Editor’s Note: In the third in a series of analyses, “Food, Fuel, and Finance: How Will the Middle East Weather the Global Economic Crisis?”,
Navtej Dhillon speaks with prominent Middle East economist Dr. Heba Handoussa on critical issues facing Egypt’s transitioning economy, including the country’s balance of trade, prospects for small and medium enterprises, and the credit and lending climate. An edited transcript of the interview follows.
Navtej Dhillon: In recent years, Egypt has experienced a surge in non-oil exports contributing to growth and employment. With an economic slowdown in the U.S. and Europe, what now happens to Egypt’s export sectors?
Dr. Heba Handoussa: The global financial crisis is likely to have significant impact on the Egyptian economy as a whole, especially for formal enterprises of the larger size in key export sectors. Two of Egypt’s largest manufacturing sectors are ready-made garments, which make up large exports to the US and the EU, and the food industry, which has markets in the EU and the Arab region. We can expect there to be significant reductions in exports in these markets. The fact that Egypt has a low-value added structure of exports with very little processing makes Egypt more vulnerable than an average manufacturing country, because these exports are likely to drop in quantity and price (which will likely drop more sharply) because of being closer to the end of the value chain.
Dhillon: Have record high oil and commodity prices been adversely affecting the terms of trade in countries like Egypt? As prices drop, but remain volatile, what will be the impact on trade and what new opportunities do they present to stimulate growth and welfare?
Handoussa: Egypt is a net exporter only if natural gas is taken into account. The fact that natural gas is exported according to very long-term agreements means that it has fixed prices, so it won’t be vulnerable to price shocks of oil, and this means that the state will not be losing considerable amounts—because we know that prices are very volatile. If we exclude natural gas from our energy balance of trade, Egypt is a large net importer of oil and oil products. [Egypt is] an important net importer if we add to that the declining price of oil, as well as food and metal which have dropped again. What this means is that the balance of payments is going to improve to the extent that the cost of these imports will decline via the drastic price declines we are witnessing and can expect in the next few months.
In addition, Egypt is the second largest cereal importer in the world, so all of these are pluses for Egypt, not just for balance of payment, but also for the state budget. As prices ease, this will be very good news for food producers in the local markets—Egypt is highly dependent on grain imports as well as producers in petrochemicals, plastics, and wood, which are all imported. This will be also very good news for the government because it will contribute to huge savings for the budget, which could be directed to welfare payments or Keynesian types of injections. These moves should be bold and the Egyptian government should take advantage of it immediately. Plans should be announced not only to discourage speculation and fears, but to encourage investment in the local market by Egyptian investors large and small, and large foreign investors, especially those from the Gulf.
Dhillon: Small and medium size enterprises (SMEs) account for a significant share of total employment in Egypt. This part of the Egyptian economy—one that serves local markets—is likely to be more resilient in the face of a global economic recession. Should we be paying more attention to this sector?
Handoussa: Egypt has 2.4 million SMEs with less than 10 workers that employ 5.2 million workers—according to Egypt’s census in 2006—and another 39,000 SMEs with between 10 and 50 workers. SMEs account for more than 80% of employment in Egypt’s non-agricultural private sector. This includes both formal and informal SMEs, however a large number of them are informal. Therefore, whatever is relevant to SMEs is also crucial to the country’s prospects for growth and development, and the welfare of not just the very poor but the also the average citizen.
The global financial crisis is likely to transform the SME sector into a refuge for those who will be unemployed from the larger formal sector enterprises, meaning those who lose jobs as a result of the recession. We have to give a lot of attention to conditions in the SME sector. The SMEs cater more to local consumers, so they are more protected from the recession and can prove more resilient as domestic demand remains strong. In the short-term, we need to ensure that SMEs have access to credit and all of the non-financial services that help to enhance productivity and market access. It will also be important to promote SME access to ICT in an effort to better inform small entrepreneurs of market challenges and opportunities.
Dhillon: Key sectors such as tourism and manufacturing face fierce competition from other countries. Does the current economic crisis open up new opportunities for Egypt to re-think its comparative advantage and capture new markets?
