Firing up the gas
An important milestone for the country’s economic health is the development of its offshore gas fields. With the addition of 22tn cubic feet (Tcf) of recoverable gas in the Zohr field, Egypt’s gas reserves stand at 65 Tcf, making them the 16th-largest in the world. As production from Zohr ramps to 2.7 bn cubic feet (Bcf) per day by 2019, the country should have a self-sufficient gas supply, moving the current account from deficit to balanced.
Egypt is not the only country discovering gas in the Eastern Mediterranean. The development of Israel’s giant Tamar field is good news for Egypt; unlike Israel, it has two inactive liquefied natural gas (LNG) plants on the coast which can be revived to process Israeli gas for export.
Lower inflation and a balanced current account can provide a respite from some of the economic pressures the country has been enduring. But if Egyptians are to enjoy a persistent rise in their standards of living, more secular changes are needed. We outline what these might be in the next section.
No country for old men
Egypt’s demography could emerge as a significant source of competitive advantage. First, its population of nearly 100m is young (more than 50% are under the age of 25 and roughly 40% are between the ages of 25-54) and growing much faster than its closest competitors both in Eastern Europe and the Middle East and North Africa (MENA).
Figure 1. Workers, arise! Forecast change in the working-age populations of East European, Middle East and North African countries
Source: Renaissance Capital, UN as at March 2018
Low labour participation
Much of the workforce is not employed. According to estimates from the International Labour Organisation (ILO), Egypt’s labour participation rate was about 48% in 2017, far below the 80% achieved by Central Europe, the destination of much of Western Europe’s foreign direct investment in the past few decades. The overall workforce is set to rise by 9%, or 6m, between 2015 and 2020, but could comfortably grow 50% by including its increasingly educated female population, a potential watershed development (of which more below).
There is a historical correlation between literacy rates and economic development in many countries, including the UK, Japan, Korea and the Soviet Union. A literacy rate of about 40% is typically needed for sustainable economic growth, with industrialisation usually requiring a rate of 70% or more. For instance, 20% of Korea’s manufacturing sector consisted of value-added industries in 1972, but neither Morocco, Nigeria or Pakistan – nor the 38 other countries shown in figure 6 – had achieved this by 2015.
Figure 2. Levels of literacy and value-added manufacturing in emerging and frontier markets
Source: Renaissance Capital, World Bank, UNESCO as at July 2017
Figure 3 shows the literacy rates of a selection of lesser developed countries. Those with a total literacy rate of 40% or lower, beginning with Chad, are largely subsistence economies with little prospect of generating sustainable growth. However, immediate success isn’t guaranteed – even for countries with literacy rates of between 70% and 80%. Some with strong literacy levels, like Pakistan, Morocco and Bangladesh, may demonstrate sustainable growth, but only India has embarked on industrialisation thus far.
Figure 3. Literacy in 2015: which of these countries are likely to industrialise?
Source: Renaissance Capital, UNESCO as at July 2017
Low literacy levels among adults may explain why former Egyptian President Hosni Mubarak’s reform plan to build a manufacturing base failed to take off in the early 2000s. However, the country’s current plan, Vision 2030, has plausible goals for growth which are backed by suitably high literacy levels: literacy among Egyptians breached 70% in 2010, reached 76% in 2015 and is estimated to hit 80% by 2020.
Figure 4. Egypt has achieved a level of literacy that should support industrialisation
Source: Renaissance Capital, UN, World Bank as at March 2018
As previously mentioned, Egypt has the potential to grow its labour force significantly by encouraging women into the workforce. With over 85% of 11-to-17-year-old females now attending secondary school, compared to less than 70% two decades ago, women represent a huge potential resource of literate workers for the country.
Higher literacy and attractive demographics should support the case for Egypt being a destination for foreign investment. Other building blocks for sustainable growth that need to fit into place include infrastructure, tourism and exports.
Figure 5. Female literacy in Egypt is rising steadily
Source: Renaissance Capital, World Bank as at June 2017
Advantageous labour costs
After the fall of the Berlin Wall, Western European multinationals poured billions into Central and Eastern Europe, which offered a paradise for manufacturing investment thanks to the former bloc’s high levels of education, low costs and abundant labour.
However, with labour participation high – it is 77% in the Czech Republic, 69% in Poland, 72% in Hungary and 79% in Germany – unemployment low and labour costs rising, only Romania now exhibits an attractive wage profile in Eastern Europe. In addition, many of these countries will have fewer young people in the coming decade: figure 6 shows the change in the number of people aged 15-24 years in North African and Eastern European countries.
