Strategy Note /

Egypt priced for distress: Too harsh but don't expect the army to drive reform

  • Valuation distressed but default unlikely: EGX30 PE 50% below 5- and 10-yr medians but FX reserves 2x s/t external debt

  • Inertia: fiscal cuts and military mega projects are no substitute for capex that drives manufacturing exports and jobs

  • Prevailing valuations are enticing, and tourism and IMF and GCC support are helpful s/t, but deep reform a forlorn hope

Egypt priced for distress: Too harsh but don't expect the army to drive reform
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
26 July 2022
Published byTellimer Research

This week, Egypt marked the 70th anniversary of the revolution that overthrew King Farouk and led to the founding of the modern republic. Many of the policies of the early years – anti-colonialism, non-alignment and hostility towards Israel in foreign policy, and socialism and state planning in economic policy – have been reversed or become obsolete. Whatever the policy, the key support for implementing it has always been from the military.

The first part of this report lays out the case that the position currently enjoyed by the military in politics and the economy is perhaps its strongest since the inception of the republic.

As before, the influence of the military over economic policy (maintaining orthodoxy) and foreign policy (keeping Egypt onside with critical geopolitical allies) should be sufficient to navigate out of the current crisis.

The second part of this report reviews how recovery from a crisis has been a powerful equity market driver in the past and how this entails an opportunity at current distressed market valuations.

But, again as before, the vested commercial interests of the military are likely too entrenched to allow the structural economic reforms – specifically, the levelling of the playing field between military-affiliated enterprises and the private sector – needed to unleash long-term growth.

This third part of this report considers the longer-term trend in a number of factors: gas exports, education, twin deficits, government debt, external debt, youth unemployment, investment, manufacturing exports and water stress. The picture that emerges of the track record on structural reform is grim.

1) The strongest military since the 1952 revolution

The military is arguably enjoying its strongest domestic position since the revolution – this is not the same as arguing that Sisi is the most powerful President in the republic's history.

Putting the effective dismantling of both the National Democratic Party and the oligarchic circle of Hosni Mubarak (post-2011), as well as the Muslim Brotherhood (post-2013), to one side, consider the following legal changes, which make the current military leadership more powerful politically and economically than their predecessors.


  • Under the 2013 Constitution, the military is stronger relative to the President today compared with prior iterations of the Egyptian government:

    • The Minister of Defence is appointed by the President but must be from the Army, a serving General for at least five years (which prevents the promotion of a dissenting colonel who is loyal to the President) and the appointment, until 2022, requires the approval of the Supreme Council of the Armed Forces (SCAF).

    • Egyptian soldiers now pledge loyalty to the Republic, not the President, and are not permitted to vote in elections (the implementation of a 2013 Supreme Constitutional Court ruling allowing soldiers to vote has been delayed until 2020, thereby preventing their politicisation).

    • The SCAF has been enlarged and requires a quorum to meet (inhibiting any attempt by the President to exploit a dissenting minority faction).

    • The SCAF does not need the President’s approval to take decisions on national security, the military budget or military courts.

    • Sisi, as Presidential candidate in 2014, had to resign from the Army (unlike predecessors Nasser, Sadat and Mubarak) before announcing his candidacy. There is little prospect of a political challenge to the military's political authority from either a large civilian political party or well-defined, distinct support base organised around President Sisi – the bloc supporting him in both houses of parliament numbers c50% but is composed of a disparate group of politicians, unified by their support of the status quo more than belief in a charismatic leader or shared ideology.

  • The 2013 Protest Law requires advance notification to stage a protest and allows the Ministry of Interior to cancel it. Spontaneous, grass-roots protests are even more difficult than prior to the 2011 revolution against Mubarak or before the 2013 removal of Morsi.


  • The 2018 Contracting Law allows military companies exemption from oversight and public bidding to "protect national security", an important change in an era of mega projects like the Suez Canal expansion and the new city development, eg the new capital.

  • The 2018 Egypt Fund Law establishes a sovereign wealth fund and allows the President to transfer any unexploited asset of the state to the fund (with no right for citizen appeal).

  • The 2020 Egypt Fund (sovereign wealth fund) and National Service Projects Organisation (NSPO, one part of the Ministry of Defence commercial complex) agreement is likely a prelude to IPOs of NSPO affiliates.

Egypt formal military spending burden is down but military-affiliated commercial enterprises likely remain dominant

Third-party analysis is available on the Egypt military's commercial interests, from Carnegie Middle East Center (2019), and on the need for a much better environment for the private sector, from the World Bank (2020).

Back in 2017, similar to now, the IMF was talking about structural reform beyond macroeconomic stabilisation – inflation control, fiscal consolidation and FX rate flexibility. Note this comment from the IMF's 26 September 2017 review report, “To support private sector development, it will also be important to limit involvement by entities under the Ministry of Defence in commerce”.

