Egypt’s Excellent Potential in Finance
With good policies, Egypt’s financial sector (8–10% of the economy) can grow fast and provide many skilled, lucrative jobs. Egypt has a diverse, medium-sized and high-potential economy, but needs to modernize its banking, modern finance and investment subsectors, while improving secondary school and university education and professional certification in finance.
Better knowledge of finance has many benefits. A business firm’s decisions, of assessing a specific project’s feasibility, choosing between projects, or investing its surplus assets, are pivotal. Capital budgeting tools allow the analysis of profits and risk, and good decision-making. This is especially important for banks in their credit evaluation process. Firms also need to decide on how to finance their operations via bonds or bank loans (debt), or stocks (equity), and how to combine both. The cost and structure of a firm’s capital and the risk/return tradeoff, outlined below, are important issues. Financial analysts and managers can also accurately interpret other firms’ financial statements and monitor their own firms’ performance. Lastly, consumers too can efficiently manage their budgets, main purchases like cars, homes and home electronics, and invest their savings and surplus wealth.
Finance Opportunities
There is much potential in finance. We start with Egypt’s modern banks, which are over-regulated and need to lend more and with greater efficiency to boost the national economy. Private bank deposits at USD 410 Billion and bank loans at about USD 190 Billion are low, partly due to a fairly common, mistaken view of bank interest as the Islam-forbidden usury (riba), but more importantly as bank interest rates rarely keep up with Egypt’s persistently high inflation, fostering destabilizing speculation in riskier assets such as real estate, the stock market and gold. Bank credit also tends to favour large firms over medium and small ones, hurting the economy as the latter are often more capable of higher profits, growth and job creation. Lastly, most Egyptian banks award loans based on the borrower’s loan collateral, rather than to projects with high expected profits and acceptable risks. This is partly due to bankruptcy laws making tax and social security claims senior to banks’ rights, causing heavy losses to banks and discouraging lending to high-profit but riskier projects.
Many of Egypt’s private firms currently lack qualified financial analysts and managers, or access to financial market funding. Overlooking the time value of money, whereby future projected cash flows are discounted according to their timing and the cost of capital, often leads to incorrect investment appraisal. A better grasp of tools such as computing a project’s Net Present Value (NPV) and Internal Rate of Return (IRR), is needed. Another key concept is the risk/return calculus, whereby higher return on investment correlates with higher risk and volatility. A third concept is the debt or equity financing trade-off. The former is riskier, and interest claims, followed by taxes, are senior to those of equity (owner) shareholders. Egyptian culture is typically conservative and risk-averse, but debt at safe, acceptable levels can boost the return on owners’ equity by distributing profit among a smaller equity pool, and lower the cost of capital, which however would rise again in case of excessive debt and risk.
Modern, non-traditional finance, especially insurance and real estate lending, lag in Egypt. The insurance market is over-restricted, and its importance often overlooked. At affordable costs, insurance provides high safety margins and protection against business bankruptcy and employee job loss, thereby allowing more economy-growing, job-creating business startups, investments and expansion. Insurance in Egypt faces two hurdles. One is a glaring shortage of qualified insurance analysts, (actuaries), of which many more are needed, while a fairly common, mistaken view persists of insurance as un-Islamic. Meanwhile, bank lending for homes is still relatively limited and mainly targets the high-profit, upmarket villas. In advanced and many developing countries worldwide, special home loans (mortgages), allow affordable and widespread home ownership, and thus serve society at large. A mortgage loan is a special, long-term loan by a bank to a home buyer. He/she has can live in the built home (loan collateral) right away in return for fully repaying the loan in installments with interest, then acquiring the home ownership title. Demand in Egypt is low. Clients lack awareness of mortgage loans, and a culturally ingrained and excessive fear of debt persists. Banks require high down payments and steep, 5, 7 or 10-year loan repayments at high annual interest rates (now 18%), mainly based on persistent and expected high inflation, and driven by poor macroeconomic policy and the high state budget deficit (6% of GDP), annual inflation rate (16.2%) and prime bank loan rate (16%).
Among major opportunities in Egypt, one is financial market investments and asset management. Egypt’s has many investment opportunities for Egyptian firms and retail investors given the right policies. Some firms have surplus capital and are willing to invest in high-promise firms with non-competing operations, which should be encouraged. Non-bank financial intermediaries, such as investment banks and asset management firms, are more limited in Egypt than banks, and need official policy support. Investment banks play an important role as intermediaries between issuers of securities and investors, in facilitating corporate mergers and acquisitions, and as securities brokers for institutional clients. Asset management firms also act as intermediaries between the securities issuers and investors, and have the financial expertise, resources and mandate to successfully undertake investments with higher risk/return profiles than those of commercial banks.
