 1H08, while the realestate sector came in last, drawing a minor 0.35% of FDI in FY07 and 0.4% in 1H08.

Table 10: FDI Distribution by Sector (FY07-1H08)

Sector FY07 1H08

New Establishments and Expansions 5,227.2 3,455.6

Sale of Assets to Non- residents 2,772.2 1,358.0

Real Estate 39.0 32.6

Petroleum Sector 3,014.8 2,923.3

Total 11,053.2 7,769.5

Source: Ministry of Investment, HC Brokerage

We expect investors to divide their investment portfolios in Egypt FY09 between commodities such asfertilizers, petrochemicals, oil and gas and metals. The Ministry of Petroleum is working on a plan to attractforeign and local investors to excavate gold mines. Egypt has attractive amounts of gold reserves.

Agriculture also grabs attention however, Egypt has some restrictions on foreign ownership of agriculturalland. Local investors are thus encouraged to invest in agricultural land as well as opening gateways toforeign partnership.


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Egypt - Economy 21

VI. Balance of Payments

Capital Account: The StickerEgypts balance of payments (BoP) is one of the economys positive features this year, expanding fromUSD3.3 billion in FY06 to USD5.2 billion in FY07. As a result, this increased surplus has progressively

enhanced Egypts foreign reserves, from USD26.2 billion in February 2007 to USD33.8 billion in April 2008.

Foreign reserves are generated mainly through the export of oil and gas, FDI and tourism receipts. Whileoil and gas revenues remained somewhat unchanged with only a slight decrease, FDI inflows haveincreased dramatically in 2007 due to the governments reform efforts, and so have tourism receipts. Thisresulted in the strengthening of the position of Egypts foreign reserves.

Table 11: BoP Main Contributors as Percentage of GDP (FY07 & 1H07/08)Item FY07 1H07/08

BoP Surplus 0.7% 0.8%

Oil Exports 1.4% 1.5%

Non-Oil Exports 1.6% 1.8%

FDI in Egypt (net) 8.3% 10.7%


A) Current AccountA comparison between 1H07 and 1H08

In the first half of 2008 the current account generated a deficit of USD245.7 million due to:

The trade balance deficit jumped from USD6.6 billion in 1H07 to USD11.3 billion in 1H08, mainly dueto a dramatic increase in imports from USD17.3 billion in 1H07 to USD24.4 billion in 1H08 which isattributed to a 32.0% rise in non-hydrocarbon imports (USD15.2 billion in 1H07 to USD20.0 billion in1H08) and a 108.8% increase in oil imports (USD2.1 billion in 1H07 against USD4.3 billion in 1H08),fuelled by a jump in oil prices. As of 1H08, investment and capital goods imports stood at 24.6% oftotal imports, down from 27.5% in 1H07. The services surplus expanded by 21.4% to stand atUSD6.8 billion in 1H08, up from USD5.6 billion in 1H07, due to a 30.0% increase in tourism revenuesfrom USD4.3 billion in 1H07 to USD5.6 billion in 1H08 and a 25.0% jump in Suez Canal receipts fromUSD2.0 billion in 1H07 to USD2.5 billion in 1H08 due to an increase in the number of ships and

tonnage. According to statistics published by the CBE, 10,644 ships transited the Suez Canal in 1H08,up from 9,679 vessels in 1H07, while total tonnage reached 445.4 million tons versus 390.0 milliontons in 1H07. However, there has been a large 60.0% increase in other payments from USD1.3billion in 1H07 to USD2.1 billion in 1H08.

Net unrequited transfers rose dramatically by 42.5% reaching USD4.2 billion in 1H08 as opposed toUSD3.0 billion in 1H07, due to a surge in remittances of Egyptians working overseas. As of 1H08,remittances stood at USD4.0 billion, constituting about 95.1% of total transfers, as opposed toUSD2.7 billion in 1H07 (91.8% of total transfers). Official transfers continue to contribute only aminority to total transfers.


