This article is by economist Ziad Daoud for Bloomberg Economic Insights. It appeared first on the Bloomberg Terminal.
Egypt’s economy took a battering after the revolution of 2011, with annual growth declining to 3.1% in 2011-16 from an average of 6.2% in 2005-10. But the economy should recover in 2018, helped by four tailwinds: declining inflation, lower interest rates, recovering tourism and gas production from a new field.
Egypt’s macroeconomic conditions were dire in 2016. Foreign currency was in short supply, resulting in the emergence of a large parallel black market. Growth was slow and only sustained by government spending, leading to a sizable build-up of public debt. Inflation was running at double digit rates and the current account deficit was widening. In November 2016, Egypt eventually sought help from the International Monetary Fund.
The IMF program was accompanied by a series of measures that, in the immediate aftermath, hurt growth and raised inflation. These included the flotation of the currency (and its subsequent 50% depreciation), the introduction of a value-added tax and multiple cuts to energy subsidies. As the bulk of these adjustments have already taken place, BE now expects growth to pick up, helped by the four tailwinds.
Inflation is expected to decline, reducing the erosion to consumers’ spending power.
Inflation shot up from 13.6% in October 2016 -– just before the currency flotation -– to peak at 33% in June 2017. The acceleration mostly reflected the pass-through from exchange rate depreciation, the introduction of a value-added tax and the reduction to energy subsidies.
While the impact of the latter factor should persist — the government is expected to continue cutting subsidies in line with its agreement with the IMF — the first two factors should drop out of year-on-year calculations in fiscal year 2018/19. As a result, BE expects inflation to gradually decline, averaging 15% in 2018/19. This is within the central bank’s 10-16% target range.
Lower interest rates
Lower central bank rates should follow lower inflation.
The central bank has raised rates by 700 bps since November 2016 in response to higher inflation. As inflation moderates, the central bank should unwind some of this monetary tightening. BE forecasts rates will be reduced by 400-500 bps over the course of 2018. This should boost growth through faster expansion in consumption and investment.
Tourist numbers declined sharply following the bombing of a Russian flight shortly after its departure from the Egyptian resort of Sharm El-Sheikh in October 2015. But there are signs the sector is recovering.
The number of tourists has picked up, climbing to nearly 780,000 per month in the first four months of the current fiscal year from about 550,000 per month in 2016/17. Moreover, tourists appear to be staying longer -– the average number of nights per tourist almost doubled to 12 in July-October 2017 compared with the same period a year earlier.
This partly reflects the 50% currency depreciation, which has overwhelmed the 30% inflation in prices and made Egypt an attractive and cheap tourist destination. The recovery also reflects an improved security setup, which has prompted many countries to either resume their flights to Egypt or announceintentions to do so soon.
New gas production
Egypt has begun production from Zohr, a supergiant gas field recently inaugurated by President Abdel-Fattah El-Sisi. Production is expected to reach1.7 billion cubic feet per day by June 2018 before rising to 2.7 billion cf/d by the end of 2019. If this goes as planned, Zohr could make Egypt self-sufficient in gas and may even help the country export gas in the future.
Medium term concerns
The story of Egypt is positive in the short term: faster growth, lower inflation and interest rates and a stable currency. But concerns remain. Most of the factors behind the expected recovery are temporary: the normalization of inflation and interest rates after a currency shock; a rebound in tourism to 2015 levels; and a ramp-up in gas production that is expected to hit a ceiling by 2020. As these temporary factors fade or reach their limit, Egypt will need to find new drivers for growth. It’s not clear where these lie right now.