Table of Contents

Egypt's Next Crisis: The Economy

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Summary

Until just a few years ago, Egypt’s ruling military elite was able to “borrow” money from Egyptian banks with no intention of paying it back. President Hosni Mubarak’s son Gamal changed all that, reforming and privatizing the system in order to build an empire for himself. For the first time in centuries, Egypt’s financial position was not entirely dependent upon outside forces. Now, Mubarak and his reform-minded son are out of the picture and Egypt has a budget deficit and a government debt load that are teetering on the edge of sustainability.

Analysis

Foreign Minister Ahmed Abul Gheit called on the international community Feb. 15 to help speed Egypt’s economic recovery. Such foreign assistance will certainly be essential, but only in part because of the economic disruptions caused by the recent protests. Even more important, the political machinations that led to the protests indicate Egypt’s economic structure is about to revert to a dependence upon outside assistance.

Egypt is one of the most undynamic economies of the world. The Nile River Delta is not navigable at all, and it is crisscrossed by omnipresent irrigation canals in order to make the desert bloom. This imposes massive infrastructure costs upon Egyptian society at the same time as it robs it of the ability to float goods cheaply from place to place. This mix of high capital demands and low capital generation has made Egypt one of the poorest places in the world in per capita terms. There just has not been money available to fund development.

As a result, Egypt lacks a meaningful industrial base and is a major importer of consumer goods, machinery, vehicles, wood products (there are no trees in the desert) and foodstuffs (Egypt imports roughly half of its grain needs). Egypt’s only exports are a moderate amount of natural gas and fertilizer, a bit of oil, cotton products and some basic metals.

The bottom line is that even in the best of times Egypt faces severe financial constraints — its budget deficit is normally in the range of 7 to 9 percent of gross domestic product (GDP) — and with the recent political instability, these financial pressures are rising.

The protests have presented Egypt with a cash-crunch problem. At $13 billion in annual revenues, tourism is the country’s most important income stream. The recent protests shut down tourism completely — at the height of the tourist season, no less. The Egyptian government estimates the losses to date at about $1.5 billion. Military rule, tentatively expected to last for the next six months, is going to crimp tourism income for the foreseeable future. Simultaneously, the government wants to put together a stimulus package to get things moving again. Details are almost nonexistent at present, but a good rule of thumb for stimulus is that it must be at least 1 percent of GDP — a bill of about $2 billion. So assuming that everything goes back to normal immediately — which is unlikely — the government would have to come up with $3.5 billion from somewhere.

Which brings us to financing the deficit, and here we get into some of the political intrigue that toppled former Egyptian President Hosni Mubarak.

One cannot simply walk out of Egypt, so since the time of the pharaohs the Egyptian leadership has commanded a captive labor pool. This phenomenon meant more than simply having access to very cheap labor (free in ancient times); it also meant having access to captive money. Just as the pharaohs exploited the population to build the pyramids, the modern-day elite — the military leadership — exploited the population’s deposits in the banking system. This military elite — or, more accurately, the firms it controlled — took out loans from the country’s banks without any intention of paying them back. This practice enervated the banks in particular and the broader economy in general and contributed to Egypt’s chronic capital shortage. It also forced the government to turn to external sources of financing to operate, in particular the U.S. government, which was happy to play the role of funds provider during the final decade of the Cold War. There were many results, with high inflation, volatile living standards and overall exposure to international financial whims and moods being among the more disruptive.

Over the past 20 years, three things have changed this environment. First, as a reward for Egypt’s participation in the first Gulf War, the United States arranged for the forgiveness of much of Egypt’s outstanding foreign debt. Second, with the Cold War over, the United States steadily dialed back its economic assistance to Egypt. Since its height in 1980, U.S. economic assistance has dwindled by over 80 percent in real terms to under a half-billion dollars annually, forcing Cairo to find other ways to cover the difference (although Egypt is still the second-largest recipient of American military aid).

But the final — and most decisive factor — was internal.

