Egypt - External soars (page 1 of 2)

Strong external performance
Egypt's external performance remains strong despite the current account surplus falling to 1.6% of GDP in FY2005/06 (July 2005-Jun 2006), from 3.1% in the previous year. This figure masks the robust performance of exports, which increased by 33% y/y, with export growth accelerating to 52.5% y/y in H2. Imports also increased strongly (by 25.8% y/y in the FY) driven by the buoyant demand in the economy. Given that imports are over double the value of exports, this resulted in the trade deficit widening. Positively, imports of investment and intermediate goods represented 53.6% of total imports, which bodes well for Egypt's economic outlook.

There were also strong performances in the invisible components of the current account, as tourism, remittances and Suez Canal earnings continued to increase. Although tourism revenues grew by 12.5% y/y in FY 2006/07, the sector was negatively impacted by the terrorist attacks in April. Visitor numbers into Egypt fell by 5.5% y/y in July, the third consecutive monthly drop. However, we are forecasting a strong recovery in the tourism sector and expect the figures to start improving from August as the conflict in Lebanon resulted in many regional tourists changing their holiday plans to other regional countries, such as Egypt.

Reform driving capital and financial inflows
There have also been positive developments on the capital and financial accounts. The progress on the reform front has raised and improved Egypt's profile in international capital markets. Foreign direct investment and inward portfolio flows have risen sharply. FDI into Egypt increased by 56.4% y/y to USD 6.1bn in FY 2005/06, equivalent to over 5.5% of GDP; this is up from under 3.0% of GDP in FY 2003/04. Importantly, non-energy investments accounted for around 70% of FDI, compared with just 33% in FY 2004/05. Meanwhile, portfolio inflows increased to USD 2.8bn in FY 2005/06, up from USD 800m. The strong external performance has resulted in the continued build up of FX reserves, which reached USD 24.1bn in September 2006, a 14.1% y/y increase.

Importantly, FDI inflows into Egypt are continuing to increase in the current fiscal year, supported by the government's privatisation program, including the sale of Egypt's third mobile network to Etisalat for around USD 2.9bn. Furthermore, 80% of Bank of Alexandria was sold to Italian bank Sanpaolo IMI for USD 1.6bn. For both these sales, the prices were at the higher end of analysts' expectations.

Strong growth... but increasing inflationary pressure
The external sector remains a strong engine of economic expansion, although growth remains broad-based with expansion in private consumption and investments (as reflected in the increase in imports). Preliminary government data places real GDP growth at 6.9% in FY 2005/06; however, this is above our and the IMF's estimates of 6.0% and 5.6%, respectively.

Robust economic activity is resulting in a pickup in inflationary pressure and CPI jumped 9.5% y/y in September. After moderate growth rates in the CPI at the beginning of the year, inflationary pressure has been accelerating since June, with the year-on-year CPI increasing by over 7.0%. Along with the strong demand in the economy, other factors driving inflationary pressure are the outbreak of avian influenza which has been placing upward pressure on food prices and the reduction in fuel subsidies. While the central bank kept interest rates on hold in October, we are forecasting a 50bps increase by year-end.