VZCZCXYZ0000
RR RUEHWEB

DE RUEHEG #2868/01 2661509
ZNR UUUUU ZZH
R 231509Z SEP 07
FM AMEMBASSY CAIRO
TO RUEHC/SECSTATE WASHDC 6990
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC 0343

UNCLAS CAIRO 002868 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR NEA/ELA, NEA/RA 
USAID FOR ANE/MEA MCCLOUD AND DUNN 
USTR FOR SAUMS 
TREASURY FOR MATHIASON AND HIRSON 
COMMERCE FOR 4520/ITA/ANESA/OBERG 
 
E.O. 12958:  N/A 
TAGS: ECON EAID EFIN EINV EG
SUBJECT: IMF BULLISH ON EGYPT:  ARTICLE IV CONSULTATION REPORT 
PRAISES MACROECONOMIC PERFORMANCE 
 
 
Sensitive but Unclassified.  Please protect accordingly. 
 
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Summary 
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¶1.  (SBU) The IMF recently concluded its annual Article IV visit to 
Egypt, issuing a preliminary report lauding the success of Egypt's 
macroeconomic reform.  The report cited strong economic growth and a 
decline in unemployment as signs of the program's success. 
Inflation is a concern, but the spike in early 2007 was due to 
one-off events, not underlying inflationary pressure.  More reform 
is needed to attract more investment, if Egypt's economy is to grow 
at a rate sufficient to sustain job creation.  The deficit must also 
be reduced, and the GOE has an ambitious plan to reach a deficit of 
3% by FY10/11.  Cyrus Sassanpour, IMF Resident Representative, 
agreed with the Treasury Attache that the report was quite positive, 
and noted that the GOE could reach its deficit reduction target 
simply by consistently cutting fuel subsidies.  Sassanpour 
recognized the need for continued reform, and believes now is the 
time - when the economy is performing well - to enact those reforms. 
 While the report accurately reflects improved macroeconomic 
figures, it does not mention some of major problems still facing 
Egypt's economy, including corruption. 
 
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Strong Macroeconomic Performance 
-------------------------------- 
 
¶2.  (U) The IMF's preliminary Article IV report, issued September 
12, lauded Egypt's macroeconomic reform, highlighting estimated real 
GDP growth of 7.1% in FY06/07 (July 2006 - June 2007) and a decline 
in unemployment from 10.5 to 9% as evidence of the program's 
success.  Strong growth was supported by record FDI inflows, (the 
GOE estimates FDI will reach $6 billion in FY06/07), which also 
fueled inflation as domestic demand increased.  Peaking at 12.8% in 
March 2007, inflation has since decreased to 8%.  The IMF report 
echoed official GOE assertions that the spike in inflation was 
caused by an avian flu outbreak and fuel subsidy reductions, and is 
therefore not a long-term concern.  The report predicts inflation 
will average 6-8% for the next few years - consistent with an 
economy growing at 6-7% annually, with annual FDI in the range of $6 
billion - provided money growth does not increase more than 15%. 
 
¶3.  (U) The fiscal deficit declined from around 9% in recent years 
to 7.5% in FY06/07, due to structural reform of the tax system, 
subsidy reductions, a Treasury Single Account, and windfall profits 
from issuance of a third mobile phone license.  Privatization 
proceeds also increased revenues, and spurred private sector growth. 
 The July 2007 issuance of Egypt's first international local 
currency bond will help establish a benchmark interest rate and aid 
in domestic capital market development, according to the report 
(Note:  The bond has an unusual design:  Denominated in dollars, 
proceeds from the issuance were given to CBE to convert into Pounds 
at the existing exchange rate.  At interest payment times and at 
maturity, the Ministry of Finance will calculate and pay interest to 
CBE in Pounds, which will convert the Pounds back into dollars at 
the existing exchange rate before pay out to investors.  Under this 
design, investors take the exchange rate risk, not CBE). 
 
