EgyptEconomic growth has softened, the fiscal and balance-of-payments deficits have deteriorated, and foreignexchange reserves have fallen to a critical minimum level.Two years after the Arab Spring uprising, Egyptians – many of whom are living below the poverty line – are stillwaiting to reap the full benefits of lasting social, political and economic change.Egypt has potential both for structural transformation towards a more productive economy and for optimal useof its immense resource wealth, provided that vital policy reforms are introduced.

OverviewAfter toppling Hosni Mubarak in February 2011, Egyptians celebrated the election of Muslim Brotherhoodcandidate Mohammed Morsi on 24 June 2012, as the country’s first democratically elected president. A newconstitution, drafted by an Islamist-dominated assembly and narrowly approved in mid-December 2012 byvoters, has dramatically divided the country. A new parliament is expected to be in place later in 2013,following elections starting in April to replace the Islamist-dominated body that was dissolved by the SupremeConstitutional Court in June 2012.As Egyptians wait to complete the transition to democratic government, they still face a number of challenges.The real gross domestic product (GDP) growth rate fell to 2.2% in the fiscal year ending June 2012, down from5.1% in 2009/10, before the revolution. Continued political instability has undermined inflows from tourism andforeign direct investment (FDI). Economic growth is expected to remain depressed, at about 2% as of June2013.Delay in agreement about USD 4.8 billion in financing from the International Monetary Fund (IMF), which wouldbe subject to conditions to increase taxes and reform subsidies and public employment, has pushed Egypt to theverge of a full-blown currency crisis. By end-January 2013, the Egyptian pound (EGP) had depreciated by over12.5% of its value since the uprising. The market expects the pound to depreciate further, to between EGP 7and EGP 7.50 to the US dollar, and a black foreign exchange market is emerging. In June 2012, Egypt’sdomestic debt and fiscal deficit reached 80.3% and 10.8% of GDP respectively, narrowing the room for fiscalmanoeuvre.Poverty remains high, with 25.2% of the population living on less than USD 1.5 per day in 2010/11. Theilliteracy rate is high at 27%, and there are wide income disparities. The Egyptian statistical agency reportedthat unemployment was 12.5% in the third quarter of 2012, although several sources indicate that theunemployment rate may actually be above 18%. Over 3.3 million Egyptians are unemployed, while theunemployment rate for 20- to 24-year-olds is 46.4%.The government is working to address several of the structural and institutional problems that beset Egypt. Ithas developed a home-grown programme to reform the inefficient energy subsidy system and is promotingpolicies to fight corruption, foster societal inclusion and enhance equality of opportunity. However, thegovernment’s reluctance to accept the IMF conditions before the elections of April 2013 reflects the difficulty ofimplementing necessary but unpopular entitlement reforms in a heavily divided society.

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Figure 1: Real GDP Growth 2013 (North)

Figures for 2012 are estimates; for 2013 and later are projections.

Table 1: Macroeconomic indicators

2011 2012 2013 2014

Real GDP growth 1.8 2.2 2 3.5

Real GDP per capita growth 0.1 0.5 1.2 3

CPI inflation 11.1 8.7 10.6 11.7

Budget balance % GDP -9.7 -10.8 -11.4 -9.9

Current account % GDP -2.6 -3.3 -3.1 -2.4

Figures for 2012 are estimates; for 2013 and later are projections.

Real GDP growth (%) Northern Africa - Real GDP growth (%) Africa - Real GDP growth (%)

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014-2%

0%

2%

4%

6%

8%

10%

Real

GDP

Gro

wth

(%)

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Recent Developments & Prospects

Table 2: GDP by Sector (percentage of GDP)

2007 2012

Agriculture, forestry & fishing 14.1 14.8

Agriculture, hunting, forestry, fishing - -

Construction 4.1 4.6

Electricity, gas and water - -

Electricity, water and sanitation 1.9 1.7

Extractions 15.5 15.5

Finance, insurance and social solidarity 10.4 9.6

Finance, real estate and business services - -

General government services 9.8 10.4

Gross domestic product at basic prices / factor cost 100 100

Manufacturing 17 16.2

Mining - -

Other services - -

Public Administration & Personal Services - -

Public Administration, Education, Health & Social Work, Community, Social & Personal Services - -

Public administration, education, health & social work, community, social & personal services - -

Social services 2.8 3.9

Transport, storage and communication - -

Transportation, communication & information 10.3 9

Wholesale and retail trade, hotels and restaurants - -

Wholesale, retail trade and real estate ownership 14.2 14.4

Since the revolution of 25 January 2011, Egypt has experienced major political challenges and a period oftransition to democracy. Despite the election of Mohammed Morsi in June 2012, as the first democraticallyelected president, political stability remains elusive. Riding high on the praise he earned at home and abroad forbrokering a truce between Israel and Hamas in Gaza, President Morsi issued a constitutional declaration inNovember 2012, awarding himself broad powers above judicial scrutiny. This led to nationwide protests by hisopponents, which were in turn violently countered by his supporters. Although the president later retractedthat decision, a new constitution – drafted by an assembly dominated by the Muslim Brotherhood and its allies,and approved by a narrow majority of 63.8% in a referendum that saw a voter turnout of 32.9% – left thecountry deeply divided politically.Despite the political upheaval, Egypt’s stock market performed relatively well compared to other emergingmarkets, posting returns of over 45% in 2012. However, the prolonged political transition has hinderedeconomic growth. Real GDP growth has not returned to the pre-revolution rate of over 5.1% in fiscal year2009/10. The growth rate accelerated slightly in 2011/12 to 2.2%, as against 1.8% in the previous fiscal year.

