Last year, the government and Central Bank launched three initiatives for 2020 to help boost healthy large and medium factories, firms near bankruptcy or bankrupt because of unpaid debts, and exporters. Industry insiders say the initiatives addressing three in a long list of problems.
Often described by state officials as the “locomotive of Egypt’s economic recovery,” industrial investments not only create permanent jobs, they account for 48 percent of dollar inflows. Yet the sector was the first and hardest hit by the aggressive structural reforms since the pound was floated in late 2016, and the sector’s recovery has been lackluster ever since. Non-oil business activity has been in contraction for a full quarter running, hitting a three-year low of 46.0 in January’s IHS Markit Egypt Purchasing Managers’ Index. Tarek Tawfik, vice chairman of the Federation of Egyptian Industries (FEI), also looks at Central Bank (CBE) and CAPMAS data about manufacturing growth rates and private industry employment and sees “concerning statistics.” Even in the World Bank’s Doing Business Report 2020 and the World Economic Forum’s Global Competitiveness Report 2019, where Egypt has improved its overall rankings—114 of 190, and 93 of 141, respectively—the country remains in the bottom 50 percent of the lists.
The government has launched three new initiatives to boost local industry, and they all prioritize financial support: a bailout of factories struggling with heavy debt; EGP 100 billion ($6.3 billion) in low interest financing for medium and large companies; and a new way of managing the export support fund. “The scope of those initiatives will provide a huge push to manufacturing in Egypt,” said CBE Governor Tarek Amer at a December press event. “The country is now financially stable, which opens the door for those initiatives to succeed.”
While the help is welcome, many in the sector feel the government needs to take a more holistic approach. “So far, attempts to support ‘big industry,’ while bold, have been individual attempts by one government agency or ministry. As a result, they were incomplete,” said Kamal El Desouky, head of Insulation Materials Chambers at the FEI, as reported by media.
Tawfik also worries about a lack of coordination among government agencies resulting in unilateral or conflicting decisions. “Make no mistake, those initiatives are but one tool in a large package,” he says. “The government must address all aspects of that package collectively, not individually.”
Tale of two realities
For many, the current administration has been doing a lot of good in the economy. That includes increasing infrastructure investment, achieving a primary surplus in the state budget, regulatory For many, the current administration has been doing a lot of good in the economy. That includes increasing infrastructure investment, achieving a primary surplus in the state budget, regulatory reforms and removing subsidies, among other things. “The government fixed all the fundamentals in a short time,” says Tawfik, noting that the state also is pushing financial and digital inclusion. “On the face of it, manufacturing should have been recovering at a fast pace.” It hasn’t, though. The next step, the FEI deputy chairman says, is for the government to tackle the “nitty-gritty” problems that hamper manufacturers daily.
“None of the reforms the government has successfully implemented addresses the business environment in Egypt,” says Mohamed Reda, CEO of Solid Capital. While some challenges are sector-specific, industrialists cite overarching problems. El Desouky noted a lack of industrial plots with suitable infrastructure for new large-scale factories. “The last land auction offered 124 plots. There were more than 3,000 applicants,” he says. “The government must first increase supply before tackling other problems.” El Desouky believed increasing the supply is more important than streamlining processes for investors right now. “According to international reports, we are attracting the most FDI in Africa,” he told media. “That is a good statistic, but just imagine what we could achieve if we balanced supply and demand for industrial plots.”
Reda, meanwhile, believes many industrial plots are not suited for the majority of industrial investors. Often, they are remote, away from vital services. More suitable ones, meanwhile, are usually “too expensive.” “For example, affordable plots in Ain el Sokhna are in remote mountain areas where there are no paved roads,” says Reda.
Other overarching problems stem from structural fiscal reforms begun in late 2016. “Those measures created new realities in the market,” says Reda, citing lower consumption due to rising prices and stagnant wages. Another is stood at interest rates, which reached 12.25 percent in January. “During the economic boom in 2007 and 2008, interest rates were between 6 and 8 percent,” he says. “We are still several years away from reaching those levels unless CBE decides to shock the market with massive drops in successive meetings in the coming 12 months.”
For Tawfik, the core problem for manufacturers is the absence of a framework for how government bodies communicate with each other, resulting in mandates, governor and ministerial decrees and executive decisions that have later been reversed due to legislative or policy conflicts. When this happens, it damages investor confidence.
The three programs
For Mohammed Abou-El Enien, chairman of Ceramica Cleopatra, it is about time the state starts to pay more attention to large industrialists. He notes that for the past few years, the government has concentrated on SMEs, financial inclusion, digital inclusion, and startups, among others. “The government has largely left large industrialists with no support, probably believing their scale and resources could overcome ongoing structural reforms,” said Mohamed El Etreby, chairman of Banque Misr to media.
Having three simultaneous support programs is unheard of. For the past decade, there would most likely be only one or, on rare occasions, two active initiatives at a time.
For Mohamed Abdel Aal, a board member of Suez Canal Bank, the nature of those initiatives shows that CBE and the government are working together to benefit large companies. “That is something we never had before,” he says.
