The political transition ushered in by the overthrow of President Mubarak in February 2011 continues. The transition has not only been long, but bumpy: social, sectarian and judicial tensions have increased, the economy has stalled, security has worsened. The new equilibrium will only come into sight once a fresh constitution is drafted and parliamentary elections are held, most likely some time in 2013. With the country so polarised both events could cause significant unrest. If the transition falters, a crisis could result.

Egypt has several attractions for investors and exporters – a large domestic market, high potential economic growth, significant natural resources; and an advantageous location – close to Europe, Africa and the Gulf.

Political uncertainty has hurt growth and investor confidence. External and fiscal deficits raise the risk of currency, balance of payments and sovereign debt crises, particularly in the event of further political shocks, or an early termination of the IMF program. Some Mubarak-era contracts are at risk of being revised or cancelled.

Despite all the political instability, economic prospects have improved over the past few months. A US$4.8b IMF loan, agreed in November 2012, combined with substantial financial support from other multilateral and bilateral partners, will lower financing strains and the risk of a disorderly devaluation of the pound.  By providing an anchor for economic policies the IMF program will hopefully boost business confidence and crowd in private capital, which has largely deserted the country since the political transition began. 

However, large risks remain. The lengthy political transition has left Egypt with much reduced economic buffers if the transition stalls or if the IMF program is terminated.  FX reserves have slumped to below 3 months of imports, the fiscal deficit is 11% of GDP, and growth has slowed to a crawl.  Moreover, attempts to rein in the fiscal deficit and boost private investment will have to be carefully balanced against popular demands for ‘social justice’ and income re-distribution.

The economy has weakened sharply since the start of the political transition. Over the 18 months to June 2012, GDP grew by just 2% pa, and unemployment increased from 9% to 12½% ― though unofficial estimates are much higher. Investment has been weak as businesses have put plans on hold, and in some cases withdrawn capital, while exports and Suez canal dues have been hurt by downturn in the EU. Growth is expected to accelerate in 2013 and 2014, but this requires political stability. Egypt is very sensitive to weak growth, because per capita income is low, the labour force is expanding rapidly, and the budget deficit is large.

Most industries slumped sharply during Mubarak’s overthrow. The subsequent recovery has been tepid, held back by political uncertainty, security problems and regional economic weakness. Tourism arrivals are still 25% below previous peaks due to the downturn in the EU and persistent fears about domestic security.  Meanwhile, industrial production rebounded quickly through 2011, but has eased through 2012 as labour unrest and weak export markets discouraged production.

Investors withdrew large amounts of capital from Egypt in response to the political turmoil, slump in growth, and uncertain investment climate. All up, net capital outflows were US$20 billion from March 2011 to June 2012.  To offset the outflow, the central bank has run down its reserves rather than allowing a sharp fall in the pound. The fears that this would end in a balance of payments crisis have faded in recent months, as multilateral and bilateral partners begin to fill financing gaps. Egypt has been offered US$14.5b on favourable terms from its bilateral and multilaterals partners. FX reserves have stabilised at around US$15b, or 2½ months’ imports.

The budget deficit for FY2011-12 was 11% of GDP, and public debt-GDP ratio 83% – both extremely high. Under its IMF program, the government will try to put the budget on a more sustainable footing by curtailing subsidies – 25% of total expenditure – and by reforming sales and income taxes. Effective communication will be vital if these reforms are to be implemented. Economic reforms are viewed with suspicion by many, as reforms to liberalise the economy during the Mubarak-era chiefly benefited the elite.  Ratings agencies have downgraded Egypt’s foreign debt over the last two years to well below investment grade ― Standard & Poor's to B, Fitch to B+, Moody's to B2. All agencies have negative outlooks.

The political transition, which started in February 2011, has three more steps to go:  a new constitution, a referendum on the constitution, and finally parliamentary elections. If all goes to plan, the parliamentary elections will be held in first half of 2013. Following the overthrow of Mubarak in February 2011, there was a year and a half of rule by an interim military council, until the Muslim Brotherhood’s Mohamed Morsi – elected as President in May 2012 – assumed legislative and executive authority in August.

Over the next year, the drafting of the new constitution and the consolidation of power around President Morsi will be watched closely.

• The constitution will determine the relative powers of president, legislature and judiciary. Achieving broad agreement on such a document will be difficult.  Secularists and Coptic Christians have already withdrawn from the constituent assembly tasked with writing the new constitution arguing that the process has been dominated by Islamists. Hardline Islamists have also criticised the document, though for different reasons. 
• On November 23, President Morsi issued a constitutional declaration excluding all presidential decisions from judicial review, and ruled that the courts cannot dissolve the constituent assembly. Some have viewed the declaration as an attempt by the President to ensure the political transition does not become bogged down in the courts.  However, such sweeping powers also create uncertainty around the Muslim Brotherhood’s political objectives and the status of Egypt’s state institutions. The Constitutional Court was to have ruled on the legality of the constituent assembly in early December. 

The World Bank ranked Egypt in the bottom quartile of countries for political stability and voice & accountability – below the regional average.

Many investors have withdrawn capital from Egypt or put investments on hold until the composition of the post-election government is known. Adding to investors’ jitters is the fact that firms seen to have benefited from the Mubarak regime ― notably in the steel, garments, tourism and property industries ― risk having their contracts revised or assets revoked.  Labour unrest has become more common.  Workers are pushing for higher wages, better working conditions and in some cases the reversal of past privatisations.

Before the political turmoil, Egypt ranked middle of the road for regulatory quality, rule of law, and control of corruption. On another World Bank gauge – ease of doing business, which attempts to measure ‘regulation and red tape relevant to a domestic small to medium-size firm’ – Egypt ranks 109 out of 183 countries.

Egypt is the most populous Arabic-speaking country, with over 80 million people. Poverty is pervasive ― 40% of Egyptians living on or below US$2 a day.  One factor behind Mubarak’s overthrow appears to have been rising income inequality.

Per capita income has risen from 2004 to 2011, but the gains have been unequally shared and per capita income remains well below the regional average.  Unemployment remains high and double-digit inflation is eroding household incomes.  In fact, some estimates suggest that the number of extreme poor has risen since 2004.

Security is an issue.

• Crime has risen. In part this reflects the fact that the police force suffers a credibility problem because of its previous close alignment with the Mubarak regime. 
• Foreign embassies rate the risk of a terrorist attack as high. The Sinai Peninsula seems particularly troubled, although the terrorist threat is also prevalent throughout the rest of the country.  In October 2012, the government announced that planned terrorist attacks in Cairo had been foiled.  
• Protests in Cairo and elsewhere occur regularly.  On occasion, turning violent.  The finalisation of the new constitution and election of parliament are flashpoints. 
• Sectarian tensions between Coptic Christians (9% of the population) and Muslim hardliners have increased. In January 2011 a bomb exploded outside a Coptic church in Alexandria.  In October 2011, clashes between security forces and Copts protesting over the burning of a church – the third since the fall of Mubarak ― left 25 dead.  

*All 2011 figures unless specified

**The HDI is composite measure of human development: long & healthy life (life expectancy), education (literacy & education enrolment) and income (GDP per capita)

***Expressed as % of GDP unless specified