The announcement of the new cabinet, which eventually comprised only a handful of new faces, was extensively trailed as marking a new beginning. Few at the time, however, expected it to tackle the on-going business of reform with quite as much energy as it has shown. The new government, it appears, has decided not just to revisit reform but to pursue its goals at a pace with which many find it difficult to keep up. The reforms announced so far -- particularly the restructuring of tariff and tax systems -- come at a cost. It is estimated that government revenues will fall by over LE7 billion in the short term, leading to growing pressure on an already alarming budget deficit. Yet the government remains convinced that whatever the short term impacts, the restructuring is essential to longer term economic health. In this year-ender issue the economy page staff examine the major events of the past 12 months, and their likely impact on economic performance in 2005. The economic trio CUSTOM tariff reductions were announced just a few weeks after the swearing in of the new government sparking optimism, in business circles at least, that the new economic trio of Finance Minister Youssef Boutros-Ghali, Foreign Trade and Industry Minister Rasheed Mohamed Rasheed and the Investment Minister Mahmoud Mohieddin at last constitute a coherent centre of economic decision-making. Nor was the optimism restricted to domestic circles. The Economist Intelligence Unit report described the trio as "well- regarded economic liberals, who have the expertise to address the problems of the Egyptian economy. They have embarked on their task with vigour and imagination, outlining a far-reaching programme for reform." The trio have a lot in common. They worked together on the Policy Committee of the National Democratic Party forging the reform plans they are now applying. Boutros-Ghali, the only face not entirely new, was the leading economic liberal in Atef Ebeid's cabinet. A major architect of macro-economic policy during the 1990s, Boutros-Ghali became minister of finance in the July 2004 cabinet reshuffle. He has also held the economy and trade portfolios. A respected technocrat, he currently sits on the General Secretariat of the National Democratic Party. He is the highest ranking Copt in government. Mohieddin, the youngest minister in cabinet, is a 39-year-old economist. Like Boutros-Ghali he comes from a long established political family. He was previously head of the Economy Committee of the NDP and now holds a portfolio newly tailored to oversee capital markets, insurance, privatisation and investment, the core of the government's ambitious reform plans. Mohieddin is no stranger to business circles, having been a board member of EFG Hermes and CIIC before entering government. Rasheed is also a new comer, taking over a portfolio that for the first time combines foreign trade and industry. His background is in business, and he has sat on the board of a giant multinational. His future, like that of his two colleagues, now depends on how the Egyptian economy performs in the coming months. Revolutionary tax reform THE INCOME tax law, expected to be ratified by the People's Assembly early in 2005, has been trailed by policy-makers as nothing less than revolutionary. The draft law is central to the Nazif government's attempts to reform the national economy, attract more local and international investment and establish trust between the tax authority and tax payers in a country where tax evasion has become the norm rather than an exception. The law will see major reductions in tax liability across almost all economic activities as well as reducing the tax burden of those on low incomes. For those earning between LE5,000 to LE20,000 a year the basic rate of income tax will be reduced from 20 to 10 per cent, while a 15 to 20 per cent tax will be levied on incomes between LE20,000 to LE40,000. The threshold at which income tax kicks in will be LE5,000. The new law will erase any tax distinctions between joint-venture and private sector companies, and profits will be taxed at 20 per cent, half the current figure, a move aimed at making Egypt more attractive to investors. Loopholes in current taxation practice will be closed. Tax break enjoyed by companies operating in new industrial zones will be cancelled, and joint-venture companies listed on the stock market will no longer be tax exempt. The sales tax system will receive a major overhaul, with a unified 10 per cent tax applied on all goods and services rather than the five, 10, 25 and 45 per cent imposed at present while the 10 per cent sales tax imposed on capital goods will be abolished, a move businessmen have long called for. Industrial inputs, intermediate and final goods needed for export-oriented manufacturing will be exempt from taxation. By broadening the base of tax payers the