Although the parliamentary elections scheduled for early 2013 will mark the end of the transition period,economic growth is expected to remain subdued at about 2% when the fiscal year ends in June 2013 and pickup to 3.5% by June 2014. On the demand side, economic activity during 2011/12 was driven by private andpublic consumption, which compensated for declining investment and a widening trade deficit. Total private andpublic consumption accounted for 90.9% of GDP and investment for 15.3% in 2011/12, compared to 87% and16.7% respectively in the previous year. Egypt’s economic growth was driven in particular by privateconsumption, which rose to 79% of GDP in 2011/12 compared to an average of 73.7% over the 2005-11 period.Finally, exports and imports stood respectively at 12.9% and 22.2% of GDP in 2011/12, compared to 11.7% and23.5% in 2010/11.At the sectoral level, the main contributors to GDP growth in 2011/12 were agriculture (2.9% growth, 14.8% ofGDP), construction (3.3% growth, 4.6% of GDP), telecommunications (5.2% growth, 4.4% of GDP) and realestate (3.2% growth, 2.9% of GDP). In contrast, poor performance in the manufacturing and tourism sectors,which expanded weakly at 0.7% and 2.3% respectively, weighed heavily on GDP growth in 2011/12; in2009/10, before the revolution, these sectors had posted growth of 5.1% and 12% respectively.Egypt’s foreign income earning has been undermined by Europe’s economic distress, unfavourably impactingthe balance of payments. Merchandise exports, which went primarily to Europe, Egypt’s main trading partner,decreased by about 0.1% to USD 27 billion in both 2010/11 and 2011/12, more than 8% below the levelachieved in 2007/08. Tourism has been hard hit by political instability, security problems and border attacks inSinai. As a result, tourism revenues decreased by 11% to USD 9.4 billion (3.1% of GDP) in 2011/12. Suez Canalreceipts stabilised at about USD 5 billion (2.1% of GDP) in 2010/11 and 2011/12, a rather positive developmentgiven the downward trajectory in canal revenues in the four previous fiscal years.Net foreign direct investment (FDI) inflows declined for the fourth year in a row, levelling off at aboutUSD 2.1 billion (0.8% of GDP) in both 2010/11 and 2011/12, down from a peak of USD 13.2 billion (8% of GDP)in 2007/08 prior to the global financial crisis. In 2011/12, net private transfers (mainly Egyptian workers’remittances) amounted to USD 18 billion (7% of GDP), up 43% from the previous fiscal year. Remittances fromEgyptian workers abroad have been on an upward trend since 2007/08.Total investment (excluding changes in inventory) reached USD 39 billion (15.3% of GDP) in 2011/12. Crude oiland natural gas attracted the largest investments (approximately 25% of the total), followed by transportationand communication (19%) and housing and real estate (16.7%). Manufacturing and petroleum products attracted8.7% of total investment, while health and educational services received only 1.6% and 2.4% respectively.The economy has suffered from the climate of uncertainty as the political crisis has deepened and the standoffbetween the executive and judiciary has worsened. Crucial tax increases and austerity measures that areconditions for the IMF loan were postponed because of the political unrest that followed President Morsi'sdecision to fast-track implementation of the new constitution. While such adjustments could depress domesticdemand, their postponement means that Egypt will continue to be unattractive for foreign direct investment.Furthermore, the economy is suffering from high interest rates on government bonds: the three-month treasurybill (T-bill) rate spiked to a monthly average of 13.1% in June 2012, up from 11.5% a year earlier. These highrates are partly to blame for driving the fiscal deficit to unsustainable levels.Furthermore, a currency crisis is looming. Egypt’s net international reserves have dropped to a critical minimumthat barely covers three months of imports (USD 13.6 billion as of end-January 2013). Foreign reservesaveraged USD 35 billion during the three fiscal years preceding the revolution. The local currency shed over4.5% of its US dollar value in a few weeks in January 2013 and has fallen by more than 10% since therevolution. As anxious Egyptians rush to buy dollars in the wake of the currency’s fall, the dollarisation ratio inhouseholds is bound to rise above the 15.5% level it had reached at end-October 2012.In January 2013, Qatar bolstered the Egyptian pound (EGP) by providing USD 2.5 billion, over and above anearlier financial package of the same amount. Nevertheless, the Central Bank of Egypt (CBE) ran down overUSD 20 billion of reserves over 2010/11 and 2011/12 to defend the local currency. The CBE has limited optionsas it attempts to control a slow depreciation of the pound.As social unrest persists and the population continues to grow, Egypt’s social and human developmentchallenges continue to mount. About 20 million Egyptians live on less than USD 1.5 a day, and over 3.3 millionare unemployed.Egypt’s need for external financing is urgent. The IMF estimates the gap at USD 14.5 billion. In January 2013,the IMF and Egypt resumed talks to move forward a November 2012 staff level agreement that had beenpostponed due to the political unrest that emerged when President Morsi fast-tracked the contentious newconstitution. The IMF financing package amounts to USD 4.8 billion and would mobilise additional lending fromother multilateral and bilateral development partners. The fiscal reforms demanded from Egypt as conditions forthe loan have proven challenging for the government, owing to the country’s current state of social and politicaldivision. It is unlikely that an agreement will become effective before the new parliament is in place.

