From wage levels to literacy, Egypt looks more competitive than ever before
We visited Egypt in February to road-test our two theories that tell us Egypt is poised to industrialise and become one of the world’s long-term beneficiaries of Europe’s economic recovery. Egypt clearly crossed the 70% adult literacy level that we believe is a precondition for industrialisation in 2010; literacy reached 76% in 2015. For the first time, the country is capable of sustaining a manufacturing sector that is above 20% of GDP, in our view, and unlike many in Sub-Saharan Africa (SSA), it has the electricity and infrastructure already in place to support that. Meanwhile, as central European wages soar due to economic recovery and a shrinking workforce, Egypt’s minimum wage is now one-eighth of the level in Turkey, one-quarter of that in Morocco and half of the level in Tunisia. Egypt is the only major economy on Europe’s periphery with both a fast-growing workforce and where fewer than 50% of adults have a job. We think Egypt can grow its workforce by over 50% by utilising its increasingly educated female population (over 80% of 11-17-year-old females now attend secondary school), and the overall workforce is set to rise by 9% (an extra 6mn adults) between 2015 and 2020. Never before has Egypt been so well placed to benefit from growth in Europe.
The reform course should deliver rating upgrades, more disinflation and lower interest rates
Egypt could squander this opportunity if it made a mess of fiscal and monetary policy. To take some extreme examples, North Korea and Zimbabwe, via incompetent economic policy making, have failed to take advantage of good human capital and proximity to richer neighbours such as Japan and South Africa. Egypt does not have much room to make mistakes. Government debt reached 103% of GDP in June 2017, the budget deficit is expected to be 9.2% of GDP as of June 2018, there is double-digit inflation and the current account deficit is around 4-5% of GDP. However, the direction remains very positive. Inflation has already been halved since the post-devaluation peak of 33% to 17% in January 2018, with monthly deflation for the past two months. This is a considerably better record than Frontier favourite Argentina. We agree with the IMF that inflation will fall to 12-13% in June. The Central Bank of Egypt (CBE) last month made an initial 100-bpt cut in the policy rate to 17.75%. We expect another 100-bpt cut at the next meeting in March, with another 100-300 bpts off by early 2019. The budget is expected to show a healthy primary surplus in 2018/2019 (perhaps already in 2017/2018), helped by growth accelerating towards 6% (a figure we, the IMF and the government all agree on). We think the currency at EGP17-18/$ is 15% cheap vs long-term fair value (EGP15/$) and still offers value to foreign portfolio investors buying five-year government bonds in Egyptian pounds at pre-tax yields of 14%. The IMF expects public debt to fall to 72% of GDP by June 2022, and we think Egypt will receive at least one sovereign rating upgrade this year. Egypt is very committed to a reform effort, which via subsidy removals in fuel and electricity might keep inflation at around 11-12% from June 2018 to June 2020, and this fiscal effort should allow a re-allocation of government spending towards infrastructure and investment.
We think maintaining a cheap or fairly valued currency would support industrialisation
What we expect to see in 2019 and beyond is a rise in manufacturing investment. Today, the focus of foreign direct investment (FDI) is the revitalised oil & gas sector, where Egypt should soon become self-sufficient again. But once it is obvious that macro stability has been restored, and when demand in Europe has eroded southern Europe’s spare capacity, we think Egypt should start attracting the low- and mid-level manufacturing plants that in the 1990s were built in Central Europe and Romania. Security concerns (as in Turkey in the 1990s), if they are recognised to be largely regional, need not prevent this. Maintaining a fairly valued or cheap currency, sticking to current fiscal plans, improving the business environment and focusing on long-term needs of education and investment will be the key requirements for Egypt to lift GDP growth from 5-6% to 6-8% in the 2020s.