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October 24, 2014

Egypt's Sisi delivers economic reforms but hurdles remain

In his first 100 days in office, Egyptian President Abdel Fattah al-Sisi has made a fast start on economic reform: slashing costly fuel subsidies, raising taxes and devising infrastructure projects to secure long-term revenues and ease unemployment.

Those are moves that have long been sought by foreign investors. But winning their full confidence will require pushing ahead with further politically-sensitive reforms and sealing an elusive deal with the International Monetary Fund.

A loan from the global lender would serve as a badly-needed stamp of approval for a country battered by political turmoil since a popular uprising ended 30 years of rule by autocrat Hosni Mubarak in 2011.

For decades, Mubarak mostly avoided politically-risky reforms that might anger a population reliant on subsidised food and fuel. His Islamist successor Mohamed Mursi also showed little sign of progress during a tumultuous year in power.

Investors hope that Sisi, a former army chief who overthrew Mursi, cracked down harshly on his followers and won the election to succeed him, will have the authority to enact measures that his predecessors could not.

"We don't want politicking, we don't want drama. We want a leader who is going to implement an investment regime for Egypt focused on the longer term," said Bryan Carter, lead portfolio manager for emerging debt at Acadian Asset Management in Boston.

Raising fuel prices and taxes may ease the burden on the cash-strapped state, which faces a crippling budget deficit around 11 percent of economic output and double digit unemployment.

But Sisi's ultimate challenge is luring back foreign investors who remain wary of Egypt's artificially strong currency, rising inflation, stifling bureaucracy and electricity shortages.

"The solution to Egypt's longer term economic problems will not come from any sort of austerity internally or restructuring of the fiscal budget. It's got to come from the catalysation of investments," said Carter.

Egypt has been consulting with the IMF about implementing a value-added tax (VAT), which the government predicts would generate more than $4 billion in revenues.

Investors are eager to see the VAT pushed through without opposition or unrest, though officials have not given a time-line for its implementation.

Egypt resumed regular consultations with the IMF this month for the first time since March 2010 - a necessary step before securing a loan package. Cairo had postponed the talks with the global financial body following Mubarak's overthrow in 2011.

Suez flagship project

Cairo is pinning its hopes on an international investment and aid conference scheduled for February in the Red Sea resort town of Sharm al-Sheikh. It hopes foreign governments, private investors and international donor organisations will make hefty pledges there.

Investment Minister Ashraf Salman told Reuters in an interview this month he was aiming for $10 billion in foreign investment in the current fiscal year and hopes Egypt will attract $18 billion a year by 2018, highly ambitious targets.

Foreign direct investment was about $8 billion annually before the 2011 uprising and reached only $4.1 billion in the fiscal year that ended in June.

Sisi's flagship project is the expansion of Egypt's Suez Canal, a strategic global shipping lane which brings in about $5 billion of revenue and foreign reserves each year.

He hopes that figure will more than double with the new venture and has set an ambitious one-year target for completing the initial phase.

The former army chief appears also to be banking on the canal's symbolism and geopolitical importance to raise his public stature.

Egypt nationalised the canal in 1956, prompting shareholders Britain and France to invade along with Israel. The crisis ended after Egypt sank 40 ships and the United States, Soviet Union and United Nations intervened forcing the invaders to withdraw.

Egyptians flocked to banks this month to buy $8.5 billion worth of Suez Canal investment certificates, which the government held up as a public vote of confidence in the economy.

Some foreign investors are not as enthusiastic as Egyptians, who have been longing for an economic recovery and political stability.

"We do not have a lot of details. There are still some question marks because it is a big project," said Remy Marcel, co-fund manager for the Middle East and North Africa at asset management company Amundi.

"It is too early to really figure out what would be the consequences of this project. On paper it looks very positive; it would help to create some jobs and increase revenues."

No quick fixes

Sisi seems to have space for further manoeuvre. So far, cuts to fuel subsidies have not triggered unrest as was feared, even though they have driven up prices across the board.

But the breathing room may not last if the president remains committed to fiscal discipline as promised. That would require him to make further bold moves such as pushing ahead with more subsidy cuts and introducing the VAT.

"There are no quick fixes, including the removal of subsidies, which most foreign investors wrongly seem to believe can be achieved without social unrest," said Daniel Broby, chief executive of Gemfonds, a UK-based investment boutique.

Egypt's currency, another critical factor for foreign investors, has been stable in the official market since June, but the persistence of the black market and constraints on dollar outflows are keeping investors cautious.

Expectations of a significant currency depreciation following parliamentary elections slated for the end of the year have delayed some investors' return to the market and also caused the hoarding of dollars, keeping the black market alive.

Egypt's main index has gained 18.6 percent since Sisi's election and now stands well above its level before the 2011 uprising. That signifies a vote of confidence by domestic investors, but official data does not show a substantial increase in foreign investors returning to the bourse.

A Cairo-based fixed-income trader said investors have not yet returned to the government bond market either.

"We haven't heard of foreigners buying government debt in the past two months or so," he said.

Realistic prospects

Egyptian ministers appointed by Sisi to oversee the economy seem far more realistic about prospects than officials who served under Mubarak and often painted a rosy picture.

Finance Minister Hany Kadry Dimian told Reuters this month the government was aiming to boost economic growth to 5-6 percent within three years and halve the budget deficit in seven years, while acknowledging challenges ahead.

"There's been nothing earth shattering. But it's the relentless march toward progress and the realisation of this (reform) framework that matters, and that's exactly what we want to see," said Carter of Acadian.

Sisi has come under strong criticism from human rights groups since last year when, as army chief, he overthrew Mursi following mass protests and then mounted a ruthless crackdown on Mursi's Muslim Brotherhood.

Security forces killed hundreds of Brotherhood supporters in the streets and arrested thousands of Islamists. Secular activists have also been jailed for violating a law which places severe restrictions on protests.

But most Egyptians crave stability and Sisi has delivered, stifling political turmoil and promising to defeat the Sinai-based militant group Ansar Bayt al-Maqdis, which has killed hundreds of members of the Egyptian security forces.

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