Macroeconomic PolicyFiscal PolicyEgypt’s fiscal deficit widened by 24% in 2011/12 to USD 27.5 billion (10.8% of GDP), from USD 22.6 billion(9.7% of GDP) a year earlier, as the government increased spending in response to the social and politicaldemands of the revolutionary movement. While revenues increased by 14.5% to USD 50 billion in 2011/12,they were outstripped by year-on-year expenditures, which rose by 17.2% to USD 77.7 billion over the sameperiod.Taxes increased by 8.2% year-on-year to USD 34.2 billion in 2011/12. The main components of taxation aretaxes on incomes and profits (45%) and on consumption (40%). In 2011/12, state-owned enterprises contributed76% of all taxes on income and profits – the Egyptian General Petroleum Corporation (EGPC) alone paid 37% –while individuals contributed only 24%. Grants from foreign governments, which are part of non-tax revenue,increased substantially in 2011/12 to USD 1.5 billion, compared to USD 0.15 billion in 2010/11.About 80% of government spending is allocated to recurrent expenditures – interest payments on public debt(22%), wages and salaries (26%), and subsidies, grants and social benefits (32%) – rather than to capital goods.Public investment spending, which averaged 4% of GDP in 2009/10, before the revolution, contracted to 2% ofGDP (USD 6 billion) by end-June 2012. As of June 2012, interest on government debt had risen byUSD 2.8 billion year-on-year to USD 17 billion (8.9% of GDP). Interest on domestic debt accounts for 97% oftotal interest payments paid by the government. Subsidies to consumers (71% of which are for energy products,the rest for food items), increased by USD 3.9 billion year-on-year to reach USD 22.4 billion by end-June 2012.To contain the growing fiscal deficit to about 9.9% of GDP in 2013/14, the government is cutting energysubsidies and raising taxes. The 2012/13 budget proposed a USD 12 billion reduction in petroleum productssubsidies, but midway through the fiscal year much of this reduction has not yet been implemented. Electricityrates have been raised, however, and the subsidy on high-grade 95-octane petrol was eliminated in November2012. Cutting this subsidy may bring only negligible savings, as users could shift demand to subsidised 92-octanepetrol, but it is a positive development that Egyptians are now openly discussing the need for reforms to theinefficient energy subsidy system (the low efficiency of subsidies generally is discussed below, in the “SocialContext and Human Development” section).Egypt is mobilising further tax revenues as well. Taxes on cigarettes have been raised. The government hasannounced increases in the progressivity of income taxes and aims to broaden the general sales tax into a full-fledged value added tax. However, implementation of such economic reforms remains uncertain because of theongoing political turmoil. A capital gains tax has been introduced on initial public offerings on the stockexchange.In its effort to diversify financing away from the domestic banking sector, the government is seeking an IMFpackage that would mobilise about USD 14.5 billion in loans and deposits from the IMF itself (USD 4.8 billion)and from other bilateral and multilateral lenders. This would provide fiscal relief from the high interest rates ongovernment T-bills: the rate for three-month T-bills, for example, averaged 13.1% in June 2012, up from 11.5%a year earlier.

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Table 3: Public Finances (percentage of GDP)

2009 2010 2011 2012 2013 2014

Total revenue and grants 27.1 21.6 18.9 18.6 18.2 18.1

Tax revenue 15.3 13.4 13.8 13.3 13.1 12.7

Oil revenue 10.7 7.5 4.8 4.8 4.8 4.8

Grants - - - - - -

Total expenditure and net lending (a) 33.7 29.4 28.6 29.4 29.7 28

Current expenditure 29.6 25.5 25.8 26.6 26.8 25.2

Excluding interest 24.5 19.7 17.6 17.7 18.1 17.4

Wages and salaries 7.3 6.9 6.9 6.7 6.3 5.8

Interest 5.1 5.8 8.3 8.9 8.8 7.8

Primary balance -1.6 -2.1 -1.4 -1.9 -2.6 -2.1

Overall balance -6.6 -7.9 -9.7 -10.8 -11.4 -9.9

Figures for 2012 are estimates; for 2013 and later are projections.

