(MENAFN- Arab Times) The acceleration in economic growth appears to have been sustained despite a soft patch in 1Q15.The pace of real growth is set to surpass 4 percent for the first time since 2010, boosted by a more stable political environment, financial support from GCC allies and improving business confidence.
A strong public sector investment drive has been a key source of growth, with a number of governmentled capital spending initiatives underway (including the expanded Suez Canal). Various recent data support the recovery story, including real GDP growth, the Purchasing Managers' Index (PMI), private credit growth and employment. While some of these figures, including the PMI, have shown some softness in 1Q15, the overall picture continues to indicate a gradual recovery in economic activity.
Private credit in particular has been strong, with growth in real terms rising to its highest level in over seven years. The risks for Egypt remain significant, though they have been receding. While the political and security situation has improved significantly, they remain somewhat vulnerable. The other uncertainty is the country's large fiscal deficit which has yet to improve despite some subsidy reforms implemented a year ago. Large GCC donationshave helped shore up public finances, but those are unlikely to be sustained in the medium term.
Still, markets remain confident that authoritiesare taking the necessary reform steps, with Egypt's recent USD bond issuance a good example of that. Recovery has been picking up pace Economic growth has continued to improve in recent months. Real GDP growth accelerated to 4.3 percent yearon- year (y/y) in 4Q14 and for 2014 as a whole. More recent data indicate that the economic recovery remains on track despite some softness in 1Q15. Growth is expected to come in at 4.3-4.5 percent in FY14/15. In FY15/16, we think growth will maintain this pace before improving further thereafter.
Improving activity has been led by robust private sector growth. Private sector growth accelerated to 6.6 percent in 2014, approaching pre-Arab Spring levels. The numbers benefited from strong basis effects in 3Q14, particularly in the tourism sector. Investment spending has also been picking up, though levels remain subdued. Aggregate investment (nominal) rose by 20 percent in 2014, with nearly half of the growth coming from the private sector.
Aggregate investment rose to around 13.5 percent of GDP during 2014, up marginally from 12.9 percent in 2013. By comparison, investment before the Arab Spring averaged a higher 20 percent of GDP. An investor conference in March 2015 in Sharm El-Sheikh was a resounding success and should provide further support to investment as well as to external reserves. Investment initiatives of around $175 billion were announced, most of those to be implemented within five years. An additional $6 billion in CBE (Central Bank of Egypt) deposits were also pledged by GCC allies, to provide much needed short term support.
The bulk of investment plans were in oil & gas ($21 billion), power generation ($43 billion) and urban development ($58 billion). Credit growth has also been accelerating, seeing its strongest month in nearly five years in March 2015.The pace has picked up to 16.2 percent y/y. When adjusted for Egypt's relatively high inflation rate, credit grew by 5.8 percent y/y, the fastest pace in over seven years. Growth in lending to the corporate sector has been particularly strong thus far in 2015 compared to a year ago.
Markit's Purchasing Managers' Index (PMI) has shown some softness in 1Q15, but this appears to be temporary. The index fell below the critical 50 mark in January and remained there for several months. Though the index improved to 50.2by June compared to a low of 46.8 seen in February, it remained weaker than most of the second half of 2014. According to the survey, activity in exports and tourism was hit by insecurity in Libya and weakness from Russia. Tourism and construction activity bore the brunt of 1Q15 weakness.
Indeed, while tourism has recovered from 2013 lows, the sector has more lately been weighed down by domestic and regional security concerns and a weak euro (keep-ing Europeans at bay). The number of tourists during 1Q15 rose by only 6.9 percent compared to double digit growth in 2014. More importantly, tourist-nights actually dropped by 8.4 percent y/y during the first three months of 2015. Figures in March alone were more upbeat, indicating the slump may have passed.