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Egypt - Economy 22

Table 12: Current Account (FY02-1H08)

USD Mil. FY02 FY03 FY04 FY05 FY06 FY07 1H07 1H08

Trade Balance (7,516) (6,614) (7,833) (10,359) (11,986) (15,816) (6,592) (11,269)

Export Proceeds 7,120 8,205 10,452 13,833 18,455 22,018 10,666 13,103

Petroleum 2,381 3,160 3,910 5,299 10,222 10,108 5,057 6,021Other Exports 4,739 5,044 6,542 8,534 8,233 11,910 5,609 7,082

Import Payments (-) 14,637 14,820 18,286 24,192 30,441 37,834 17,258 24,372

Petroleum (2,476) (2,313) (2,549) (3,975) (5,359) (4,128) (2,064) (4,308)

Other Imports (12,160) (12,507) (15,736) (20,218) (25,082) (33,706) (15,194) (20,064)

Services (net) 3,878 4,948 7,317 7,842 8,191 11,451 5,573 6,795

Receipts 9,618 10,441 12,981 15,030 17,438 20,408 9,997 12,841

Transportation, of

which

2,714 2,964 3,755 4,260 4,947 6,371 3,074 3,653

Suez Canal Dues (1,819) (2,236) (2,848) (3,307) (3,559) (4,169) (2,016) (2,511)

Travel 3,422 3,796 5,475 6,430 7,235 8,012 4,289 5,580

Investment Income 938 641 485 911 2,002 3,045 1,411 1,675

Government Receipts 188 252 179 157 358 254 47 77

Other 2,353 2,786 3,086 3,272 2,896 2,727 1,176 1,856

Payments5,739 5,492 5,663 7,187 9,247 8,957 4,424 6,046

Transportation 420 392 668 902 1,215 1,273 566 835

Travel 1,207 1,372 1,315 1,438 1,620 1,918 969 1,497

Investment Income,

of which

842 748 691 1,164 1,471 1,857 979 954

Interest paid (688) (625) (585) (584) (587) (598) (300) (340)

Government

Expenditure

660 455 489 657 1,320 1,196 591 650

Other 2,609 2,524 2,498 3,026 3,622 2,714 1,319 2,110

Goods & Services

Balance

(3,638) (1,666) (516) (2,517) (3,795) (4,365) (1,018) (4,474)

Transfers 4,252 3,609 3,934 5,427 5,547 7,061 2,967 4,228

Private Transfers

(net)

3,108 2,945 3,046 4,371 4,975 6,261 2,725 4,022

Official Transfers

(net)

1,143 663 888 1,056 571 800 242 206

Current Account

Balance

614 1,943 3,418 2,910 1,751 2,696 1,949 (246)

A comparison between FY07 and FY06

During the past year, Egypts current account surplus has expanded, reaching USD2.7 billion in 2007against 1.8 billion in 2006, and constituting about 2.2% of GDP as opposed to 1.6% in FY06. Thisexpansion resulted from a 27% increase in transfers from USD5.5 billion in 2006 to USD7.1 billion in2007. However, the trade deficit has widened reaching 3.4% of GDP in 2007 against 1.6% of GDP in2006. This is because of a great 24% increase in merchandise imports, standing at USD37.8 billion inFY07 as opposed to USD30.4 billion in FY06, as a result of increasing non-oil imports from USD25.1billion in FY06 to USD33.7 billion in FY07 (a 34% increase). Oil imports, on the other hand, havedeclined by 23%, from USD5.4 billion in FY06 to USD4.1 billion in FY07.

Merchandise oil exports have remained more or less at a constant level, decreasing only slightly by1.1% (from USD10.2 billion in FY06 to USD10.1 billion in FY07), while non-oil exports increasednoticeably by 44.6% to reach USD11.9 billion in 2007 against USD8.2 billion in 2006. This is a greatimprovement compared to the 3.5% decline in non-oil exports during the period of 2005-2006, whichillustrates that there has been progress in Egypts non-hydrocarbon sector, and that there is hope fora brighter future for Egypts industrial sector. As of 2007, the hydrocarbon sector constitutes 45.9%of Egypts external trade, as opposed to over 50% in 2006.