Figure 6. Egypt is forecast to have a large population of people aged 15-24 by 2024
Source: Renaissance Capital, United Nations as at June 2017
While foreign direct investment in Central Europe will persist, its workers will move up the value-added curve, treading the path set by Japan in the 1950s and 60s, then by Korea, Hong Kong, Singapore, Taiwan and China, and most recently by Vietnam and Bangladesh. Meanwhile, wages in North Africa are cheaper than those of all European countries except Ukraine (see Figure 7).
Figure 7. Labour costs in Europe and North Africa
Source: Renaissance Capital, Eurostat, IMF as at June 2017
Figure 8. Egypt’s minimum monthly wage, in US dollars, is low among emerging and frontier markets
Source: Renaissance Capital, national media as at March 2018
Expansion of essential infrastructure
As well as labour, manufacturing requires infrastructure. While more needs to be done, the exploitation of Egypt’s offshore gas fields, leading to self-sufficiency in electricity generation will remove a major obstacle to growth for Egypt. At the same time, reduced government spending on subsidies frees investment capital for major projects, including the recent deepening of the Suez Canal, the planning for a new capital city to the east of Cairo, five new airports, a nuclear power plant and several monorail lines. Finally, plans are being finalised for the development of the Golden Triangle region in the south of the country in which private businesses reportedly operate largely free of red tape and are generally being managed efficiently and free of corruption.
Tourism: resort trade resumes
Tourism, Egypt’s biggest export, is recovering and should benefit from the resumption of Russian flights to major resorts in April (see figure 9). Security remains a concern, but since the primary threat is from jihadist group Al Qaeda in the Sinai Peninsula, which operates near the Gaza Strip, the impact on the industry is limited.
Figure 9. Tourism growth is likely to accelerate as Russian sun-seekers return
Source: Renaissance Capital, CAPMAS, Bloomberg, CBE as at March 2018
More than oil: exports
Egypt’s other major export is oil, which brings in $1bn of revenue annually. Others include fertilisers, textiles, ready-made clothes, chemicals, wires and cables and household electrical appliances. They each accounted for between $500m-$800m in 2017 (see figure 10).
Figure 10. Beyond oilfields and resorts: Egypt’s other export industries
Source: Renaissance Capital, Central Bank of Egypt as at March 2018. *Provisional data
Egypt's economic prospects: oasis or mirage?
Egypt’s economy has yet to achieve sustainable growth, but the development of the Zohr gas field and the improving tourist trade should combine over the next two years to dramatically lower its current account deficit. This should arrest the climb in external debt as a percentage of GDP.
Other signs are relatively healthy as well. The Egyptian pound has depreciated enough, credit-rating agencies are likely to upgrade the country’s sovereign-debt rating as the government adheres to the IMF package, and demand for loans should increase as interest rates decline.
The country’s stock market has been becalmed since 2013: it now trades at an 11.2x price-to-earnings multiple (on a 12-month blended forward basis) in US dollar terms, roughly 0-1.5 standard deviations higher relative to both its own history and to global emerging markets. But with consensus forecasts of earnings growth of 46% for this year and a return on equity of 21%, we think the market provides an opportunity to access an improving macro story despite its relatively high current valuation.
While today it may seem a stretch that Egypt could attract investment from an industrial manufacturing giant – its low-cost, young and literate workforce is an attractive asset. Historically, multinationals have invested in Egypt to service its growing population; with the political situation relatively quiet, a few multinationals are starting to expand and upgrade their factories in the country again, targeting domestic consumers. Another year or two of stability could attract investment in manufacturing, starting a new chapter in the country’s development.
We see Egypt’s GDP growth accelerating from 4.2% in the last fiscal year to 4.7% this year, and possibly 5.5% by 2020. A substantially higher oil price or a much stronger dollar may cause problems, but we don’t view these as sustainable phenomena. While it is likely that the nation’s current account deficit could reappear in a positive growth scenario, it would likely be due to capital goods being imported rather than a deterioration in exports growth.
With ongoing economic reform and progress, Egypt could truly emerge, and its large, long-suffering population could begin to experience the rising standards of living enjoyed by the Asian and Eastern European populations that have walked the path of industrialisation before them.
Are we witnessing an economic oasis or mirage? In our view, Egypt has begun to realise its growth potential and investment opportunities are within grasp, rather than shimmering in the distance.