Such support is essential, given that manufacturers are still adjusting to the new realities of the post-2016 structural fiscal reforms. One of them is new costs, including real estate taxes and development fees, as well as energy expenses that fluctuate with international prices. Another is that several imported goods are exempt from customs after full implementation of free trade agreements with the European Union and Turkey over the past two years. “These supporting initiatives also help to stabilize the banking sector, which has been heavily investing in Treasury debt the past few years,” said Abdel Aal.
The devaluation of the pound caused significant damage to manufacturers with dollar-denominated debt and dependence on imports. That was enough for a number of large companies to start going bankrupt or report they are near bankruptcy. Accordingly, the first state-initiative for 2020 is to bail them out.
It is not the first time the state has attempted to save struggling factories. In October 2017, the government launched a rescue program for them, and a year later it started another that helps local feeders find local clients. Both have failed to deliver, according to parliamentarian Tarek Metwaly. In November, he submitted a clarification request to the prime minister and minister of trade and industry about the two initiatives. “To have so many initiatives aiming for the same thing shows the real extent and depth of the problems facing producers,” said Abdel Aal.
The government announced the latest bailout program in November. It has no set budget, according to Gamal Negm, deputy governor at the CBE. However, it will not accept submissions beyond June and is limited to companies with an outstanding loan principal less than EGP 10 billion. “We estimate that 8,586 struggling factories would benefit from this initiative,” says Negm. “Those companies have outstanding debts worth EGP 35.6 billion.” Of them, EGP 4.3 billion is loan principal. The rest are unpaid interest payments, whether delayed or not yet due. Currently, 182,000 formal manufacturers owe a combined EGP 432 billion to domestic banks.
The initiative requires eligible factory owners to pay only the remaining loan principal over two equal installments. After the first installment, all late debt-repayment cases will be dismissed. After the second payment within a predetermined time frame, banks would close their loans. “The CBE will remove the company from all blacklists and adjust its credit score to reflect the settled loan,” says Negm. “We want to make sure that when those businesses are free of their outstanding debt, they have access to banks at the best possible rates to rebuild themselves.”
According to Moharam Helal, an economics professor at Cairo University, the most significant advantage of the initiative is that bailing out struggling factories is much cheaper and faster than trying to attract investors to establish new factories from scratch. “New factories mean running after licenses, permits and building the factory and prepping it,” he says. “Struggling factories have those basics already covered.”
However, almost all private banks don’t like that initiative as they will lose outstanding interest payments, which accumulates to more than the loan principal. Currently, only the eight state-owned banks have announced their participation in this program. One of the biggest losers is the National Bank of Egypt, which announced that 1,900 of its clients are eligible for the bailout. That would see the bank receive EGP 3.5 billion in loan principal, but lose a potential EGP 8 billion in interest. “We are still working on how to implement it, but that initiative is a good one as it will greatly fix Egypt’s investment environment,” said Yehia Abou eEl Fettouh, deputy chairman of the National Bank of Egypt to press.
According to an anonymous source at a private bank, it is highly unlikely any international banks will willingly participate. “That is unless the CBE pledges to cover those losses in full,” says the source.
Tawfik is concerned about the underlying principles of having such a program. He believes the government must identify the companies whose business models no longer work. “The business model before 2016 relied on umbrella subsidies and an artificially valued pound. Their costs have spiraled out of control after the float and subsequent subsidy reforms,” he says. Unless those companies update their business models, he adds, “Even if the state bails them out they won’t be able to fly.”
Others worry that even if the government selects the right companies, the initiative may do more harm than good. “The first problem is that repaying all outstanding debt principal in two installments in quick succession would be too much,” says Samir Aref, chairman of the 10th of Ramadan Investors Association. Those companies don’t have enough liquidity to pay their installments, let alone repay the remaining loan principal.” That may force them to sell some assets to pay. For him, that initiative would most likely become a safe exit for factory owners who have cases filed against them.
Another point of concern is the initiative doesn’t say what happens if a business’s assets are less than the loan principal, says the anonymous banker.
Hani Berzi, head of the FMCG Export Council, believes this is the only way to ensure a struggling company is committed to succeeding after the bailout. “The two lump sum payments are a good stipulation,” he told media. “It affirms the business’s commitment to reform its practices.”
For Mohamed El Mohandes, head of Engineering Chambers at the FEI, even if a surviving company pays its loan principal, it probably still would need new debt to rebuild its cash pool, buy raw materials and even capital equipment. “That would be happening in the same [on the ground] environment that ruined those factories the first time,” he said to media. “We are just setting them up to fail again. I find it baffling.”
El Mohandes pointed out that the bailout should require mandatory management courses for factory owners and top managers to improve decision-making. “Bad management decisions led them to that position in the first place,” says Aref.
The second initiative is the first time the CBE or government has dedicated a program to support large healthy companies. “That funding program is going to existing factories with a strong footing in the market, but they need cheap funding to increase their competitiveness in Egypt and abroad,” said Amer of the CBE during the launch announcement in November.
