North Africa’s largest economy Egypt is still battling high inflation rates and a weak economy. Even that the North African gas producer has been very successful lately, looking forward to a re-entrance as an LNG exporter soon, the underlying fundamentals of its economy are still weak. Since the start of the Arab Spring, which brought not only the Muslim Brotherhood to power, resulting in Egypt’s military taking over soon, the economy has been hit by large scale unemployment, extremely high inflation rates and a total shutdown of tourism. Still, some light is at the end of the tunnel.
President Sisi, re-elected lately by a vast majority, has been able to put part of the country’s economy back on track. Increased security and stability has not only resulted in a growing influx of tourists, but also brought back major FDI volumes, mainly from the Arab World and China. A full revamp of the economy is planned, supported by expected high gas revenues and a removal of energy and food subsidies. At the same time, Cairo has been looking at other options too. Not to fall into the same trap as other countries, Cairo plans to set up a sovereign wealth fund, managing state assets of around LE200 billion ($11.3 billion), while an issued and paid capital is expected of LE5 billion. To set the latter up, the Egyptian Cabinet has approved in April a draft law to establish a sovereign wealth fund.
Egypt’s new Minister of Planning Hala Al Saeed stated that the bill stipulates that the SWF has the authority to set up sub-funds and is allowed to take part in other Arab funds. Still, the Egyptian parliament still needs to approve the law. The law also states that the fund is meant to optimize assets and manage state companies, which are planned to be listed on the Egyptian Exchange (EGX).
The set up of an SWF is not new. Egypt already announced in its 2016 5-year plan to float 15-30 percent of public companies to attract investments. A 1stPhase would entail around 23 companies to head for an IPO. Total value of the first phase is slated to be around LE430 billion. In the 2018/19 government budget already LE10 billion is expected. Egyptian analysts are reasonably optimistic about the move to set up an SWF. Most indicate that via IPOs illiquid assets can be transferred to become liquid, aka attracting strategic investors. They expect that higher liquidity in the market will push the overall stock market capitalization up, and will deepen the market. For most investors, building and real estate assets, and land, will generate the highest interests at present.
There are however several risks when taking this approach. First of all, as stated by the Egyptian Ministry of Finance, the government is targeting a lower budget deficit of 8.4 percent of GDP (LE 438.59 billion) in the new budget for the fiscal year 2018/19. With only removing subsidies and higher tourism revenues, the latter situation is not to be reached. Not yet available IPO revenues could however be targeted to pay off part of the future bills. If this is the case, the set-up of an SWF is already threatened, as financial reserves could already be dwindling before a real start is being made. The main use of an SWF financial assets should be to support sustainable economic (and social) development. When part of the IPO generated reserves are linked to paying day to day bills, the effects will be minimal.
A balance is needed to be able to pay off some of the existing debt or budget deficits, while at the same time remove the currently high risk premium for investors in Egypt due its credit situation, but at the same time support projects in infrastructure, high-tech or energy efficiency.
At the same time analysts need to ask themselves in far the new SWF will be having a mandate to act independently. Media sources have indicated that to provide independent and prudent decision making, several committees have been proposed to manage investment, governance, internal auditing, risk and benefits. At present, as indicated by the minister, the fund is going to be managed by the Ministry of Planning and Administrative Development. The latter could however be worrying for local and foreign investors. Looking at the fact that the overwhelming majority of Egypt’s state-owned companies are being linked or run by the Egyptian army, independent management is far from reality. The proposed state-assets to be offered in an IPO are not yet fully defined. Again, the role of the Egyptian military or semi-military in these assets could become a constraint.
For a real success story, Cairo should reconsider its current approach and assess the option of mandating a private sector asset-management firm to run the fund. If this is not an option, Egypt’s government could have a look at the Dutch pension funds set up. While being guaranteed and regulated by Dutch law, the operations and management of the funds is fully independent.
One specific aspect to be considered before implementing an SWF is to assess the need of a diversified investment portfolio. At present, the strategy taken feels like there is more of an emphasis on short-term investments and budgetary policies, than the underlying need for long-term investments. As proven by mainstream institutional investors, and especially Dutch pension funds, such as ABP or PGGM, long-term investments are needed to sustain the overall impact of a fund, not only for the government but additionally for Egyptians. With a focus on short-term, investments could even increase the total risk volume for a country such as Egypt. Taking again the Dutch approach, a 70/30 mix, in which long-term investments or holdings are linked to infrastructure and real estate, is the most feasible. Until now, no information has been provided by Egyptian officials about the investment mix or even the targeted sectors. Some fear exists that most of the funds available will again be put into the hands of existing government linked entities or military owned companies. To attract high levels of foreign direct investment the latter two options should not be the main target. Diversification and support of new economic entities should be considered to be a priority.
Cairo also should be very careful not to count too much on the influx of other Arab countries. Even that Egypt’s allies Saudi Arabia and UAE have been investing heavily into the country, partly to support geopolitical and military cooperation against perceived threats, such as Muslim Brotherhood and Qatar, a strong reliance on Arab cash into the new SWF could hijack already the potential. As some would state, “it is better to start small but independent, than to grow quickly but be pressured by friends”. Cooperation with Arab SWFs such as ADIA, PIF, Mubadala or even Mumtalakat, could be functional, but only if they will behave like prudent investors and not as political parties looking for influence.