The Egypt Fund Law and the NSPO agreement described above establish a path to privatisation but how attractive are military-affiliated companies, which have benefited from an uneven playing field, and likely remain beholden to a dominant shareholder, to minority investors, particularly those with an ESG filter, remains to be seen.

Furthermore, if much of the pledged investment from GCC sovereign wealth ends up in privatised military-affiliated companies, that will boost FDI statistics but it is unlikely to structurally reform these companies or the sectors in which they operate.

2) A crisis recovery investment thesis

The current factors driving Egyptian equities to their cheapest valuation in at least a decade, measured by forward PE, are largely global – US rate hikes and tighter global liquidity, the global growth slowdown and reduced risk appetite, and high commodity food prices.

Egypt, for over two decades, has been an equity market driven, in its best performing years, by bouts of hope for structural reform (eg 2005-08 or 2017-18) or recovery from a crisis (eg 2013-14).

Egypt equities story: recovery from crisis and reform hope

Although the margin for error is slim, Egypt should have sufficient orthodoxy in its interest rate, fiscal and FX policies, as well as sufficient support from the IMF and the GCC, to recover from the current crisis. Foreign reserves are approximately double short-term external debt.

That may be enough for investors in Egypt's eurobonds. And it may sustain the equity story for a while; at least enough to close some of the 50% discount to 5-year median PE or 40% discount to 5-year median PB.

Egypt equity index on 5x PE: 50% below 5y and 10y medians

3) Not a structural reform investment thesis

For long-term investors in Egypt, beyond the recovery from crisis trade, there needs to be a credible thesis for growth. That is where structural reform comes in – changes that encourage investment, raise productivity, and create jobs, consumption power and exports, as opposed to fiscal consolidation or mega construction projects with uncertain long-term benefits.

I remember writing, in 2017, about the potential for the combination of the Industrial Licensing, Investment and Tax laws to unlock the potential of low-cost, logistically well positioned and EU tariff-friendly manufacturing exports in Egypt, particularly in the Suez Canal Zone.

There is little evidence that these reforms have paid off – the domestic and foreign private sector is not being enticed into sectors that might support the manufacturing export sector, unlike the oil & gas or real estate sectors. And the potential export benefit of the cheap currency, following the Q4 16 devaluation appears to have been wasted.

Egypt real effective exchange rate 5% above 10year median

Most variables paint a grim structural picture

Success on gas and education

Two unequivocal positives, in terms of structural change in Egypt, are:

  1. The shift back to a net export position in natural gas; and

  2. Increasing education levels.

Egypt's primary energy mix is 60% gas; it now net exports

Egypt education penetration up, particularly after 2011

Mixed progress on twin deficits, debt, youth unemployment

After 2016, there has been an improvement in the twin deficits, particularly on the fiscal side, and gross government debt. But Covid and the higher food prices have stalled this trend.

Egypt twin deficit cuts at risk from Covid and imported food

Egypt fiscal cuts reined in government debt after 2016

External debt has risen substantially in the Sisi era, doubling from 15% of GDP to over 30%.

Egypt external debt more than doubled under Sisi leadership

The youth unemployment statistic has improved, dropping from 35% in 2013, to 17% in 2021. However, youth labour force participation has also dropped in the same period, from 34% to 23%.

Egypt's youth unemployment down but participation is too

Little progress on investment and manufacturing export intensity

The era, under President Mubarak and Prime Minister Nazif, from 2004 to 2008, when Egypt introduced market reforms, reduced non-tariff trade barriers, reformed the tax system and deepened the financial sector, sparked a boom in capital expenditure from both local and foreign investors.

Since that burst, the capex intensity of the Egyptian economy has declined, albeit with a bounce in 2017-19, driven mainly by the oil & gas and real estate sectors.

Egypt investment intensity is far below PM Nazif reform era

There has been very little progress in the contribution of manufacturing exports to the economy. Gross manufacturing exports as a share of GDP are down from a decade ago.

And, while net manufacturing exports (gross exports minus gross imports) have improved slightly, they remain negative.

In 2021, Egypt's net manufacturing exports were around negative 5% of GDP, compared with positive 6-7% for the emerging market manufacturing leaders, China and Vietnam.

Egypt manufacturing export intensity is stagnant

Water remains an acute long-term vulnerability

There has been no arrest in the increasing levels of water stress in Egypt. This issue is likely to worsen the more that Ethiopia fills up the Grand Ethiopian Renaissance Dam (GERD). This has already caused considerable friction between Egypt and Ethiopia but, de facto, the goal posts for negotiation are being moved as GERD fills up.

For all of Egypt's geopolitical importance, to the US, Israel and the GCC, it has not leveraged this into a decisive change in relations with Ethiopia.

Egypt's acute water stress: hence Ethiopia friction over Nile

The silver lining for the Egyptian military is that nothing builds popular support more than a genuine, external national security threat, which is, long term, what the loss of control of Nile water flow amounts to.