Manufacturing has been the main engine of growth over the last year. The sector, which accounts for around a fifth of GDP and includes oil refining, saw growth accelerate to 16 percent in 2014 and contributed more than half of the gain in output. Other growing sectors include hotels and restaurants, real estate services, construction, and retail trade. Inflation has accelerated over the last year. The government's move to raise fuel prices in mid-2014, as it sought to cut subsidies, was partly responsible for higher prices.
However, the devaluation of the pound earlier this year led, once again, to inflationary pressures. Inflation rose to 13.1 percent y/y in May 2015 compared to a low of 8.2 percent y/y a year before. Inflation is expected to peak around mid-2015 before easing thereafter. The budget deficit remains a key risk to the outlook.
Egypt's fiscal position has deteriorated further over the last year, widening to a 12-month trailing 13.7 percent of GDP through April 2015;the comparable figure a year ago was 10.8 percent. The figure is expected to narrow somewhat by the end of the FY14/15 fiscal year in June 2015, to around 12.5 percent of GDP. Spending growth has continued to outpace growth in revenues. Spending has risen to over 34 percent of GDP, up as much as six percentage points since 2010.
Meanwhile, revenues (excluding grants) have dropped from 20 percent of GDP to around 18 percent. There does not appear to have been a turnaround in trend over the last two years in either. Grants provided by GCC allies have offered some relief since mid-2013, but those have declined over the last few months.
They accounted for as much as 4.8 percent of GDP in FY13/14, but have declined to 2.3 percent in the last 12 months through April 2015 and are likely to decline further in FY15/16. The current government is committed to fiscal reforms, as revealed by last year's fuel price hikes. Further subsidy reform is expected, including the introduction of a fuel ration card. The government also plans to take steps to boost revenues with measures such as a valueadded- tax (VAT).
However, the recent scrapping of new taxes on dividends and capital gains means some critical fiscal reform will be delayed. The current account deficit has deteriorated through 1Q15 largely on a decline in official transfers, though weaker oil exports and strong import growth were also to blame. While Egypt continues to benefit from GCC deposits at the CBE, grants to the government have declined.
The deficit widened to 3.4 percent of GDP on a 12-month trailing basis, its worst level in two years. Egypt's trade balance widened by 25 percent over the last year through March 2015 as a result of solid imports growth and a decline in oil exports. At the same time, official transfers have virtually gone to zero (they accounted for 3.6 percent of GDP a year ago).
While growth in service receipts (which include tourism revenues) and worker remittances has been healthy, they only offset some of the deterioration in the trade balance. Higher foreign direct investment (FDI) has helped shore up Egypt's external position. FDI rose to its highest quarterly level since 2008 in 1Q15, helping to offset some of the deterioration in the current account. Egypt is expected to continue to benefit from higher FDI on the heels of the March investor conference. Indeed, Siemens recently signed a $9 billion project for a wind farm.
However, FDI levels remain far below pre-2009 levels. Country risk has remained contained as reflected by the decline in Egypt's sovereign yields. Yields on USD denominated sovereign debt due in 2020 and 2040 have been sable at relatively low levels, reaching 4.6 percent and 6.9 percent, respectively, in early June 2015. The country's credit default swap (CDS) has also been relatively stable at just over 300 basis points.
Official reserves held by the CBE have increased in recent months, thanks largely to a $6 billion deposit by GCC allies in April 2015. Reserves stood at $20.1 billion by the end of June 2015, or around 3.7 months of imports. Official support, capital controls, and a decline in the value of the pound in January helped reduce the pressure on reserves. The CBE allowed the Egyptian pound (EGP) to depreciate against the US dollar in February and again in early July.
The moves helped counter the strength of the dollar over the last year, which has seen the pound gain against all other currencies. Even after the recent devaluations, the pound remains up on trade-weighted terms compared to a year ago. According to the JP Morgan EGP index, the pound was still up 6.3 percent y/y in early July 2015. After a strong 2014, Egypt's stock market has underperformed since it peaked in January 2015. The MSCI total return index was down by nearly 4.7 percent through June 2015. Softer economic data in 1Q15 and the new capital gains tax appear to have weighed on equities.
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