Tuesday, September 9, 2008

World slowdown stems Egypt’s upward trend

04 August, 2008

The successful transformation of Egypt’s banking sector has hit trouble. Charlie Corbett reports on how global financial turmoil and soaring inflation have hit the banks’ consolidation efforts.

The government-backed transformation of the Egyptian banking sector hit a stumbling block in June. Since 2004, when the reform process started, plans to purge Egypt of its anachronistic and opaque state banks to form an efficient and profitable privatised regime have gone without a hitch.

The process was punctuated by a series of landmark deals that showed the world how far Egypt had come in its financial maturity, and how far it was willing to go. Top of the list of iconic deals was the government’s 2006 sale of 80% of state-owned Bank of Alexandria to Italy’s Gruppo Sanpaolo IMI. The sale of Egypt’s fourth largest bank made $1.6bn for the government – six times the bank’s book value.

The Bank of Alexandria deal was a high point in a process that saw foreign banks from across the world snap up Egyptian banks with abandon. The sector shrank from a lumbering 61 banks in 2004 down to a more sleek 36 in 2008. That figure was due to have fallen yet further in the first half of 2008 but it looks like the consolidation party could be drawing to a close.

Attempted mergers

Two merger deals have fallen through in the past three months. The first and most telling was the recent cancellation of the sale of state-owned Banque du Caire, Egypt’s third largest bank, after the bids received were too low.

In what is perhaps a sign of more straitened times across the world for banks, the Egyptian government announced in June that it would wait until better conditions presented themselves before it sold.

According to one report, the government had been looking for about $1.6bn for a 67% stake in the bank, but offers had been at least $250m below that figure. The bank was valued last year at $2.6bn by Egyptian central bank governor Farouk el-Okdah. Bidders for Banque du Caire had included the National Bank of Greece, United Arab Emirates based Mashreqbank and a consortium made up of Arab National Bank and Arab Bank Group, Samba Financial Group and Standard Chartered. Such was the shock felt at the cancellation of Banque du Caire’s sale that Egypt’s benchmark CASE 30 index fell by 1.3% upon the news.

Another deal that had seemed a sure-fire winner earlier in the year was the merger between Commercial International Bank (CIB) and Arab African International Bank (AAIB). Talks between the two banks broke down in May after the two parties could not reach mutually acceptable terms.

CIB chief executive Hisham Ezz al-Arab had said last November that it was not his intention to rush into a merger. Despite the breakdown of merger talks with AAIB, the former Deutsche Bank, JPMorgan and Merrill Lynch banker remains bullish towards the sector as a whole.

Healthy competition

Mr al-Arab sees the shrinking bank sector as a healthy sign for the industry. “Competing with strong banks is much better for the market than competing with weak banks,” he says. “Competing with a stronger institution raises the bar and provides customers with better service. Banks move from being product-centric to being customer-centric.”

Egyptian banks are benefiting from the flood of foreign money coming into the region, in particular from Egypt’s neighbours in the Gulf. High oil prices mean that Arab oil exporters are awash with cash, and asset-hungry Arab sovereign wealth funds are stalking Egypt for opportunities to invest.

According to Mr al-Arab, 45% of foreign direct investment coming to Egypt is for greenfield projects. “They are looking for finance both from international banks, and also from local banks,” he says.

Similar to banking sectors across Africa, however, Egypt’s banks have little or no retail penetration. Just 10% of Egyptians have bank accounts so the potential for growth is huge.

“The retail sector has started to grow and consumer lending is now about 10% of GDP [gross domestic product],” Mr al-Arab says. “There is great potential for that market to keep growing.”

Of CIB’s loan book, just 12% is made up of retail loans while the remainder is in corporate loans. The bank plans to change this and has recruited a retail risk manager and retail chief executive from overseas banks to shore up its knowledge of the sector.

“We did not have the right experience to run the retail business so we went and recruited people from overseas who had worked in other markets,” says Mr al-Arab.