Accordingly, the CBE has allocated EGP 100 billion for the program, with no deadline or sector limitations. “We generally would prioritize industries with export potential or those that produce something that Egypt imports,” said Amer.
The initiative stipulates a 10 percent interest rate. That compares to the current CBE corridor lending rate of 13.25 percent. Amer noted at the event the CBE would pay the difference in interest income to banks’ lending under the initiative, saying, “We realize this would be a big sacrifice for any bank.”
The catch is that sales revenue of eligible companies should not be more than EGP 1 billion. Another restriction is that factory owners could spend the borrowed money only on machinery, equipment and other capital investments. Thirdly, companies that are part of the bailout program are not eligible.
According to Amer, the fund should help as many as 96,000 medium-sized and large factories in Egypt. Negm notes the initiative places no ceiling on financing per client.
Ashraf el Kady, chairman of United Bank, believes the program is the missing piece of the puzzle for large corporations in Egypt. “They already know how to navigate the current realities,” he told the press. “All they want is to have lower-cost funding.” That would prove vital given that Egypt has free trade agreements with Morocco, Turkey, the EU and Africa.
For Berzi, restrictions on how factories spend this money fixes a major problem that surfaced in the EGP 200 billion SME funding initiative. “They gave those SMEs loans for 5 percent interest with no limitations on how to spend it,” he says. “The result was that many of them put the money in the bank to collect interest of 10 percent or more.”
Tawfik generally likes this initiative on a company level. “Who wouldn’t want to lower the cost of funds?” he asks.
However, Berzi and Tawfik say the initiative may not work for some large businesses. “Not all large and medium companies’ problems revolve solely around securing cheap financing,” said Berzi to media. “Some have other deeper problems that the initiative with its spending limitations can’t fix. Training is just one example.”
Helal, the economics professor, doesn’t expect a quick turnaround for most large manufacturers securing the loans. “We must not forget that the market reality is still the same,” he says. “Production costs are still high and rising. Wage hikes have yet to make people feel comfortable about spending. Meanwhile, the low interest rate may reduce the cost of funding, but only by a little.”
For decades, the idea the government should pay manufacturers to export never materialized on the ground, despite having a dedicated fund. However, nearly 2,000 exporters should be benefiting from the new EGP 6 billion Export Development Fund.
Subsidies under the new system amount to between 8 and 10 percent of the value of a company’s exports. Factories could increase their subsidy based on complex and comprehensive criteria. To respond to international and domestic needs, the law allows the government to change the fund’s criteria and allocations annually.
Overall, the new system is more convoluted than the one it replaces. One example is that eligible exporters would receive only 40 percent of their subsidy in cash; 30 percent will go to settle debts to the government, such as overdue taxes. The remaining amount will cover the cost of technical assistance to companies, such as paying for participation in international fairs or training. “The old system was cash only,” says Tawfik.
He points out that no one knows why the government chose to adopt this approach. “What happens if a company pays its taxes on time? Or if it is in a free zone and therefore doesn’t pay taxes? And what if it is a multinational company that doesn’t need outside technical assistance,” says Tawfik. “Would that mean they would get 40 percent of their subsidy, while a company that doesn’t pay its taxes would get the full amount?” He adds that the government has not responded to the FEI’s repeated requests for clarification.
Experts also point out the fund would first have to repay billions in outstanding export subsidies under the old program, according to Tawfik. So far, only 25 companies had partially settled their government debt as of November 2019, according to several online media outlets. “Securing any amounts from the export fund is always good news,” says Magdy Tolba, deputy head of the Textile Export Council.
Tawfik believes that the key to making a subsidy work is to make it targeted support: “The export plan must be granularly detailed and clear, with aims to achieve certain benchmarks within specific timeframes,” he says. “We are talking about subsidizing a specific product with specific criteria to a specific market over a specific period.”
Another point is the government needs to abandon its talk of adjusting the subsidy every year based on how exports performed the previous year. “That doesn’t work because companies set three- to five-year plans,” says Tawfik. “They can’t afford to deal with different eligibility criteria every year.”
Making a difference?
Some have a real concern that this comprehensive support framework, which now encapsulates almost all manufacturers in Egypt regardless of size, operations status and markets they serve, has become a necessity rather than a temporary measure.
The government certainly believes more support is still needed. In November, Finance Minister Mohamed Maait announced at a press conference there would be more initiatives until mid-2020 that support manufacturers. Some of those initiatives will pertain to value-added taxes, energy prices, further supporting exports and eliminating the real estate tax for select industries in specific locations.
For Tawfik, none of that would make much impact if the government doesn’t create a body to assess the “legislative impact” of every decree and decision before announcing them. “There must be some sort of coordination between middle-tier government officials among all government agencies,” says Tawfik. “We must eliminate any chance of conflict.”
Meanwhile, to ensure that all government officials make “correct” decisions, the state must announce a clear and comprehensive industrial strategy by which all government agencies must abide. “There is no other way to boost Egypt’s manufacturing scene,” says Tawfik.