The economic implications of Egypt’s revolution

As we are captivated and confused by what we see and hear unfolding in Egypt, the focus has been – for good reason – on the nature of this ?revolution,? or as others are calling it, a ?democratic tsunami.?

Whatever the outcome of this volatile and highly fluid situation, one area that has so far been rather overlooked is the economic implications for the country. Let us start by looking at aspects of infrastructure that are of considerable domestic importance to Egypt?s economy and whose disruption could also have an impact on foreign investment.

Safeguarding the oil pipeline linking the Red Sea with the Mediterranean is a cornerstone of the Egyptian economy. The Sumed pipeline is a major artery in the global supply network. It begins on the Gulf of Suez and runs northwest past Cairo before reaching tanker facilities on Egypt?s Mediterranean coast near Alexandria. It serves as a more important conduit for crude oil than the shipping lane through the Suez Canal. An interruption of the pipeline?s operations would be more damaging for crude oil transport than a temporary shutdown of the Suez Canal transport route.

In terms of traded oil flows, the Strait of Hormuz, through which 40 percent of all seaborne oil flows, is far more important for world oil supplies. The military has taken charge of the Canal Zone to guarantee the safety of shipping. About 4.5 percent of the world?s traded crude flows through the Suez Canal. However, the temporary closure of the Suez Canal would still constitute an extreme event.

What cannot be excluded if unrest spreads further in the region are the repercussions for oil production, transport and pricing policies. Export capacity could be affected, and possibly hoarding may begin in anticipation of rising prices. Here the reaction of Saudi Arabia will be critical. Oil could therefore prove a volatile hedge in the coming weeks. A price hike of nearly 10 percent in some oil benchmarks has already taken place over the past two weeks. Natural gas prices on most world markets are tied to oil and are thus gradually following suit.

Oil prices breached the US$100 threshold last week. The risk of disruption in the supply of oil may lead to a significant increase in prices. In the summer of 2008, oil prices had doubled from a year earlier, reaching a peak of US$148 a barrel. Only after the past fortnight?s events in Egypt have they again breached that symbolically important threshold.

Further spikes during 2010 in other agricultural commodity prices, especially food-sensitive ones, were also related to oil price increases: Over the 12-month period, the price of wheat rose 110 percent, soya beans 59 percent, corn 87 percent and sugar 22 percent.

Egypt is an important participant in the natural gas market, in particular as an exporter of liquefied natural gas (LNG). The Suez Canal has become increasingly important for LNG tankers. Fourteen percent of the global liquefied natural gas trade is shipped through the canal. Several large refineries are located around Suez, most of them foreign-owned. BG Group, the British oil and gas explorer which has two LNG trains near Alexandria, evacuated most of its staff during the past week. Norwegian oil company Statoil has halted drilling in Egypt for the time being.

There are signs emerging of slowing cargo operations at the Egyptian ports of Alexandria and Damietta. From a European perspective, Spain would be most vulnerable to an interruption of Egyptian transit operations because an estimated 10-15 percent of its liquefied natural gas imports come from Egypt.

In the financial sector, the most immediate concern is to halt an increasing capital flight. Approximately US$2.5 billion has left the country since the start of the uprising against the Mubarak regime. Banks closed when the protests intensified, but a few commercial lenders opened a week later on Sunday, February 6, and many rushed to withdraw individual and corporate deposits. What will happen when they all reopen? The lingering questions concern whether the central bank will subsequently impose some form of capital control.

International rating agency Moody?s cut the ratings of the five largest Egyptian banks (by assets) on Wednesday, February 2. After plunging 20 percent, the Cairo bourse was closed for a full 11 days.

A sensitive barometer for the medium-term economic consequences of the current situation and its potential risks is the exchange rate between the Egyptian pound and the US dollar. It reached a six-year low this past week. The central bank tried to intervene in currency markets to stabilize the Egyptian pound. Unofficially, the central bank maintains a currency peg to the dollar. But any sustained intervention by central bank authorities in Cairo would deplete its reserves (currently estimated at US$36 billion). Alternatively, it could allow a controlled depreciation of the currency.

In any case, the reaction of two constituencies will be crucial, one domestically, the other foreign. In the short term, Egyptians may prefer a switch to safe-haven currencies, in particular the Greenback, with knock-on effects of a further ?dollarization? of the domestic economy. Put otherwise, a bank run cannot be excluded, and the central bank may be fighting a losing battle by trying to stabilize the exchange rate. Avoiding a currency crisis and stemming a possible bank run will be high on the agenda of the central bank authorities in Cairo in the coming weeks.