Mubarak’s son Gamal sought to change the way Egypt did business in order to build his own corporate empire. One of the many changes he made was empowering the central bank to actually enforce underwriting standards at the banks. The effort began in 2004, and early estimates indicated that as many as one in four outstanding loans had no chance of repayment. By 2010 the system was largely reformed and privatized, and the military elite’s ability to tap the banks for “loans” had largely disappeared. The government was then able to step into that gap and tap the banks’ available capital to fund its budget deficit. In fact, it is this arrangement that allowed Egypt to weather the recent global financial crisis as well as it did. For the first time in centuries, Egypt’s financial position was not entirely dependent upon outside forces. The government’s total debt load remains uncomfortably high at 72 percent of GDP, but its foreign debt load is only 11 percent of GDP. The economy was hardly thriving, but economically, Egypt was certainly a more settled place. For example, Egypt now has a mortgage market, which did not exist a decade ago.

From Gamal Mubarak’s point of view, four problems had been solved. The government had more stable financing capacity, the old military guard had been weakened, the banks were in better shape, and he was able to build his own corporate empire on the redirected financial flows in the process. But these changes and others like them earned the Mubarak family the military’s ire. Mubarak and his reform-minded son are out of the picture now, and the reform effort with them. With the constitution suspended, the parliament dissolved and military rule the order of the day, it stretches the mind to think that the central bank will be the singular institution that will retain any meaningful policy autonomy. If the generals take the banks back for themselves, Egypt will have no choice but to seek international funds to cover its budget shortfalls. Incidentally, we do not find it surprising that now — five days after the protests ended — the banks are still closed by order of the military government.

Yet Egypt cannot simply tap international debt markets like a normal country. While its foreign debt load is small, its total debt levels are very similar to states that have faced default and/or bailout problems in the past. An 8-percent-of-GDP budget deficit and a 72-percent-of-GDP government debt load are teetering on the edge of what is sustainable. As a point of comparison, Argentina defaulted in 2001 with a 60-percent-of-GDP debt load, and it had far more robust income streams. Even if Egypt can find some interested foreign investors, the cost of borrowing will be prohibitively high, and the amounts needed are daunting. Plainly stated, Cairo needed to come up with $16 billion annually just to break even before the crisis and the likely banking changes that will come along with it.

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Protest 2011

Egypt: The Distance Between Enthusiasm and Reality is republished with permission of STRATFOR.

Certainly, there was a large crowd concentrated in a square in Cairo, and there were demonstrations in other cities. But the crowd was limited. It never got to be more than 300,000 people or so in Tahrir Square, and while that’s a lot of people, it is nothing like the crowds that turned out during the 1989 risings in Eastern Europe or the 1979 revolution in Iran. Those were massive social convulsions in which millions came out onto the streets. The crowd in Cairo never swelled to the point that it involved a substantial portion of the city.

In a genuine revolution, the police and military cannot contain the crowds. In Egypt, the military chose not to confront the demonstrators, not because the military itself was split, but because it agreed with the demonstrators’ core demand: getting rid of Mubarak. And since the military was the essence of the Egyptian regime, it is odd to consider this a revolution.

Mubarak and the Regime

The crowd in Cairo, as telegenic as it was, was the backdrop to the drama, not the main feature. The main drama began months ago when it became apparent that Mubarak intended to make his reform-minded 47-year-old son, Gamal, lacking in military service, president of Egypt. This represented a direct challenge to the regime. In a way, Mubarak was the one trying to overthrow the regime.

The Egyptian regime was founded in a coup led by Col. Gamal Abdul Nasser and modeled after that of Kemal Ataturk of Turkey, basing it on the military. It was intended to be a secular regime with democratic elements, but it would be guaranteed and ultimately controlled by the military. Nasser believed that the military was the most modern and progressive element of Egyptian society and that it had to be given the responsibility and power to modernize Egypt.

While Nasser took off his uniform, the military remained the bulwark of the regime. Each successive president of Egypt, Anwar Sadat and Hosni Mubarak, while formally elected in elections of varying dubiousness, was an officer in the Egyptian military who had removed his uniform when he entered political life.