Monetary PolicySince 2004, Egypt has pursued a managed float exchange rate regime that aims to hold the rate at EGP 6 to theUS dollar. With the onset of the political crisis, this policy has been increasingly difficult to maintain in the faceof a sharp drop in foreign earnings and capital inflows. As a result, in January 2013 the exchange rate fell toover EGP 6.5 to the dollar, and net international reserves (used by the CBE to support the exchange rate),dropped by end-January 2012 to USD 13.6 billion, from USD 26.6 billion in June 2011.Current foreign reserves held by the CBE cover just about three months of imports, which the central bankconsiders to be a critical minimum. The CBE has said that the remaining reserves would be used only to financeexternal debt service, cover strategic imports and respond to emergencies. The central bank thereforeintroduced currency auctions and other foreign currency controls in December 2012. Support from the IMF isnow needed urgently if Egypt is to avoid a disorderly domestic currency devaluation that would trigger higherfood prices and further social unrest.Interest rates have been maintained at their November 2011 level (overnight deposit rate, 9.25%; discountrate, 9.5%; overnight lending rate, 10.25%; and seven-day repo rate, 9.75%). This represents a delicate trade-off between the need to revitalise growth (with lower interest rates) and the need to curtail inflationarypressures (with higher interest rates). The interest rate adjustments of November 2011 caused the above-mentioned spike in the three-month T-bill rate. As of June 2012, yields on one-year T-bills were about 14.8%,compared to 11.5% a year earlier, and they have continued to rise, reaching 15.8% by end-August 2012. TheCBE cut reserve requirements on deposits in local banks from 14% to 12% in April 2012, and further to 10% byend-June 2012, but this accommodative monetary policy appears to have had little impact in terms of curtailingthe rise in interest rates.The year-on-year headline inflation rate, as measured by the urban consumer price index, slowed from 11.8%in June 2011 to 4.66% in December 2012 as economic activity continued to contract because of political unrest.Core inflation also dropped from 8.94% year-on-year to 4.44% over the same period. However, the centralbank foresees local supply bottlenecks for food and butane, and distortions in the distribution channels for foodproducts as inflationary risks and wants to take a more proactive role in managing them. It has formed an inter-ministerial persistent inflation group with a mandate to address directly the structural causes of inflation.Economic Cooperation, Regional Integration & TradeEgypt’s trade deficit increased slightly, from USD 27.1 billion (11.8% of GDP) in 2010/11 to USD 31.7 billion(9.2% of GDP) in 2011/12, and is no longer offset by tourism and investment receipts, now in decline. Driven bythe depreciation of the Egyptian pound and (despite incipient reforms) an inflexible subsidy system for fuel and

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food, the mounting import bill of USD 58.7 billion, up 8.5% from the previous year, continued to be the drivingfactor behind the deficit. Overall export growth was flat, as exports totalled USD 27 billion in both 2011 and2012. Within that total, however, non-petroleum exports declined and petroleum exports increased. Theservices trade balance was positive (USD 5.4 billion) but continued its stark downward trend fromUSD 10.3 billion in 2009/10 and USD 7.9 billion in 2010/11. The driving factors here were declining receiptsfrom tourism and investment. The current account deficit widened from 2.6% of GDP in 2011 to 3.3% in 2012.Remittances from Egyptians working abroad increased by about 43% to USD 18 billion in 2012, preventingfurther deterioration of the current account position.The European Union (EU) continues to be Egypt’s major trading partner, absorbing USD 11 billion of Egypt’sexports and supplying USD 19.3 billion of its imports in 2011/12. Within the EU, Italy accounts for the largestshare (20.7%) of merchandise exports. Between 2007/08 and 2010/11, the EU accounted for an average of 36%of merchandise trade, the United States for 10%, and the Arab world and Asia for a fifth, while Africa (excludingArab countries) accounted for only 2% of exports and 1% of imports. Since the revolution, the authorities havestepped up efforts to deepen the Egyptian private sector’s participation in infrastructure projects in the rest ofAfrica and to support training and capacity-building initiatives on the continent.Investment has suffered from heavy short-term and long-term capital outflows. Net portfolio investmentdoubled its negative balance in 2011/12 to USD 5 billion. The net FDI balance remained positive at USD 2 billion(0.8% of GDP), but outflows have doubled over the last two years to USD 9.7 billion, compared to inflows ofUSD 11.8 billion. The EU accounted for 82% of gross FDI inflows to Egypt in 2011/12.

Table 4: Current Account (percentage of GDP)

2004 2009 2010 2011 2012 2013 2014

Trade balance -10 -13.4 -11.4 -11.8 -9.2 -8.1 -7.3

Exports of goods (f.o.b.) 13.4 13.4 10.8 11.7 12.9 13 12.8

Imports of goods (f.o.b.) 23.4 26.8 22.2 23.5 22.2 21.1 20.1

Services 9.6 6.6 6.7 6 3.6 3.4 4.3

Factor income -0.3 0.1 -2 -2.6 -2.6 -2.6 -2.8

Current transfers 5 4.4 4.7 5.8 5.2 4.4 3.9

Current account balance 4.3 -2.3 -2 -2.6 -3.1 -2.9 -2

Figures for 2012 are estimates; for 2013 and later are projections.

Debt PolicyEgypt’s gross domestic debt had risen to 80.3% of GDP (USD 205 billion) by end-June 2012, from 76.2% of GDP(USD 176 billion) a year earlier, as the government continued its policy of financing the widening budget deficitby issuing T-bills. The stock of T-bills and bonds reached USD 178.7 billion (87% of gross domestic debt) by end-June 2012, an increase of 18% year-on-year.Yields on T-bills rose in 2011/12 to an average of 15%, compared to an average of 12% in 2010/11. As a result,interest payments rose by 24% (USD 3.2 billion) to reach USD 17 billion by end-June 2012, and totalgovernment debt service increased from USD 19.4 billion in 2010/11 to USD 23.4 billion over 2011/12. Tomitigate the increased costs of borrowing and enhance foreign reserves, the government in August 2012launched auctions of one-year euro T-bills. The August auction saw the major banks buying EUR 513 million ofT-bills at an average yield of 3.245%, exceeding the government’s expectations of EUR 400 million.Foreign debt levels remain manageable, however, at about USD 5.7 billion in both the 2010/11 and 2011/12fiscal years. The ratios of debt service to exports and debt service to current receipts stood at 6.1% and 4.4%respectively at the end of June 2012, compared to 2005-12 historical averages of 6.6% and 5.5% respectively.The IMF package under discussion could enable Egypt to diversify its borrowing away from reliance onincreasingly unsustainable domestic debt. Furthermore, it could enhance investor confidence in the Egyptianeconomy, and the rating agencies Moody’s, Standard and Poor’s, and Fitch are expected to reverse theirdowngrades of the country’s sovereign ratings.

