Is business as usual possible in Egypt?

Dr Elizabeth Stephens takes a look at the current condition of the Egyptian economy, and asks whether businesses will be able to operate with any kind of normality.

A series of challenges have been presented to investors since the deposing of Hosni Mubarak, with uncertainty and outbreaks of violence exerting downward pressure on investment flows. Despite the deteriorating economic environment and payment delays that plague the oil and gas sector in particular, many foreign companies have remained committed to their Egyptian operations, anticipating a return to stability.

Events in the past eight weeks - the ousting of President Mohammed Morsi and the military’s clearing of two protests camps in Cairo resulting in the death of hundreds of Egyptians – have fundamentally altered these calculations. The potential for disintegration has become clear.

The inflow of funds from the Gulf states is positive and more funding is likely to be announced in the coming months if there is a fall in violence. Egypt is receiving several billion dollars in financial aid and considerable assistance in kind. Saudi Arabia is paying directly for wheat contracts while the Qataris are supplying gas, creating a more positive picture than the USD 19 billion in foreign exchange reserves implies.

In the short term Egypt’s economy will muddle along but underlying economic problems will worsen over the course of the year due to disinvestment. Saudi Arabia is muting the figure of USD 12 billion in aid for the Egyptian fiscal year of July to June 2014 but even Riyadh with its deep pockets will be reluctant to bankroll another state indefinitely.

Over the medium term we may end up with predictable confrontation; cycles of protests that don’t escalate in the manner of recent weeks but with each protest having the potential to unleash another uprising. This makes it difficult for companies to recommit fully to their Egyptian operations because of the risk this creates in moving staff and their families back to Cairo.

While parallels have been drawn with Algeria in the 1990s, one of the many notable differences is that Algiers could be ignored by oil companies operating in the country in a way that Cairo cannot. Egypt’s economy is dependent on the service sector whereas Algeria was a hydrocarbons-dependent economy. Ultimately, Algeria was able to transcend its difficulties with higher state spending as oil prices rose. There is no such light on the horizon for Egypt.

Oil and gas companies recently renegotiated payment agreements with the government and payments were to be resumed in exchange for the reinstatement of investment programmes. In the current climate companies will be reluctant to ramp up investment and a new agreement will need to be reached with interim oil minister Sherif Ismail. Ismail knows the energy companies well and will be sympathetic to their predicament, although the outlook for either party is not positive at present.

In contrast to Libya and Iraq, foreign investors in Egypt’s oil and gas sectors can’t even argue that commitment in the short term will lead to worthwhile gains and financial upside in the future. There is no reserve replacement potential for the next five years at least and the risk of expropriation will rise as the domestic energy balance becomes more precarious.

Astute investors had their credit and political risk insurance in place ahead of the uprisings. While the insurance market has remained open throughout the course of Egypt’s political transition, with some rate and capacity fluctuations, the recent coup and violence has led the private market to close for new credit and investment risk. Existing cover continues and underwriters will honour their commitments but support for new market entrants is only available from multilateral insurers for very select investments. Some limited insurer appetite remains for political violence cover.

The Egyptian economy is highly dependent upon the service sector. Photograph: Getty Images.

JLT Head of Credit & Political Risk Advisory

Photo: Getty Images
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There are risks as well as opportunities ahead for George Osborne

The Chancellor is in a tight spot, but expect his political wiles to be on full display, says Spencer Thompson.

The most significant fiscal event of this parliament will take place in late November, when the Chancellor presents the spending review setting out his plans for funding government departments over the next four years. This week, across Whitehall and up and down the country, ministers, lobbyists, advocacy groups and town halls are busily finalising their pitches ahead of Friday’s deadline for submissions to the review

It is difficult to overstate the challenge faced by the Chancellor. Under his current spending forecast and planned protections for the NHS, schools, defence and international aid spending, other areas of government will need to be cut by 16.4 per cent in real terms between 2015/16 and 2019/20. Focusing on services spending outside of protected areas, the cumulative cut will reach 26.5 per cent. Despite this, the Chancellor nonetheless has significant room for manoeuvre.

Firstly, under plans unveiled at the budget, the government intends to expand capital investment significantly in both 2018-19 and 2019-20. Over the last parliament capital spending was cut by around a quarter, but between now and 2019-20 it will grow by almost 20 per cent. How this growth in spending should be distributed across departments and between investment projects should be at the heart of the spending review.

In a paper published on Monday, we highlighted three urgent priorities for any additional capital spending: re-balancing transport investment away from London and the greater South East towards the North of England, a £2bn per year boost in public spending on housebuilding, and £1bn of extra investment per year in energy efficiency improvements for fuel-poor households.

Secondly, despite the tough fiscal environment, the Chancellor has the scope to fund a range of areas of policy in dire need of extra resources. These include social care, where rising costs at a time of falling resources are set to generate a severe funding squeeze for local government, 16-19 education, where many 6th-form and FE colleges are at risk of great financial difficulty, and funding a guaranteed paid job for young people in long-term unemployment. Our paper suggests a range of options for how to put these and other areas of policy on a sustainable funding footing.

There is a political angle to this as well. The Conservatives are keen to be seen as a party representing all working people, as shown by the "blue-collar Conservatism" agenda. In addition, the spending review offers the Conservative party the opportunity to return to ‘Compassionate Conservatism’ as a going concern.  If they are truly serious about being seen in this light, this should be reflected in a social investment agenda pursued through the spending review that promotes employment and secures a future for public services outside the NHS and schools.

This will come at a cost, however. In our paper, we show how the Chancellor could fund our package of proposed policies without increasing the pain on other areas of government, while remaining consistent with the government’s fiscal rules that require him to reach a surplus on overall government borrowing by 2019-20. We do not agree that the Government needs to reach a surplus in that year. But given this target wont be scrapped ahead of the spending review, we suggest that he should target a slightly lower surplus in 2019/20 of £7bn, with the deficit the year before being £2bn higher. In addition, we propose several revenue-raising measures in line with recent government tax policy that together would unlock an additional £5bn of resource for government departments.

Make no mistake, this will be a tough settlement for government departments and for public services. But the Chancellor does have a range of options open as he plans the upcoming spending review. Expect his reputation as a highly political Chancellor to be on full display.

Spencer Thompson is economic analyst at IPPR