Mubarak’s decision to name his son represented a direct challenge to the Egyptian regime. Gamal Mubarak was not a career military officer, nor was he linked to the military’s high command, which had been the real power in the regime. Mubarak’s desire to have his son succeed him appalled and enraged the Egyptian military, the defender of the regime. If he were to be appointed, then the military regime would be replaced by, in essence, a hereditary monarchy — what had ruled Egypt before the military. Large segments of the military had been maneuvering to block Mubarak’s ambitions and, with increasing intensity, wanted to see Mubarak step down in order to pave the way for an orderly succession using the elections scheduled for September, elections designed to affirm the regime by selecting a figure acceptable to the senior military men. Mubarak’s insistence on Gamal and his unwillingness to step down created a crisis for the regime. The military feared the regime could not survive Mubarak’s ambitions.

This is the key point to understand. There is a critical distinction between the regime and Hosni Mubarak. The regime consisted — and consists — of complex institutions centered on the military but also including the civilian bureaucracy controlled by the military. Hosni Mubarak was the leader of the regime, successor to Nasser and Sadat, who over time came to distinguish his interests from those of the regime. He was increasingly seen as a threat to the regime, and the regime turned on him.

The demonstrators never called for the downfall of the regime. They demanded that Mubarak step aside. This was the same demand that was being made by many if not most officers in the military months before the crowds gathered in the streets. The military did not like the spectacle of the crowds, which is not the way the military likes to handle political matters. At the same time, paradoxically, the military welcomed the demonstrations, since they created a crisis that put the question of Mubarak’s future on the table. They gave the military an opportunity to save the regime and preserve its own interests.

The Egyptian military is opaque. It isn’t clear who was reluctant to act and who was eager. We would guess that the people who now make up the ruling military council were reluctant to act. They were of the same generation as Hosni Mubarak, owed their careers to him and were his friends. Younger officers, who had joined the military after 1973 and had trained with the Americans rather than the Soviets, were the likely agitators for blocking Mubarak’s selection of Gamal as his heir, but there were also senior officers publicly expressing reservations. Who was on what side is a guess. What is known is that many in the military opposed Gamal, would not push the issue to a coup, and then staged a coup designed to save the regime after the demonstrations in Cairo were under way.

That is the point. What happened was not a revolution. The demonstrators never brought down Mubarak, let alone the regime. What happened was a military coup that used the cover of protests to force Mubarak out of office in order to preserve the regime. When it became clear Feb. 10 that Mubarak would not voluntarily step down, the military staged what amounted to a coup to force his resignation. Once he was forced out of office, the military took over the existing regime by creating a military council and taking control of critical ministries. The regime was always centered on the military. What happened on Feb. 11 was that the military took direct control.

Again, as a guess, the older officers, friends of Mubarak, found themselves under pressure from other officers and the United States to act. They finally did, taking the major positions for themselves. The demonstrations were the backdrop for this drama and the justification for the military’s actions, but they were not a revolution in the streets. It was a military coup designed to preserve a military-dominated regime. And that was what the crowds were demanding as well.

Read more: Egypt: The Distance Between Enthusiasm and Reality | STRATFOR

Egypt on the Brink: From Nasser to Mubarak. By Tarek Osman. Yale University Press; 304 pages; £14.99. To be published in America by Yale in December; $20. Buy fromAmazon.co.uk, Amazon.com

Book review from The Economist:  "IT MAY not be as big as India or China, but Egypt is, like them, an ancient country that has contributed mightily to civilisation, remains central to its region and is also in the grip of momentous change. Strange, then, that despite continued fascination with ancient Egypt, so little aside from turgid academic tomes or breathless journalistic accounts has been published about the current condition of the most populous country in the turbulent Middle East, and among the most influential.  “Egypt on the Brink” is a slim book, simply written and easy to understand, and it goes a long way to filling this void. The author, Tarek Osman, a Western-educated Egyptian banker and occasional columnist, brings the eye of an intelligent amateur to the story of his country’s past half-century....read more from from The Economist