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Figure 2: Stock of total external debt and debt service 2013

Figures for 2012 are estimates; for 2013 and later are projections.Debt/GDP Debt service/Exports

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20140%

10%

20%

30%

40%

50%

Perc

enta

ge

Economic & Political GovernancePrivate SectorThe private sector has accounted for 62% of GDP and employed 70% of Egypt’s workforce over the past fiveyears. Before the revolution, Egypt suffered from an overburdening bureaucracy, corruption and insufficientcompetition in many sectors. Favouritism, lack of transparency and protection of market segments prevailed.Consequently, one of the demands of the revolution was an overhaul of the relationship between governmentand the private sector. Although crucial for Egypt’s competitiveness in the long run, this demand has linked thegovernment-business relationship to the drawn-out process of political and legal transition, resulting inwidespread uncertainty and timid private sector investment.Standard measures of competitiveness reflect some of these problems and uncertainties. Egypt ranked 107th outof 146 economies on the World Economic Forum’s Global Competitiveness Index in 2012/13, down from 81st

position in 2010/11. In the World Bank report Doing Business 2013, Egypt ranked 109th out of 183 economies,down from 108th in 2011 but up from 110th in 2012. The reliability of contracts and the capacity to have themenforced through the legal system rank among the chief concerns. Egypt ranked 144th out of 184 countries onthe “enforcing contracts” sub-index. Other major weaknesses were noted in paying taxes (145th place), dealingwith construction permits (155th) and resolving insolvency (137th). Egypt continues to have the highest share ofcomplaints about corrupt practices as major obstacles to business. Customs clearance delays have been cut,though perceptions associated with trade facilitation remain negative. Import and export procedures remainedtime-consuming in 2011 (12 days for each, according to Doing Business 2012).Since the revolution, steps have been taken to change the situation reflected in these indicators. A largenumber of corruption investigations have been started and several high-profile indictments made againstbusiness and former high-ranking officials and ministers. Several land allocations made by the formergovernment through direct contracts have been withdrawn, and privatisations of former state-owned companiesin the oil and manufacturing sectors have been reversed. A special committee established to settle land disputeswith investors expects to net about USD 3.3 billion by the end of 2013. In addition, the new constitutionestablishes a national anti-corruption commission.Financial SectorEgypt’s financial sector has recovered markedly from its overextended position in 2007, but it remainsinefficient at providing credit to the private sector. In 2012, the problem was the opposite of that in 2007:uncertainty over the speed of recovery and transition led to a build-up of liquidity in banks. The loans-to-deposits ratio stood at 49.8% by end-September 2012, and non-performing loans amounted to a comfortable9.9% of total loans at end-June 2012. The government remains the largest borrower, squeezing credit forprivate sector investment.Accommodative monetary policy has had some effect in getting the liquidity in banks into the real sector of theeconomy: credit to the private sector grew by about 7.3% between 2011 and 2012. However, deposits alsorose by 6.4% to USD 172.7 billion. Insufficient access to finance was rated among the top obstacles to businessgrowth by firms in the 2008 Enterprise Survey of Egypt. The government has sought to increase financing forthe private sector. In 2010, access to credit information was expanded with the addition of retailers to a privatecredit bureau database. At the time of writing, the deposit requirement for lending to small- and medium-sizedenterprises (SMEs) was 0%. The central bank’s training institute works with banks to build capacity for lendingto small firms, and the Bedaya Center of the General Authority for Investment is working to develop SMEs inEgypt.The banking sector is struggling with both fragmentation and a lack of competition between institutions. Effortsto privatise state-owned banks have stalled owing to the financial crisis and subsequently the revolution. As aresult, sizeable amounts of money are tied up in inefficiently small institutions. To counteract furtherfragmentation of the banking sector, the CBE has capped the number of operating licences for commercialbanks. Thus, acquisition of an existing bank is the only way to enter the sector. At the same time, however,high yields and insufficient access to finance, especially for smaller firms, suggest that competition betweenbanks for loan and investment opportunities is insufficient. Allowing small banks with new business modelsfocusing on SMEs to enter the market without requiring a joint venture or purchase of an existing bank mightaddress these shortcomings.Egypt’s stock market is lively and active, but its capitalisation is low compared to deposits in the bankingsystem. Market capitalisation was USD 71 billion before the revolution (end-June 2010) and had fallen by 4% toabout USD 64.8 billion as of October 20121. The latter figure corresponds to 33% of total deposits in thebanking system, indicating the comparatively low importance of equity stocks.Public Sector Management, Institutions & ReformRevamping Egypt’s public sector to transform it from a post-socialist provider of large-scale employment with apresence in most parts of the economy into a modern, efficient administration oriented towards service delivery