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More Investment Needed 
---------------------- 
 
¶4.  (U) The IMF noted that to sustain growth and job creation, 
investment equal to 26% of GDP is needed over the next few years. 
Obstacles to this level of investment include poor infrastructure 
and government services, lack of credit to SMEs, and lack of trained 
labor.  Further structural reforms are also needed to meet the GOE's 
deficit target of 3% by FY10/11.  While expressing confidence in the 
GOE's ability to meet this target, the report notes that deficit 
reduction is the overarching challenge for the GOE (Note:  Several 
of the IMF recommendations for reducing the deficit, including 
property and sales tax reform and improved cash management, are 
benchmarks under the "Private Sector Development" portion of the 
proposed new USAID cash transfer program).  The IMF also recommends 
that fuel subsidies - currently 5-6% of GDP - be further reduced. 
Such reduction would discourage investment in energy-intensive 
industries in which Egypt does not have a long-term comparative 
advantage, according to the report. 
 
¶5.  (U) While noting the potential for "reform fatigue" as some are 
adversely affected and/or disappointed with reform, the IMF 
encourages Egypt to take advantage of the favorable outlook to 
 
continue with reform.  The report was broadly supportive of CBE's 
movement toward an inflation-targeting monetary policy, and 
encouraged more privatization in the banking sector, which is 
already approximately one half private sector-owned resulting from a 
financial sector reform program.  The full Article IV report is 
expected to be considered by the IMF Board in November. 
 
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IMF Representative Bullish 
-------------------------- 
 
¶6.  (SBU) Cyrus Sassanpour, IMF Resident Representative (ResRep) 
echoed the report's laudatory assessment to TreasAtt.  While 
praising the solid macroeconomic numbers, he recognized that the GOE 
data, upon which the report is based, is not always reliable.  Local 
analysts, including Sassanpour, believe that the GOE consistently 
underestimates unemployment.  Sassanpour was especially critical of 
the Central Agency for Public Mobilization and Statistics (CAPMAS), 
the main data gathering agency, though their information has 
improved somewhat in recent months.  Budget transparency has 
improved, according to Sassanpour, largely due to the Minister of 
Finance's efforts to increase transparency in GOE agencies.  Despite 
improved budget transparency, and improvement in the way fuel 
subsidies are shown in the budget, the Article IV report cited 
transparency in the Egyptian General Petroleum Company as an area 
still in need of improvement (Comment: Improved budget transparency 
is one means of empowering civil society to demand greater 
government accountability.  We are hopeful that increased USG and 
donor attention to this issue will have some democracy dividends). 
 
 
¶7.  (SBU) Sassanpour also noted that the dividends of macro reform 
are being felt, as investors now see Egypt as a stable investment 
destination, a view backed by the growing FDI figures.  He argued 
that the GOE can meet its target of reducing the fiscal deficit by 
1% of GDP annually simply by consistently cutting subsidies.  The 
GOE has put forth a plan to reduce energy subsidies to industry over 
the next five years, and Sassanpour expects another cut before the 
end of the year.  On the revenue side, better enforcement of the new 
tax law is needed, but the new law itself, coupled with 
restructuring of the Tax Authority, is a major achievement.  Within 
the MENA region, Sassanpour argued that Egypt is now a tax reform 
leader, a view expressed by other MENA countries at the last 
OECD-MENA Investment Conference. 
 
¶8.  (SBU) While the macro picture continues to be fairly rosy, 
Sassanpour noted that more reform is still needed in the real 
economy, particularly in agriculture, infrastructure, labor markets, 
and skills training.  These reforms need to happen while the economy 
is doing well, so the difficult adjustments required by such reforms 
can be offset by overall growth and job creation. 
 
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Comment 
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¶9. (SBU) While the IMF report accurately reflects the improved 
macroeconomic environment in Egypt, the macroeconomic picture is 
only part of the overall economic landscape.  The Minister of 
Finance, with whom the IMF works closely, has made monumental 
efforts to improve Egypt's fiscal situation.  His efforts, however, 
and those of economic reformers in general, continue to face 
political obstacles and sectoral challenges.  Corruption remains a 
major impediment to growth.  The culture of cronyism and family 
connections is still deeply rooted in Egyptian society, and affects 
the business sector from start up through operation and expansion. 
Business owners still need the right "connections" to facilitate 
access to land and utilities, issuance of licenses, financing, and 
contracts.  The World Bank, which works more closely with the 
financial sector than does the IMF, has a decidedly more skeptical 
view of the likelihood of continued economic reform (septel). 
 
JONES