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Egypt - Economy 23

Table 13: Oil Exports Breakdown

USD Million FY01 FY02 FY03 FY04 FY05 FY06 FY07

Total Oil Exports 2,632 2,381 3,161 3,910 5,299 10,223 10,108

Crude Petroleum 1,166 686 1,117 1,414 1,938 3,214 3,128

Petroleum Products 1,467 1,695 2,044 2,497 3,361 7,009 6,980

% GDP 0.73% 0.61% 0.74% 0.80% 0.97% 1.62% 1.48%


Suez Canal receipts rose by 17% in FY07, reaching USD4.2 billion as opposed to USD3.3 billion inFY05 on the back of a continued increase in the number of transmitting ships passing through thecanal, as well as an upsurge in net tonnage carried.

Tourism revenues also increased from USD7.2 billion to USD8.0 billion due to an increase in thenumber of tourist arrivals from 8.6 million tourists in FY06 to 9.7 million in FY07 and a rise in thenumber of tourist nights from 85,113 nights in FY06 to 96,270 nights in FY07. The Egyptiangovernment is hoping to attract 20 million tourists by the year 2015. The main contributor to theservices account surplus, however, would have to be investment income receipts, which rose greatlyby 52% amounting to USD3.0 billion in FY07 as opposed to USD2.0 billion in FY06. As a result, theservices account surplus expanded remarkably by about 40%, standing at USD11.5 billion in FY07,up from USD8.2 billion in FY06.

Table 14: Tourism Indicators

FY01 FY02 FY03 FY04 FY05 FY06 FY07

Tourist Arrivals (000) 5,347 4,341 5,329 7,512 8,651 8,693 9,758

Tourist Nights (000) 32,702 28,542 33,011 73,002 85,730 85,113 96,270

Average Stay Per Tourist (nights) 7.2 7.0 6.8 10.4 10.4 10.4 9.8


The inward transfer of funds by Egyptians working abroad grew by 26.0% (from USD4.9 billion inFY06 to USD6.2 billion in FY07), while official transfers inwards also rose by 40.0% (from USD0.57billion in FY06 to USD0.8 billion in FY07). Both contributed to the expansion of the net unrequited

transfers account by 27.0% to reach USD7.0 billion in FY07, up from USD5.5 billion in FY06.

World Trade

Imports from the EU and USA amounted to 56.0% of Egypts total imports (34% from the EU and 22%from the USA), while 66% of its exports went to these markets (35% to the EU and 31% to the USA). Inthe event of supply and demand shocks from either of these markets, Egypts external trade balanceswould be at a rather unstable and troubled state. Moreover, any major variations in the value of the EGPagainst either the Euro or USD would have a recognizable effect on the Egyptian economy. However, theslight appreciation of the EGP against the USD over the past period has not dented Egypts exports to theUSA. In fact, they have increased by about 21%, from USD5.6 billion in FY06 to USD6.8 billion in FY07.

Chart 10: Imports and Exports by Geographical Distribution (FY07)

Imports

USA

22%

Middle East

8%

EU

34%

Other

10%

Asia

16%

Other

Europe

8%

Russia

2%

ExportsAfrica

1%

Asia

14%

EU

35%

Other

2%

Middle East

12%

Other

Europe

5%

USA

31%



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Egypt - Economy 24

Intermediate goods, investment goods, and raw materials continue to constitute the largest shares ofEgypts imports respectively, which should, in the long run, have a positive impact on local productivity.