is among the most important and difficult challenges facing the government. Egypt has a large, inefficient,underpaid civil service subject to political pressure. In the long run, the size of the public administration is to berestrained by replacing only those who retire. However, post-revolutionary governments have continued to usethe public sector as a tool to meet social pressure and demands for job creation, including increases in minimumwages, making future reform even more difficult. Egypt’s public sector employs around 5.8 million persons, withan additional 0.5 million temporary workers.Egypt has more state-owned enterprises than the average for developing countries. Many of these publicentities are overstaffed and underequipped, needing investment and staff reductions if they are to becomecompetitive. In addition, the Egyptian military holds a substantial share of state economic corporations, but littleis known about the extent or productivity of these holdings. Privatisation, which could transform thesecompanies, is hampered by the legacy of high-profile corruption cases in past (Mubarak-era) privatisationprojects. The new constitution explicitly makes it difficult to sell state assets.Decentralisation could help make public sector management more efficient. A national strategy fordecentralisation, launched in July 2009, is based on ensuring the rights of local communities to decide on theirown needs and priorities. The finance ministry is developing a fiscal decentralisation plan, but in the meantimelocal communities have no authority to raise revenue or create revenue sources on their own.In enacting the new constitution, Egypt has taken the first step in the arduous process of transforming itspolitical, social and economic institutional frameworks. Successful completion of the elections scheduled to beginin April 2013 would be another step forward. In the future, it will be imperative for the government to work inpartnership with empowered civil society and private actors to build more accountable state institutions thatdeliver efficient basic public services and enforce the rule of law.Natural Resource Management & EnvironmentEgypt was ranked 60th out of 132 countries in the 2012 Environment Sustainability Index, a slight improvementover the 2010 ranking of 68th out of 142 countries. With its numerous world cultural heritage sites andrenowned biodiversity hotspots, and given the economic importance of tourism, Egypt carefully conserves itsnatural and cultural heritage.Only 3.45% of Egypt’s land area is arable. The encroachment of urban areas into farmland, which has onlyaccelerated since the revolution, is therefore a worrisome trend. In the absence of effective land management,farmland is being increasingly enclosed and divided up by urban sprawl, undermining productivity in theagricultural sector. Climate change risks, including rising sea levels in the Nile Delta area, are another source ofconcern.Deteriorating water quality and decreasing quantity are major concerns. Population growth has reduced percapita water use to less than 1 000 m3 per year, while demand from households, agriculture and industry hasincreased. This heightens the potential for conflict with the Nile Basin riparian countries, as Egypt’s annual shareof Nile water resources remains fixed at 55.5 billion m3.Egypt’s energy strategy, adopted in 2008, aims to increase the share of renewable energy sources to 20% by2020. This increase will be obtained mainly by scaling up wind power to 12% (7 200 MW), as solar powerremains costly and internal hydropower capacity is nearly exhausted.Collection of municipal solid waste covers only 65% of the 55 000 tonnes of waste that accumulate daily, posingserious environmental challenges.Political ContextIn 2012, Egypt held its first free parliamentary and presidential elections in more than 60 years, although theparliamentary elections were later annulled by the Supreme Court and rescheduled for early 2013. MohammedMorsi of the Freedom and Justice Party (Muslim Brotherhood) was the victor of the presidential election. Thetransition from a de facto military regime to a democratically legitimised one has been an important step. Theyear closed in a less conciliatory tone with the adoption of a contested new constitution by referendum on15 December 2012. The referendum was preceded by two weeks of sometimes violent protest by bothopposition and government supporters. The opposition considered that the constitution did not sufficientlyprotect individual and religious freedoms.The conflict over the drafting of the constitution brought to the fore the rifts in the political landscape. Theinitial anti-Mubarak coalition gave way to a strong opposition made up of liberal and conservative forces.Considering the re-emergence of severe violence between protesters and government forces in January 2013,the political camps seem bent on a strategy of confrontation. The 2013 parliamentary elections will mark animportant milestone and determine the new balance of power between, on one hand, the Muslim Brotherhoodand other Islamists, and on the other, the secular, liberal camps in the opposition.

