This record is a partial extract of the original cable. The full text of the original cable is not available.

C O N F I D E N T I A L SECTION 01 OF 03 CAIRO 000035 
 
SIPDIS 
 
STATE FOR NEA/ELA, NEA/RA, AND EB/IDF 
USAID FOR ANE/MEA MCCLOUD 
USTR FOR SAUMS 
TREASURY FOR MILLS/NUGENT/PETERS/KLINGENSMITH 
COMMERCE FOR 4520/ITA/ANESA/TALAAT 
 
E.O. 12958: DECL: 01/02/2016 
TAGS: ECON EFIN ETRD EINV PREL EG
SUBJECT: THE EGYPTIAN ECONOMY IN 2006 - CAN EGYPT SUSTAIN 
 
REFORM? 
 
REF: 05 CAIRO 9314 
 
Classified by ECPO Acting Counselor John Desrocher, for 
reasons 1.4 (b) and (d). 
 
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SUMMARY AND INTRODUCTION 
------------------------ 
 
¶1.  (C) As noted in reftel, the Mubarak regime has clearly 
recognized the need for wholesale economic reform to avert a 
serious deterioration in employment prospects and living 
standards for Egypt's burgeoning population and to keep Egypt 
afloat in the global economy.  Gamal Mubarak's Policy 
Secretariat in the National Democratic Party (NDP) began an 
 
SIPDIS 
economic policy review in 2002, but real change only came in 
2004, with the appointment of reform-oriented economic 
ministers.  These ministers took some bold steps upon 
appointment, including slashing tariffs and eliminating 
diesel subsidies.  The reformers took further steps in 2005, 
including cutting tax rates and accelerating privatization of 
state-owned enterprises.  Reaction in the local business 
community has been positive, but business leaders have called 
for deeper economic restructuring and some have questioned 
the NDP's long term commitment to reform.  Others have 
speculated that the real aim of economic reform is to 
alleviate domestic and international pressure for political 
change.  As Egypt heads into 2006, economic reform itself may 
become more politicized, as those who stand to lose from 
changes in the status quo begin to more actively resist 
continued reform efforts.  End summary and introduction. 
 
----------------------------------------- 
ADDRESSING STAGNATION AND UNEMPLOYMENT... 
----------------------------------------- 
 
¶2.  (SBU) After years of economic stagnation that culminated 
in a currency devaluation in early 2003, the Mubarak regime 
has clearly recognized that it cannot maintain the status quo 
in the economic realm.  Although official unemployment is 
10%, private analysts put the actual figure as high as 20%. 
Underemployment is also a significant problem, as many of the 
approximately 600,000 workers who join Egypt's labor force 
each year are college graduates with limited job 
opportunities in the current economic environment. 
 
------------------------------ 
THROUGH TARIFF AND TAX CUTS... 
------------------------------ 
 
¶3.  (U) The Nazif administration followed its first big 
reform, the reduction of customs tariffs in September 2004, 
with a similar reduction in tax rates in June 2005.  A new 
tax law reduced personal and corporate tax rates by half, and 
changed the relationship between taxpayers and the Tax 
Authority.  Taxpayers now file self-assessments, which the 
Tax Authority accepts as accurate, with an option to audit. 
Under the previous system, the Tax Authority assessed taxes 
for individuals and corporations and presented taxpayers with 
a bill.  This process could take years, leaving business 
owners, as well as potential lenders and investors, in the 
dark regarding what a firm's tax bill would be and when it 
might come due. 
 
¶4.  (U) The aim of the new law, according to Minister of 
Finance Youssef Boutros Ghali (YBG), was not only to 
stimulate economic activity, but to encourage the large 
informal sector to register with the government and begin 
paying taxes.  YBG asserted that growth resulting from the 
reduction in tax rates, combined with incorporation of 
informal activity into the tax base would offset decreases in 
revenue from the tax cuts.  This logic largely proved valid 
with regard to the tariff reductions of 2004.  In 2004 YBG 
predicted a 37% drop in revenue due to the tariff cuts, but 
actual figures for fiscal year 2004/05 showed a decrease of 
only 16%.  The difference was made up by an increase in the 
volume of imports stimulated by lower tariffs. 
 
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AND PRIVATIZATION 
----------------- 
 
¶5.  (U) As 2005 draws to a close, economic growth has reached 
an annualized rate of 5.3%.  Most of the growth is from FDI, 
which increased from $400 million in FY 03/04 to $3.9 billion 
in FY 04/05.  While most of this investment is in the 
petroleum sector, non-petroleum investment still trebled. 
Foreign investors are drawn by a booming stock market and 
Minister of Investment Mahmoud Mohieldin's aggressive sale of 
some of the GOE's most valuable state-owned enterprises.  In 
2005, the Ministry of Investment (MOI) divested GOE shares in 
several joint venture banks, sold a controlling stake in 
Egypt's largest cement producer to a French company, and held 
IPOs for two major petroleum firms and 20% of Telecom Egypt 
(TE), the country's fixed-line telephone monopoly.  In the 
case of TE, the IPO was oversubscribed 10 times by individual 
investors and 60 times by institutional investors.  Proceeds 
from the sale of public assets have already generated $920 
million in revenue for the GOE in the first half of the 
current fiscal year. 
 
