Can Egypt borrow and spend its way to sustainable GDP growth?
Courtesy: Official Suez Canal Facebook Page

As Egypt’s mounting security challenges and draconian legislative measures dominate headlines, the growth of gross domestic product (GDP) represents a rare bright spot the government can point to as a sign of success.


GDP growth got off to a roaring start at the beginning of the 2014/15 Fiscal Year, with 6.8 percent growth reported in the first quarter. A slowdown began in the second quarter, as growth recorded 4.3 percent. By May, the planning ministry said growth for the second half of the fiscal year was likely to stand at around 3 percent


Despite this noticeably downward trend, the government still decided to forecast a growth of 4.5-5 percent for the fiscal year, which began in July, and an even higher rate of 6-7 percent by the 2018/19 Fiscal Year.


This, analysts say, is by no means a sure thing, and a closer look at GDP helps explain why.


What’s in a GDP?


Gross domestic product measures economic output by adding up the sum of consumer and government spending, investment and net exports in a given year. Among the many critiques of GDP as a measure of a country’s economic success is that more spending means more GDP growth, regardless of what the money is spent on.


In the short term, a patient racking up hundreds of thousands of pounds of medical bills for ineffective treatments contributes more to GDP growth than a productive but modestly paid worker, while an acrimonious divorce that racks up huge legal bills is better for GDP than a stable relationship.


By the same measure, any government spending raises GDP, regardless of whether the expenditure is good for the nation’s economic future. In the year the money is spent, a million pounds pumped into building massive flag poles will have the same impact on GDP as spending a million pounds setting up centers to train workers in needed skills.


At least in the short term, a government can effectively borrow and spend its way to GDP growth.


That’s basically what Egypt’s government has been doing, says Hany Genena, head of research at Pharos Securities brokerage. The last few years have seen a dramatic rise in public spending, with the state launching huge projects such as the new Suez Canal, which is set to open next week. With tax revenues, tourism and foreign direct investment still slow, much of the funding for these projects has come from borrowing.


“It’s not the best thing, but it’s not the worst either,” says Genena. “The cash flow will wash out the debt, eventually.”


Little information is publicly available about how much government money is going towards these projects, or exactly where the money is coming from. One figure hints at the magnitude. By appealing to the public to buy Suez Canal bonds — effectively loaning the government money — Egypt raised more than LE60 billion last summer. 


According to official figures, Egypt’s GDP amounted to LE1.643 trillion in the 2013/14 Financial Year. If just half of the LE60 billion was paid out to build the canal over the past year, that would push real GDP growth up by around 2 percent, Genena notes.


It’s normal for governments to spend money to kickstart the economy, says Mohamed Abu Basha, an economist at investment bank EFG-Hermes. This is the logic behind stimulus programs.


“The private sector always waits for the government to invest first,” Abu Basha says. “It’s very important the government remains the main driving force to accelerate growth and boost confidence.”


Public projects are also carried out by a mix of private, government and military contractors, so not all of the money invested comes out of state coffers.


Genena, however, is concerned about where the government money is coming from.


In the first few years after the 2011 uprising, the government relied on borrowing from local banks — in the form of bonds — to finance its needs. The percentage of banking assets comprised of treasury bills and bonds was around 25 percent in June 2010, Genena notes. By June 2013, it had hit 40 percent.


After that, the ratio remained more or less still. “The banks were willing to roll over debt, but not to advance more debt,” he says. By the time it reached 40 percent, banks were basically saying that’s it, “we are unable to take more.”


Next came resorting to grants. But that, too, seems to have dried up.


After repeated bailouts from supportive Gulf states, Egypt dramatically cut anticipated donations. The 2015/16 budget anticipates just LE2.2 billion in grants, compared to LE23.5 billion the year before. “The GCC is not willing to give a blank check,” says Genena.


Instead, the government is relying on borrowing from abroad, like the $6 billion in Central Bank deposits received earlier in the year, or a $1.5 billion eurobond launched in June. This, Genena says, is an indication that Egypt has tapped all sustainable borrowing sources. 


“We are heading for a red zone,” he says. “This is very problematic if sustainable cash flows do not recover.”


Abu Basha is more optimistic. Projects from the Sharm el-Sheikh economic summit should start materializing in the coming two years, he says. “Projects that have already been approved are going into the execution phases.”


If so, it would not only stave off a disaster, but could put Egypt on strong footing for years to come.


In spending out on investment, the government is taking a gamble. If massive projects like the Suez Canal extension succeed, they bring in much more money than was spent, with the short-term GDP bump caused by government spending contributing to a sustainable boost in economic activity.


However, if these huge projects do not generate a surge of investment and productivity, Egypt could struggle to pay its debts or find new loans, and be forced into austerity.


In the short term, economists are predicting a slowdown.


The deceleration has already started, with each successive quarter failing to measure up to the strong growth reported in the first quarter of 2014/15.


“There is very strong seasonality in GDP growth. Winter is usually slower,” notes Genena.


Until the government releases data on the fourth quarter — from April to June 2015 — it’s hard to say for certain whether a few quarters of weaker growth indicate a longer-term slowdown.


But Genena says we are already seeing signs of a slowdown in key sectors, such as real estate. “Whether there is a decline, we will have to wait and see,” he says.


Abou Basha’s firm revised down growth estimates after April, and is less optimistic than the government about the coming year. “Our own forecast is 4.5 percent,” he says.


As for 6 percent growth in the next few years? Genena says, “Definitely, definitely, for sure we will not see it.”

Isabel Esterman 

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