Social Context & Human DevelopmentBuilding Human ResourcesBy international standards, the government allocates a substantial amount of public spending to education (3.6%of GDP and 12% of total spending in the 2012/13 budget), and universal primary education, one of theMillennium Development Goals (MDGs), has been achieved. Nonetheless, the existing system is arguably of lowquality and does not respond to the needs of the labour market: only two out of ten higher education graduatesfind jobs after graduation. Furthermore, the system exacerbates inequalities between the well-off, who canafford access to high-quality education from private providers, and the poor, who cannot. The new constitutioncommits the state to eradicating illiteracy (which currently affects 27% of the population) within ten years.The 2012/13 budget allocates about 5.4% of total public expenditure (1.6% of GDP) to health. Despite anextensive network of health facilities, there are urban-rural inequalities in access to health care. Egypt’s HealthInsurance Organisation covers only half the population, providing incentives for the growth of private sectorproviders, which remain unregulated. HIV/AIDS prevalence among 15- to 49-year-olds is low – about 0.03%according to the World Health Organization, or 0.10% in 2009 according to the World DevelopmentIndicators – but there is a dearth of information on people living with HIV/AIDS.High turnover in the civil service is slowing the change in social policies demanded by Egyptians. As a result,poverty and unemployment rates remain high, and public service delivery in health and education remainsweak. To overcome these challenges, the government in March 2012 proposed an 18-month National Plan forPriority Economic and Social Measures, the central objective of which is a “New Social Contract” that guaranteeshigher social protection, better education and health services, and inclusive growth. Furthermore, to removeconstraints on public service delivery, the new constitution commits the state to provide improved health careand education services, free of charge for those who are unable to pay, and guarantees sufficient allocation ofpublic spending to these services.Poverty Reduction, Social Protection & LabourEgypt has made progress on human and social development and is on track to achieve the MillenniumDevelopment Goals. Nevertheless, much remains to be improved and regional gaps are widening. The 2011UNDP Human Development Index ranked Egypt 113rd out of 182 countries. Extreme poverty and hunger havebeen curtailed; infant mortality and malnutrition have been halved; life expectancy has risen from 64 to 71years; and there has been demonstrable improvement in maternal health and the fight against HIV/AIDS.According to World Bank estimates, however, some 22% of Egyptians have incomes lower than USD 2 per dayper person, while rural poverty rates reach 44%. There are large regional disparities in income, infrastructure,access to finance, education and labour markets. The rural-urban gap has been widening, with Cairo aloneproducing over half of Egypt’s GDP. The World Bank estimates that Upper Egypt, with only 40% of thepopulation, accounts for 60% of poverty and 80% of the severely poor. Dependence on low-value agricultureand disparities in the investment climate are major contributors to the rural-urban divide.Egypt spent USD 22 billion (9% of GDP) during the 2011/12 fiscal year on social safety nets, mainly for subsidieson energy (USD 16 billion, 6% of GDP) and food (USD 5 billion, 2% of GDP). These expenditure items havebeen relatively constant over several decades. While social safety nets could make a measurable difference tothe poor, less than 25% of Egypt’s subsidies actually reach their intended targets, while the subsidy systemcontributes to unsustainable fiscal deficits. Distribution mechanisms are untargeted and disproportionate acrossregions. As a result, the top 40% of the population enjoys about 60% of energy subsidies, leaving the bottom40% with only 25% of the benefits. These disparities are wider in urban areas: the top 40% of the urbanpopulation receives about 75% of energy subsidies and over 90% of petrol subsidies. The government hasinitiated steps to reform the inefficient energy subsidy system through the introduction of smart cards thatwould cap the amount of petrol available to a consumer over a given period of time.The situation of labour in post-revolutionary Egypt is uncertain. Since the revolution, strikes have become aregular occurrence across sectors and regions. Although the government has taken sporadic measures toaddress structural labour market problems, weak labour rights and standards remain a source of concern.Unemployment protection schemes and social insurance laws protect only workers in the formal sector. Thegovernment’s minimum wage policy shows a lack of clarity and progress. In June 2011, Egypt’s interimadministration set the monthly wage rate for civil servants at USD 120 (EGP 700) per month. Some sourcessuggest that this minimum rate will be raised to USD 200 (EGP 1 200) monthly within three years underPresident Morsi’s Renaissance Project, yet even the implementation of the earlier rate of EGP 700 has provenproblematic: over half a million temporary workers in government have not received the promised minimumwage, and it was unclear whether the minimum wage also applies to the private sector. If it had been fullyimplemented in the civil service, the upward adjustment to the wage structure could have addedUSD 1.5 billion to government spending in fiscal year 2011/12. The new constitution requires the governmentto establish a minimum wage, a pension scheme, social insurance and health care that would guarantee decentlivelihoods for workers and in some cases the unemployed. Labour laws need to be strengthened in turn.Gender Equality

In post-revolutionary Egypt, the economic and political empowerment of women is uncertain and their statusmay be deteriorating. Women’s participation in the democratic process remains challenged by the emergingagenda of Islamist political forces. Recent political developments in the country demonstrate that it is difficult toguarantee the enforcement of measures to promote gender equity in the current climate. Interim governmentsafter the revolution were criticised for not protecting women’s rights, particularly concerning crimes againstwomen that occurred during the protests at Tahrir Square. Sexual harassment is a major concern and, givenEgypt’s international commitments, a liability. The National Council for Women is addressing this issue, but itneeds stronger political support.Women remain marginalised in economic activities. Data from Egypt’s statistical agency show an unemploymentrate of 24% among women during the third quarter of 2012, more than double that of men (9.1%). Althoughwomen make up 30% of the professional and technical workforce, only 9% of Egypt’s administrators andmanagers were women in 2007.