Handoussa: I see Egypt’s comparative advantage more as a services-based society than manufacturing based. In terms goods and services, we are not on the high end of valued commodities. This means instead of aiming for five-star quality service, Egypt should focus more on eco-tourism and mid-level tourism, given that during this recession there will be tourists looking for cheaper alternatives, like Basata [a cheap holiday spot on the Sinai peninsula] for example. Egypt is one of the lowest cost tourist destinations on the Mediterranean. So, at the moment we’re at the low end of mass tourism—a strength that should be harnessed by giving local communities a bigger stake in the tourism industry, and the ability to earn an income from it.
There needs to be a dramatic shift in the mind of policymakers in terms of the vision of how we want to position Egypt. I’m suggesting not focusing exclusively on the high-tech value chain: not to replicate what rich countries and the Gulf are doing; but to find ways of expanding good tourism with limited resources. Egypt needs to make use of its cheap labor: only 2 countries, Sri Lanka and Bangladesh, have cheaper labor.
Dhillon: OECD countries might be tempted to scale back their foreign assistance. What message do you have to the international donor community on their commitments and priorities for Egypt?
Handoussa: It will be interesting to see how donors will behave vis-à-vis Egypt. Will they reduce or continue or step up their grants and aids? Because, for Egypt’s soft development, the delicate things like how to do business, how to help entrepreneurs find their niche, and how to manage micro-finance, training, and capacity-building are crucial. If there is going to be a decline, the government must step in and compensate. This type of development doesn’t consist of tangible showy projects, but rather the intangibles such as capacity-building that absolutely need to continue.
Dhillon: In the U.S. and Europe, we seem to be reverting back to greater regulation of the financial sector. Doesn’t Egypt need the opposite?
Handoussa: What is alarming is that, in the financial sector, the message seems to be to increase regulation because of what is happening in the U.S., which is exactly the wrong thing to do in Egypt. Mortgage and insurance lending, all forms of credit needs to be enhanced and deregulated. Egypt has one of lowest levels of lending in terms of micro lending or mortgage lending, and the attitude has always been one of reluctance within the banks. They are very risk averse. We just started to make a dent in the market for credit to SMEs and to house purchasers. Housing finance and microcredit is relatively new to Egypt.
I also want to say that, when you compare Egypt with what is now happening in the U.S. and some European countries—the banks have excess liquidity in Egypt. The ratio of credits to deposits in the banking system is only 55% as compared to an international norm of 80%. So it’s not that they are safe, they are too safe.
So I hope that central bank will take seriously its responsibility to enhance lending and the incentives for the banking sector to provide credit. Now is not the time to raise the interest rate. It is my view that inflation targeting, which has been the priority of the central bank for the last 12 months or more should shift because of our expectations. It is true that inflation was almost 20%, but don’t keep interest rates high—you have to compensate for all the people that are going bankrupt by not making credit so expensive. Therefore the banking sector has a very important job to reduce the gap between the lending rate and the deposit rate, which is very large.
Dhillon: Finally, let’s go back to where we started and that is looking at the prospects for Egypt’s export industry. As Egypt’s export industry looks vulnerable in the face of global economic slowdown, what short-term and long-term steps can the government take to ensure that the real Egyptian economy doesn’t take a huge hit?
Handoussa: It has been noted that China has already moved to increase subsidies to exporters and has reduced interest rates to enhance investment. We’ve done nothing except talk. It’s time to create a package that includes better terms for exporters.
It’s time to move very fast on the business environment in terms of regulations, procedures, and the enforcement of the law. For the third year running, Egypt is one of the top ten reformers of its business environment according to the World Bank’s Doing Business report and, yet, Egypt still ranks 114th in terms of ease of doing business. This is where Egypt can influence investors now, by creating a favorable business environment.
In the real economy, we are not yet seeing the effects of the recession. If we preemptively make some small changes in laws and procedures, it is a signal to investors to re-root their investments. Egypt is already considered an important emerging market. So, if we play it right, if we manage this crisis right, we could come out as winners rather than losers from this upheaval.