government hopes to make up for any fall in tax revenue as groups exempted from tax under the current regime are brought within the system. Plans are afoot to fully automate the sales tax and income tax authorities. Tax payers can now apply online to register, fill in and submit tax forms. Both authorities stress that tax collectors are being retrained, and that, henceforward, tax payers are to be considered innocent until proven otherwise. Escaping the burden AS THE NEW government's reform package begins to be felt the growing fiscal deficit will continue to be the main economic concern of the new year. The deficit grew in 2004 and will continue to do so over the next fiscal year. New customs tariffs and a tightening of monetary policy aimed at stabilising the pound are expected to upwardly pressure already alarming levels of public debt. The government's wage and subsidy bills have grown steadily as it attempted to compensate for sluggish private-sector growth. Combined with increased interest payments this has led to a widening of the budget deficit to 6.1 per cent of GDP in 2002/03, up from around one per cent of GDP between 1994/95 and 1997/98. The depreciation of the pound and increases in the global prices of food staples make it more difficult to contain the problem for a government that has had to increase direct subsidies in order to protect the poor from the worst ravages of inflation. Subsidies are budgeted at LE15.6 billion for the fiscal year 2005, almost twice the outlay for the previous year. Even without the increase in subsidies public debt jumped to LE407 billion in fiscal year 2003/2004. The government's decision to push ahead with tax and customs reform, cutting corporate and personal tax by half, will see further reductions in government revenues. It is by no means clear, certainly not in the short term, that these will be compensated for by increased economic activity. With increased interest rates and debt-servicing costs it is predicted that the budget deficit will widen to 8.7 per cent of GDP in the short term. In an attempt to tackle the crisis the government has already started to cut subsidies. This year it reduced subsidies on fuel and electricity, the most significant element of Egypt's state support system estimated to cost some LE29 billion annually. In early September the retail price of diesel was raised by 50 per cent to LE0.6 a litre. Natural gas prices were also raised by 30 per cent, almost reaching the cost price. In early October water prices were almost doubled to LE0.23 per cubic metre. The moves so far are unlikely to have a major impact on government finances but may well be intended to test the public's stomach for more cuts. The government has already signalled that it intends to target direct subsidies, not only on bread but also on transport and housing, all of which have unpredictable social and political consequences. Tariffs cut As part of its attempts to generate confidence in the local economy the government reduced tariffs in 2004. Average customs duty decreased from 14 to nine per cent, and the list of items attracting duty was reduced from 13,000 to 6,000. The restructuring of tariffs aimed to rectify distortions on customs duties levied on over 500 items, including raw materials, chemical components and production inputs. The new customs duties range between two and 40 per cent, with raw material and production inputs at the bottom of the scale and finished products near the ceiling. The number of tariff bands has been reduced from 27 to six and all customs services fees, which ranged between one and four per cent, have been cancelled. The IT sector was completely exempted from customs duties on production inputs. Custom reform aims at promoting local industry and encouraging exports. It also, said the minister of trade, was intended to signal to foreign investors that Egypt was open for business and that henceforth the government would conduct Egypt is open for business and that the government was intent on simplifying top heavy bureaucratic procedures. Most analysts have greeted government moves as a step in the right direction, raising the competitiveness of Egyptian products and encouraging investment. Enter TRIPs EGYPT is scheduled to meet all its Uruguay round commitments, foremost among which is the agreement on Trade Related Aspects of Intellectual Property Rights (TRIPs), in 2005. TRIPs actually came into effect in Egypt in January 2000, though the pharmaceutical industry negotiated a grace period of five years. To prepare for the implementation of TRIPs Egypt issued a new intellectual property rights (IPR) law in 2002. One of the most important provisions of the law, which deals with all aspects of IPR and not just patents for pharmaceuticals, is the protection of the end product and not just its formula. The law, furthermore, allowed for patents to