Thematic analysis: Structural transformation and natural resourcesEgypt’s economy is among the most diversified in Africa and does not depend on a single abundant naturalresource for future growth. Nevertheless, energy resources have played an increasingly important role over thelast decade relative to agriculture, manufacturing and services. Between 2000 and 2011, agriculture,manufacturing and services each lost 2 to 3 percentage points of their contribution to Egypt’s GDP, whereasextractive activities gained 7.6 percentage points. The weak performance of services is largely explained by thesharp decline in tourism following the revolution. Financial services gained about 1 percentage point of GDP andtelecommunications doubled its contribution to 4%. Public administration gained 2 percentage points.Structural reforms that opened the country up for investment and improved the business climate droveeconomic expansion before the revolution. FDI reached USD 10 billion in 2006, up from USD 1 billion in 2000.Investments largely went into oil and gas exploration and extraction, leading to a significant expansion ofreserves, as well as into various service industries, especially tourism, finance and telecommunications. Incontrast, much of the manufacturing sector suffered from trade liberalisation following Egypt’s accession to theWorld Trade Organization in the late 1990s. The textile sector in particular suffered heavily, as this largelyinefficient state-owned sector began to face competition from cheaper imports, in both domestic and exportmarkets. Egypt has also managed to attract a significant car manufacturing industry, but it produces largely forthe domestic market, which enjoys high import barriers.Oil, natural gas and derivative products are the most important items in Egypt’s natural resource basket. Egypthas also begun to mine and export gold, but so far only in small quantities. Extractive industries accounted for15.6% of GDP in 2011/12. Exports of oil products and derivatives amounted to USD 13.5 billion in 2011/12,accounting for just over half of all exports. Soft commodities come a far second, with USD 2.5 billion inagricultural exports in 2010. The biggest line items are oranges (16% of exports in 2010), onions (7%) andcotton (6%). Gas production has expanded significantly over the last decade, thanks to foreign investment intothe sector. In 2011, gas production reached 2.17 trillion cubic feet (tcf), up from 0.74 tcf in 2000. According tothe Egyptian Natural Gas Holding Company (EGAS), known reserves increased from 53 tcf in 2000 to 77 tcf in2011 (quoted in Oxford Business Group). Yet-to-find reserves that should be discovered by 2040 are estimatedat 90 tcf. Despite this strong growth, existing production capacity is insufficient to meet both export anddomestic demand. As its export commitments to European and Asian markets are set in long-term contracts,Egypt intends to build infrastructure for gas imports.The oil sector presents a similar, if more mature, picture. Proven reserves increased from 3.7 billion barrels(bbl) in 2010 to 4.4 billion barrels in 2012, due to exploration activity by international investors (Oil and GasJournal, January 2012 estimate). Despite these new finds, Egypt’s oil production has been in decline. The USEnergy Information Administration (EIA) reports that production in 2011 (727 000 bbl/day) was only 78% of its1996 peak (EIA, International Energy Statistics). Domestic oil consumption, in contrast, has grown by over 30%over the last decade and reached 815 000 bbl/d in 2011 (www.eia.gov/cabs/Egypt/Full.html), surpassingproduction since 2008.The puzzling contradictions of high and growing domestic demand, abundant natural resources and insufficientproduction are explained by artificially distorted prices. Egypt has established a massive energy price subsidyscheme that now carries the risk of undermining the very resource wealth whose benefits it was meant tospread. As a result of the subsidy, Egypt’s energy consumption is well above that found in comparableeconomies and continues to grow much faster than elsewhere. Consumption of natural gas grew by 15% in2011, a year of economic contraction. As world market prices for oil have risen, the government’s losses fromproviding cheap fuel to industry and households have become increasingly heavy, exceeding USD 1 billion peryear as of 2010 (Egypt Independent, www.egyptindependent.com/news/egypt-joins-list-mazut-importers). Thesupply-side instrument of the energy pricing system is the monopsony of Egyptian Petroleum Corporation(EGPC). Oil producers are required to sell their production to EGPC at a price below the world market price.EGPC then feeds the crude oil into its refineries or sells it on international markets. Existing oil fields havedelivered sufficient margins under this system, but these fields are maturing and newly discovered reserves areincreasingly difficult and expensive to access. As a result, investment in new production has been insufficient, aspotential investors expect better returns. This situation is exacerbated by the current economic and politicaluncertainty, which further deters investment.Up the value chain, Egypt prides itself on having the largest petroleum refining sector in Africa. Refining crudeoil to higher-grade petroleum products is the first step in the petroleum value chain and could be an importantstepping-stone to other higher value-added industries in the sector. Like most government-run industries inEgypt, however, refining suffers from underinvestment and outdated capital. Most of Egypt’s refining capacity isat a low technological level and cannot meet domestic demand for refined petroleum products such as dieseland fuel oil. An important improvement to the situation will be Egyptian Refining Corporation, the firstinternationally financed (USD 3.7 billion) and privately run refining plant on a modern scale, which will supply50% of Egypt’s diesel demand. Construction of the refinery began in 2012. Given Egypt’s sizeable domesticmarket for refined petroleum products, further upgrading of the refining sector through public-privatepartnerships (PPPs) could ensure the sector’s survival.Egypt boasts substantial potential for both structural transformation towards more productive activities and for

making the most of its immense resource wealth. To achieve these goals, it must tackle two challenges. First,liberalising the energy prices facing producers, refiners, households and businesses would do much to bringincentives back into line with the long-run objective of sustainable investment-driven growth. Second, attractingmuch-needed investment to upgrade capital-intensive industries is crucial to making Egyptian industrycompetitive. The biggest obstacles are the ossified market structures in these sectors, which are oftendominated by a few oligopolistic or monopolistic firms that are either government-owned or in the hands ofoligarchs following privatisation during the former regime.Notes

1. The US dollar value of market capitalisation captures the effect of a lower exchange rate. As of early February2013, the Egyptian pound had lost over 18% of its value compared to June 2010.