Chart 11: Imports and Exports by Category

Imports

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


%o

ftotalimports

Undistributed Imports

Consumer Goods

Investments Goods

Intermediate Goods

Raw Materials

Fuel and Oil

Exports

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


%o

ftotalexports

Undistributed Exports

Finished Goods

Semi-finished Goods

Raw Materials

Cotton

Fuel & Oils


B. Capital and Financial Account

A comparison between 1H07 and 1H08FDI in Egypt has increased in 1H08 by 8.3% reaching USD7.8 billion compared to USD7.2 billion in 1H07,mainly due to a surge in foreign investment directed towards the oil sector, which recorded USD2.9 billionin 1H08, up by 141.7% from USD1.2 billion a year ago, and inflows directed towards incorporations andcapital increases, which came in flat at USD3.5 billion in both 1H08, same as 1H07. Net portfolioinvestments in Egypt have fallen greatly to stand at a negative balance of USD1.7 billion in 1H08 asopposed to USD57 million in 1H07. Privatization proceeds also dropped year on year from USD2.6 billion in1H07 to USD1.4 billion in 1H08. Finally, the capital and financial account as a whole increased remarkably,mainly due to the upsurge in FDI inflows into the economy. The capital account grew by 107.7% to recordUSD3 million in 1H08, up from a deficit of USD39 million in 1H07 while the financial account expanded tostand at USD3.1 billion in 1H08, up from a negative balance of USD401 million in 1H07.

Table 15: Capital and Financial Account (FY02-1Q08)

USD Million FY02 FY03 FY04 FY05 FY06 FY07 1H07 1H08

Capital and Financial Account (963) (2,733) (5,016) 3,377 3,511 1,134 (440) 3,150

Capital Account 0 0 0 0 (37) (39) (39) 3

Financial Account (963) (2,733) (5,016) 3,377 3,548 1,173 (401) 3,147

Direct Investment Abroad (15.2) (30) (155) (39) (145) (536) (68) (198)

Direct Investment in Egypt (net) 428 700 407 3,901 6,111 11,053 7,245 7,770

Portfolio Investment Abroad (net) (3) (15) 113 540 (729) (558) (322) (611)

Portfolio Investment in Egypt (net) 998 (405) (225) 831 2,764 (937) 57 (1,734)

Bonds 953 (218) (147) 25 2,690 (551) (421) 919

Other Investments (net) (2,372) (2,983) (5,155) (1,856) (4,452) (7,851) (7,313) (2,080)

Net Errors & Omissions (106) 1,336 1,440 (1,810) (2,009) 1,453 1,396 182

Overall Balance (456) 546 (158) 4,477 3,253 5,282 2,906 3,087

Change in CBE reserve assets

(increase=-)

456 (546) 158 4,477 (3,253) (5,282) (2,906) (3,087)


A comparison between FY07 and FY06

As of FY07, Egypts declining capital and financial account (from USD3.5 billion in FY06 to USD1.1 billion inFY07) resulted from a few disappointing capital and fiscal account figures. Net portfolio investment inflowsexperienced a huge drop from USD2.7 billion in FY06 to a negative balance of USD0.9 billion in FY07.

Other investments have also worsened, from a negative balance of USD4.4 billion in FY06 to a negativeUSD7.8 billion in FY07. On the brighter side, FDI increased remarkably by a whooping 81% to reachUSD11.1 billion in FY07, up from USD6.1 billion in FY06. This increase can be attributed to the

governments reform efforts to attract FDI inflows into the economy.


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Egypt - Economy 25

FDI, tourism and non-oil exports are regarded as the leading contributors to this years balance ofpayments. A great emphasis should be placed on the fact that non-oil exports have exceeded hydrocarbonexports, which was not the case in 2006. This is a good sign for the economys industrial future, as it

indicates the potential for sustainable growth. However, oil exports as a percentage of GDP have increasedgreatly reaching 7.9% in FY07 as opposed to 1.62% in FY06, also boosted by escalating internationalenergy prices. For now this should lure in huge amounts of FX as oil prices are skyrocketing and expectedto continue the trend, but on the long-term, heavy reliance on depleting resources is not a solid plan to relyon. Increasing tourism receipts also had a great role in Egypts favorable balance of payments, and thistrend is expected to continue with the government investing in developing the tourism sector and making itone of its top priorities. And as there lies the risk for terrorist attacks there also lies the huge potential fordevelopment, marketing Egypt as one of the top tourism destinations in the world. Finally, the hugeupsurge in FDI inflows contributed a great deal to Egypts balance of payments, and a reduction wouldmost certainly have a negative effect on the economy. However, this reliance on foreign sources offinancing could pose large threats to the economys sustainability in the long run. To avoid such a situation,the government must utilize these FDI inflows in a way that would benefit the economy in the long-term,while taking into consideration that foreign funds are bound to be repatriated at some point in time.