be placed "in the mailbox" -- the patent office was allowed to accept applications for pharmaceutical products but delay their processing until the grace period ends. It also included an exclusive marketing rights clause, enabling companies to market a product exclusively if it is patented, has received marketing authorisation elsewhere and has a patent "in the mailbox" in Egypt. The end of the five-year grace period would, it was feared, lead to a hike in the price of medicine. But over 90 per cent of drugs on sale are already in the public domain, so major price increase will apply only to new medicines. The government, furthermore, must approve all drug pricing, and it is unlikely that drug companies will apply with prices that make no sense in the local market. In the case of a licence being applied for and the terms requested by the company considered too harsh the government may issue a compulsory licence on condition that the drug is for non- commercial use. Compulsory licences can also be issued in times of emergency, such as the outbreak of epidemics. In all cases of compulsory licencing the patent holder must be informed and remunerated. Egypt will also meet its commitments in the textile and clothing sector. Full liberalisation of the sector will bring tariffs on ready-made garments down to 40 per cent and on textiles to 30 per cent. Unifying Arab trade 2005 will also see the completion of the final phase of the Greater Arab Free Trade Agreement (GAFTA) which will effectively abolish tariffs. The agreement will bind 17 Arab states, opening a potential market of 300 million. Sudan, Somalia, Yemen, Djibouti and Comoros will be exempted from the scheme and allowed a further five years to realign their economies. Zero tariffs had been scheduled for 2007, a date amended by the 2001 Amman Arab Summit at which it was decided to double the annual cuts in tariffs from 10 to 20 per cent. Moves towards Arab economic integration, discussed since the 1960s, have been frequently halted for political reasons. But this time, according to Ahmed El-Goweili, secretary-general of the Arab League's Council for Arab Economic Unity, "the political will is there to open up." Arab exports, 70 per cent of which are in the petroleum sector, are valued at $300 billion. With imports of $200 billion, they account for only 3.5 per cent of world trade. Inter-Arab trade stands at a modest $40 billion, less than a 10th of overall Arab trade. The agreement, which El-Goweili calls "the biggest step in the history of Arab economies", still faces obstacles. Even with tariff eliminations in place individual states will be allowed "negative list" of trade items exempted from tariff reductions, an attempt to protect infant industries that cannot yet cope with competition. But, says El-Goweili, "it is a matter of time before these negative lists are eliminated." Other regulatory issues still need to be resolved. In March Arab states will meet in Algeria to define rules of origin and agree on a value added regime. Other hurdles facing inter-Arab trade include a lack of trade facilitation services and inadequate transportation systems. With a customs union scheduled for 2008 and a common market in 2020, Arab nations will open their markets in an unprecedented manner. A provisional improvement FOLLOWING three years of decline the Egyptian pound stabilised against the US dollar at around LE6.2- 6.27, reflecting a turnaround in Egypt's current account balance. The gap between the official and parallel market narrowed to less than one per cent and foreign currency became increasingly available. The improved situation of the pound, due largely to more coherent monetary policies, enabled the government to annul the foreign exchange surrender requirement, adding to the confidence felt in business circles. The measure, instituted in March 2003, obliged enterprises engaged in foreign currency-generating activities to sell 75 per cent of foreign currency receipts to banks within a week . Farouk El-Okda, appointed Central Bank of Egypt's governor in December 2003, spearheaded the gradual tightening of monetary policy, raising interest rates to help stabilise inflation and steady the pound. Interest rates on Treasury bills, kept artificially low for government borrowing purposes, and other savings instruments have risen in an effort to counter inflation and support the Egyptian pound. The CBE also introduced a range of new tools to influence monetary conditions including the long awaited dollar inter-bank trading system. The task was made easier by a boom in tourism, an increase in exports stimulated by the depreciation of the Egyptian pound, strong oil prices and falling demand for imports. The balance of payments for 2002/2003 was in the black for the first time since 1996/1997. The fall in the value of the Egyptian pound in 2003 inevitably hit local