Broad-based growth

Healthy GDP growth of about 7% over the past two years in Egypt has meant banks and industry alike have prospered. The government’s reform process is reaping dividends and foreign investment into Egypt has soared. As a percentage of GDP, foreign direct investment has grown from 1.5% of GDP in 2004 to 8.5% now. Of that, 35% came from Gulf States.

According to Egypt’s minister of investment, Dr Mahmoud Mohieldin, the country’s growth has been driven by the private sector.

“There have been very positive developments on the export front but private investment is the main driving force behind growth in Egypt,” he says.

It is not just in one or two sectors that Egypt has experienced growth, according to Dr Mohieldin, it is across the board: “There have been positive developments across manufacturing, financial services and even the agricultural sector has seen very positive developments in terms of investment.” The growth of Egypt’s stock exchange is indicative of the wider prosperity the nation has enjoyed of late. Chairman Maged Shawky Sourial says the trading volumes have grown from 10,000 trades a day worth EGP200m ($37.89m) in 2004 to 60,000 trades a day worth EGP2bn today.

He says that the exchange has implemented strict new listing rules that encourage better governance and transparency. This has reduced the number of listed entities from well over 1000 in 2004 to just 370 today.

Despite the fall in the number of companies on the exchange the total market capitalisation of the exchange has grown, observes Mr Sourial.

For him, it is the government’s aggressive reform agenda and restructuring of the bank sector that has contributed the most to growth. “We have no restrictions on foreigners trading or caps on foreign ownership,” he says. “There are also no capital restrictions in terms of repatriation of profits. Compared with other regional markets we are unique in this.”

But Mr Sourial believes there is still more that the government can do to benefit the financial sector. “There is a need for the private sector to be involved in infrastructure investment. It would provide more growth in the economy and provide a lucrative investment environment,” he says.

Inflation spectre

Looking ahead, Egypt’s economy could be in for a rockier ride during the next few years. The spectre of inflation looms large over the whole world, but it is a particularly dangerous phenomenon in a country such as Egypt which has a large and vulnerable low-income society. Beltone Financial, an Egyptian investment bank, recently hiked its inflation forecast for Egypt from 10% in 2008/09 up to 14%.

The government, however, is fighting back. In May, it announced a series of fiscal measures to finance an increase in its expenditure on wages, subsidies and pensions to help low-wage earners.

“Inflation is very much a worldwide phenomenon, but people don’t care whether it is imported or home grown, they need quick measures to deal with the problem,” says Dr Mohieldin. “We introduced major reforms to increase wages and salaries for low-income civil servants and workers and increased subsidies to the poor. At the same time, we did not want to damage the balance of the budget so we introduced measures to increase revenues.”

Dr Mohieldin believes that the measures taken to counter government spending on the poor will not affect the budget deficit. “In fact we expect it to be brought down from 6.9% of GDP to less than 6.7%,” he says.

The measures include raising taxes and fees on a number of products and services, including energy, cigarettes and vehicle registration. The government has also removed tax exemptions on some financial instruments.

Growth stunted

The turmoil in global financial markets has largely passed Egypt by, but the country has not come away totally unscathed. The collapse of the Banque du Caire deal is indicative of an era of shaky nerves in the banking sector and an unwillingness to take risks.

The combination of higher inflation and higher interest rates will also have a negative impact on growth. Beltone Bank takes a measured view of the prospects of Egypt maintaining its 7% a year GDP growth. It said in a recent report that Egypt’s growth, which had been fuelled by strong domestic demand as well as foreign demand capitalising on Egypt’s assets, demographics and location, could be stunted.

“While we have passed the sweet spot of the cycle, we are now in a phase of maturity where sustaining growth at high levels is possible but would require more prudent navigation and management of public expectations and reactions on the government’s part,” says the report.

Mr Mohielden is aware of the challenges. “We must make growth sustainable. It is not enough to take an ‘on off’ approach to the economy,” he says. “Sustainability is as important as having these levels of high growth. It was not so in the past – but we are learning lessons.”

Beltone Financial chairman Aladdin Saba is confident that growth will be sustained. “The excess liquidity within the Gulf is fuelling infrastructure projects and new developments, which are trickling down into the wider economy in Egypt and the region generally,” he says.