For Egypt to maintain high GDP growth rates, a positive balance of payments performance and continuedFDI inflows, it needs to focus on developing its non-oil sector, direct its FDI inflows to sectors in which ithas a competitive advantage, and reduce its reliance on sectors that are susceptible to external shocks.


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Egypt - Economy 26

VII. US Sub-Prime Crisis and Egypt

The recent turmoil in the US caused by the sub-prime mortgage financing crisis is expected to have animpact on global growth rates. We, however, forecast growth rate for Egypt in FY08 to be at 7.1%.On the investment side, we expect the slowdown in the US coupled with the petrodollar bonanza to spur

investments in Egypt yet stimulate inflation, which is Egypt's prevailing challenge. But since we expect theinflation rate to be above 12.0% in FY08, triggered by the recent diesel and kerosene price increases, andgiven the fact that the inflationary trend is on top of a one way upward ride hitting 16.4% in April 2008, weexpect investments to be poured into primary sectors (where inflation benefits mostly the commoditysector) as opposed to value-added (tertiary sectors) given that investors would be able to export. Althoughinstability in prices hampers investments, making the outlook seem murky as it creates unfavorableenvironment for investors, this in itself might stimulate investments in price driven sectors (which is aglobal trend). These sectors are basically oil, gas, metals, and agricultural products which Egypt is blessedto be endowed with. If Egypt manages to pull 8.8% of FDI to GDP in FY09 (USD16.0 billion) we thusexpect GDP to grow at above 7.0%, making investments the prime engine for growth. On the other hand ifonly 5.5% of FDI to GDP (USD10.0 billion) are drawn in we thus expect GDP to grow at 6.7%.

All the while, on the international trade facet after examining the impact of the US slowdown on trade,

tourism and private transfers, an insignificant effect on the trade balance will be felt in FY08. On the otherhand, we expect a current account deficit stemming from the increase in total imports and fuelled by risingdomestic demand.

Back to The Past and Into the Future

Mimicking the impact of the US downturn on trade with Egypt, after September 11th, 2001 shocks wemanaged to draw the following conclusions:A) In trade, the impact was reflected in 2002 performance with exports to the US remaining almost flat in2001 and dropping by 10.0% from 2000. Exports to the US represented a high of 45.3% of total exportsduring its peak time in the new millennium, however, the weight has been dropping ever since; especiallysince Egypt has managed to shift its exports to Europe, and recently increase trade with the Arab worldand Asian countries. We therefore do not expect to see a clear negative setback in Egyptian exports to theUS in 2008. In FY09, signs of contraction in exports are expected, yet insignificant to the trade balancedeficit especially since in our assumptions, US imports from Egypt should also drop (see table 1). Egypt has

a backlog of trade agreements with European, Arab and Asian countries which should enable it to channelexports destinations other than the US.B) In tourism, which is Egypt's main foreign currency earner, visitors coming from the US are minimal,standing at 2.4% of total tourists. A drop represents an insignificant portion of Egypt's tourism receipts.C) Although remittances flowing from the US represent the largest portion after Arab countries, a drop ofwhich is not expected to make a considerable impact in total inflow of workers remittances. It constituted33.0% of total workers remittances in FY07 and has maintained its average over the past five years. Itdropped only 9.0% in 2002. (see table 16).

Table 16: Worse Case Scenario Estimates for Trade with the US (FY09**)

USD bn FY07 FY08* Impact from US FY09**Total

Exports 22.0 26.0 10.0% drop 29.1

Imports 38.0 47.0 53.2

Documents

Egypt Country Report-18May08