Secondly, the reaction of international capital investors to the crisis in Egypt is crucial. Foreign investors own a fifth of the total treasury bill market and about 40 percent of the domestic bond market. They account for approximately 17 percent of the bourse?s turnover in Cairo. Foreign direct investment to Egypt reached US$6.6 billion in 2010. Approximately 75 percent of this total hails from the US and the European Union (in particular France, the UK and Germany). Tourism accounts for roughly 5 percent of annual economic output.

At present we know absolutely nothing – and they themselves may know very little – about what kind of economic reform agendas are on offer from the different groups, institutions and individuals that are more or less being termed the ?opposition? to the Mubarak regime. The new vice president, Omar Suleiman, who is still also head of military intelligence, has not spoken on economic matters. The various opposition groups offer no more clarification. The Muslim Brotherhood is strongly and credibly engaged in social, health and religious services. The same applies to the Islamic Action Front. Mohamed ElBaradei, the ex-diplomat and former head of the International Nuclear Energy Agency, has yet to make any statements addressing economic issues.

But whoever wins power in the coming weeks or months will need to formulate an urgent economic program. The window of opportunity that exists today until September 2011, when presidential and parliamentary elections are expected to take place, will need to be used fast and comprehensively by the different opposition groups – not least for the fact that foreign observers and investors will want to know what the opposition has to offer in terms of economic policy-making priorities.

Take a look at the magnitude of the challenge: According to the World Bank, Egypt ranks 137 in the world in per capita income, just behind Tonga, an archipelago in the South Pacific Ocean comprising 176 islands, and ahead of Kiribati in the central tropical Pacific Ocean. With a similarly sized population of about 80 million, Turkey has an economy that is nearly four times the size of Egypt?s.

Two-thirds of the Egyptian population is under the age of 30. This demographic?s future in terms of jobs, education, housing and food supplies will have to be addressed. Whoever ends up governing Egypt in the near future will need to identify a sustainable growth strategy at rates of at least 6-7 percent to create jobs for 650,000 new entrants to the labor market every year and to lift 40 percent of the population out of poverty.

The impact of the crisis on foreign companies operating in Egypt has to be taken into consideration. Foreign firms such as Heineken NV, Alcatel-Lucent SA, Danish shipping giant Moller-Maersk, French cement concern Lafarge SA, Coca-Cola and Germany?s Siemens all have major investments and a considerable number of foreign employees in the country. Electrolux put on hold its acquisition of Cairo-based Olympic Group, the region?s biggest home appliance maker.

Finally, the opposition will have to address and confront an institution that currently appears to be its most important ally: the largely secular military. Despite its crucial decision to side with the opposition and guarantee unprecedented street demonstrations, we should not lose sight of the fact that the Egyptian military is a crucial economic factor in the country. It operates in a quasi-parallel economy, with interests and business ventures ranging from electronics, household appliances and clothing to the food sector.

To illustrate, the Egyptian military has a wide commercial network, including military-owned companies in the water, olive oil, cement, construction, television, food products, hotel and gasoline industries. The military personal in charge of these enterprises are frequently retired former army generals. They have entrenched interests and deep loyalties and will not be easy to shift from their positions. It is possibly a sign of the opposition?s uncertainty and weakness that they have not (yet) dared to address these connections and interests. Otherwise, they may quickly find out that their presumed ally on the streets has formidable interests that it will defend tooth and nail once they are being challenged.

The current popularity of the military within the various opposition groups will not necessarily last. Securing a peaceful and democratic transition in Egypt will have to include, by design and in a transparent manner, the transition of the military itself. Next to its economic firepower, which will feature on the reform agenda, this endeavor also includes the manner in which it is being subsidized by Washington at an annual cost of US$1.6 billion.

In conclusion, whatever happens in the coming days, weeks and months on the streets, in the barracks, at cafes and on Facebook in Egypt will also be defined by the economic challenges that the country faces and which have to be addressed by the post-Mubarak authorities. Other countries are looking at Egypt with anticipation, hope, concern and confusion. They are doing so not least for the reason that a popular but untested opposition movement will need to formulate feasible economic alternatives to the corrupt, inefficient and discredited Mubarak regime.

* Jens Bastian is a visiting fellow for the political economy of Southeast Europe at St Antony?s College, Oxford, UK, and a senior economic research fellow at the Hellenic Foundation for European and Foreign Policy (ELIAMEP) in Athens.

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