purchasing power, provoking concerns that inflation would soar. Despite improved confidence in the convertibility of the currency the new government has yet to clarify its exchange-rate policy though in the absence of any signs to the contrary most analysts expect that the government will persist with a steady depreciation of the pound. The large budget deficit and growing public debt -- at the heart of the run on the pound -- remain a significant concern and the currency is still in need of a credible budgetary foundation. The Economist Intelligence Unit forecasts that the pound will fall to LE6.48 to the dollar by end of 2005, a decline of 3.7 per cent over 12 months, and to LE6.76 by end of 2006. Up and coming The Egyptian capital market began 2004 in bullish mood, not least because the depreciation of the pound had made local share prices more attractive. The arrival of the new government, promising a raft of reforms, acted to heighten the optimism and by November the market's most active 30 companies index, CASE30, had recorded a 104 per cent increase. The year witnessed a surge in market capitalisation from LE171.49 billion at the end of December 2003 to LE223.83 billion by November 2004. The Financial Times reported market growth of 94 per cent in dollar terms, making it "the best performing bourse in the world during the last two years". While shares accounted for the vast majority of transactions -- bonds accounted for less than five per cent of overall turnover -- the situation is likely to change following the introduction of a new primary dealers system which should energise trading in government debt securities. The innovation has encouraged several companies, including Orascom Telecom and Telecom Egypt, to push ahead with plans for bond issues. The Financial Action Task Force (FATF), a watchdog sponsored by the Group of Seven (G7) industrialised nations, removed Egypt from its blacklist of countries that fail to take adequate measures against money laundering. The move helped boost foreign confidence in the market. Foreigners were net buyers, accounting for a record-breaking LE16.9 billion of transactions. In August Mohamed Abdel-Salam was chosen as chairman of the bourse, in addition to his chairing the central depository and settlement company. His familiarity with the technical side of bourse management raised hopes that transaction-smoothing procedures will soon be introduced. Indeed, one of his first decisions was to increase the number of companies traded with no ceiling for price movements to 22. Market transactions continued to be dominated by big players, with 60 per cent of trading concentrated on the top 10 blue chips. Telecommunications was the market's leading sector, with Vodafone, Orascom Telecom and MobiNil the market leaders in terms of value traded. Strong profits and new acquisitions backed their performance. The cement market rallied following an increase in building material prices and renewed foreign interest. Ciments Français, part of the Italcementi group, launching a $550 million bid for the government's share of Suez Cement. Should the bid succeed it will be Egypt's largest privatisation to date. In the banking sector the Commercial International Bank (CIB) became the first Egyptian company to be listed on Arab bourses. Its shares are now listed on the Abu Dhabi Securities Market and the Kuwait Stock Exchange. Backbone of reform The banking sector, often criticised by international donors as undercapitalised and state dominated, has been targeted by government reformers. The problem of loan default remains pressing, with non-performing loans estimated to represent 14 per cent of overall credit. The government is seeking to encourage smaller banks to merge, with Al-Mohandes, Misr Exterior, Egyptian Unified, Nile, Al- Togariyoon and the Islamic Investment banks earmarked for merger with the larger state banks. The Unified Banking Law of 2003 stipulates a minimum capitalisation of LE500 million, a provision that will come into force next year. Misr Exterior Bank has already been acquired by its major shareholder, the state-owned Banque Misr, which financed the acquisition with a LE1.8 billion no-interest loan from the Central Bank of Egypt. The overhaul of the sector, announced in September, will also include the sale of all shares in joint venture banks held by the big four within three years. When Ahmed Bahgat, the Egyptian businessman, offered to restructure his debts of LE2.4 billion ($385.8 million) in return for withdrawal of a court action against him, his creditors accepted the proposal, pointing to a possible model in dealing with loan defaulters. Days later the People's Assembly voted to amend Article 133 of the Central Bank law, authorising local banks to settle disputes with defaulting clients and dropping all court sentences against those clients if debts are repaid.