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GROWTH FOCUSED MOSTLY IN EXPORT SECTORS 
--------------------------------------- 
 
¶6.  (U) Much of the investment and economic growth seen in 
2005 was concentrated in export sectors, particularly the 
petroleum field as noted above.  The GOE encouraged 
development of its natural gas industry, and is expected to 
shift more resources into natural gas exploration as Egypt's 
oil reserves dwindle.  Textile exports also increased, 
particularly to the U.S. from the Qualifying Industrial 
Zones.  As exports increased, however, so did pressure on the 
Egyptian Pound (LE).  The Central Bank of Egypt (CBE) has 
maintained the currency stable at near LE 5.75/$ for most of 
2005 by building Egypt's foreign currency reserveS, which 
have now reached $21 billion.  Conditions may be right in 
2006 for an appreciation of the LE, as domestic demand 
increases due to lower inflation and interest rates.  YBG 
signaled as much in early September, when he said publicly 
that the GOE would let the LE appreciate once CBE's foreign 
reserves reached $23 billion. 
 
--------------------------------------------- ----- 
OUTLOOK FOR 2006:  REFORM CAMP IN CABINET GROWS... 
--------------------------------------------- ----- 
 
¶7.  (SBU) President Mubarak signaled his commitment to 
continued economic reform when he announced the new cabinet 
line-up on December 27.  All of the reform-oriented ministers 
will remain in their current positions, and the reform camp 
will actually expand.  Mohammed Mansour, a highly regarded 
businessman with close ties to the U.S., has been named 
Minister of Transportation.  Mansour is the cousin of another 
cabinet reformer, new Housing Minister and former Tourism 
Minister Ahmed Maghrabi.  Mansour also thinks and operates 
much like a third cabinet minister drawn from the private 
sector, his friend and fellow Alexandrian, Trade Minister 
Rachid.  The new ministers of agriculture, health, and 
tourism also bring extensive private sector experience to 
government. 
 
------------------------------------ 
...BUT CAN THEY MEET THE CHALLENGES? 
------------------------------------ 
 
¶8.  (SBU) The new cabinet will face major challenges in 
implementing continued economic reform.  While the business 
community and wealthy elites have been generally favorable to 
the Nazif administration's reform agenda, the average 
Egyptian (too poor to pay income tax or, even after tariff 
cuts, buy imported goods) perceives no direct benefit from 
the reforms to date.  Continued reform will, of necessity, 
have to address the massive subsidization of food, water and 
energy, the biggest drag on the GOE's budget.  The deficit 
reached 10% this year and will continue to increase absent 
steps to reduce subsidies and rationalize the bloated public 
sector. 
 
¶9.  (C) Surveys indicate that most Egyptians still favor the 
security of public sector jobs over private sector 
employment, but the Nazif administration has already 
indicated that it will not create unnecessary public sector 
jobs to control unemployment.  The business community asserts 
that for the private sector to create more jobs, a reduction 
is needed in bureaucratic impediments to economic initiative. 
 While the GOE has taken some steps in this regard, such as 
accelerating the pace of privatization of state-owned 
enterprises and creation of the MOI's "one-stop shop" for 
business development, entrepreneurs still face numerous 
hurdles in dealing with the government offices.  Anecdotal 
evidence from private sector contacts indicates that the 
one-stop shop has merely concentrated all the hurdles in one 
location, but has not made them easier to overcome.  Private 
sector leaders have made it clear that they see a free trade 
agreement with the U.S. as essential to prompting the 
structural economic reform needed to allow the private sector 
to take the lead in Egypt's economy. 
 
¶10.  (C) Corruption also remains a significant impediment to 
growth, and may become more difficult to control as economic 
reform progresses.  As the GOE continues its efforts to 
strengthen the institutions necessary for efficient 
functioning of the economy, those efforts will likely bump up 
against entrenched bureaucratic interests, and perhaps the 
interests of high-level members of the NDP and Mubarak 
regime.  Minister of Investment Mohieldin, addressing the 
AmCham and visiting representatives of Deutsche Bank, noted 
that for true economic development to occur, businesses would 
need to be free to establish ventures without "gaining 
approval," a subtle recognition of the widely held belief 
that all economic activity must be "approved" by the highest 
levels of the Mubarak regime.  Minister of Trade Rachid was 
even more outspoken at another AmCham conference, at which he 
stated that corruption was harming economic growth and should 
not be tolerated.  Unless corruption is addressed, economic 
reform may indeed begin to threaten more than just the 
bureaucracy, and may therefore go the way of Egypt's 
political reform agenda, i.e., halting steps as opposed to 
the sweeping reforms seen in 2005. 
 
RICCIARDONE