More options are needed to invest in mutual funds with varying levels of expected return and risk. In ascending order of risk/return, those include: 1) Safe and low-volatility securities combining cash deposits, Treasury bills, and government bonds, 2) Mixed funds of government bonds, investment-grade corporate bonds, and preferred stock, 3) Riskier funds of common stock funds, high-yield bonds, and commercial paper (a high risk/return, 3–6 months’ investment), and finally 4) Venture capital: money by wealthy investors to startup firms and small businesses with long-term growth potential. That would be a key source of funding for such firms, which usually lack access to bank loans. It has the highest risk/return profile, and typically gives investors a say in the firm’s management. Arabian Gulf country sovereign and investment funds, firms and wealthy individuals also have abundant surplus cash to invest in a variety of ways, which is a great opportunity for Egypt’s financial intermediaries and high-potential economy.
Attractive options exist for more investment: foreign direct (operating in Egypt), or equity portfolios. Many mutual stock funds from richer countries seek to globally diversify their assets. Egypt in 2004–08 was a lucrative, successful market for both types of investments, with reform needed to restore this success. Egypt must be visibly, ideologically and sustainably committed to market reform and investor-friendly policies, and to develop deeper and more liquid, domestic bank savings and financial markets. A final, high-profit financial sector growth area is business process outsourcing, as in the Philippines and India. Egypt has high potential for foreign firms operating in Arabic, English, in Egypt and fellow Arab and African countries, or large firms from all of them. The firms would outsource to their branches in Egypt, or qualified Egyptian firms, back-end processes such as accounting, payrolls, taxes, translation and software Arabization, and front-end processes such as customer contact centers in Arabic and English.
Reform
A good strategy is needed to fulfil Egypt’s potential. To start, banks operations merit consensus recognition as Islam-compliant. This would increase retail deposits at banks, which also need deregulation and more scope for lending. Regarding bank project appraisal, the Central Bank of Egypt should guide, support and encourage state-owned banks in particular to adopt profit-based lending. Seniority of banks’ rights in bankruptcy claims would encourage banks to lend more to riskier, high-profit projects. Good credit rating bureaus and various sectoral information and analysis available to credit officers can help them make better loan decisions. Finally, credible monetary policy, outlined below, would foster low, stable inflation and inflation expectations, boosting bank deposits and lending and curbing the destabilizing speculation in riskier assets noted above.
Modern finance needs policy support. Insurance as well merits consensus recognition as Islam-compliant by businesses and citizens. Firms would buy fire, property and business insurance policies, while more consumers could buy property insurance, choose from various life insurance policy options, and more confidently buy durables such as cars, new homes and home electronics. Meanwhile, supporting and encouraging retail investment, investment banks and asset management firms has five main advantages: 1) More options, suitable for diverse investors, 2) Fees and income for banks and other financial intermediaries, 3) Capital for firms and the state, 4) A deeper, healthier, more reliable and less risky stock market, and 5) A better balanced and more fairly-valued real estate market.
Regarding real estate, apartment purchases, especially by middle-income and young, first-time buyers, are rare. Special, 15, 20 or 30-year mortgage loans by banks merit support. Monetary policy is important for long-term mortgage market health, as rates need to be market-responsive, and mortgage lending is an interest rate-sensitive activity. A strong, credible and independent Central Bank (CBE)’s monetary policy would firmly target annual inflation at 3–5%, and set nationwide mortgage rates, at 10% for now to support the market, then every three months later on. Those would be at a flexible 1–3% above the CBE’s bank prime lending rate, and unified for 15, 20 and 30-year loans, so as to lighten the burden of repaying the latter two categories. Along with strict market oversight and smart regulation, this rate-setting flexibility would be a policy tool allowing the CBE to influence and balance the mortgage market, and either cut rates to spur lending or raise them to cool the market. As inflation and interest rates are kept sustainably low and steady, high inflation expectations will recede, which in turn will give banks crucial confidence to offer loans and buyers to borrow at the required lower rates.
Key mortgage market reforms also include targeting mortgage lending to incomes of $625–1,900/month, and apartment prices of $25,000–125,000, covering the middle income and above-medium-priced apartments. This is necessary at this stage, as lower-income buyers cannot afford the risk and onerous payments of mortgage loans, while high-income home buyers can afford to pay in cash or in installment plans to the real estate developer firms. Other reforms include streamlining the legal and regulatory framework, qualified mortgage loan officers and legal counsels, licensed by the Egyptian Banking Institute (EBI), which needs more policy support and funding, specialized mortgage banks with strict capital requirements and secure long-term funding, promotion and greater banking client awareness of mortgage lending, performing rigorous client income, asset and credit history checks, and strictly regulating lending to protect both responsible buyers and mortgage banks. Most important are strict loan-to-income ratio criteria, and mortgage insurance, which can protect many responsible but distressed borrowers.
To attract worldwide portfolio and foreign direct investments (such as factories), better-regulated financial markets and decisive anti-bureaucracy reforms, as enacted by China, are needed to benefit national businesses, foreign direct and portfolio investors alike. Training financial managers in key financial techniques would pay quick dividends, as would secondary schools and colleges teaching students how to manage personal finance including big-ticket purchase loans, and the three key concepts: 1) Time value of money, 2) Risk-return calculus, and 3) Debt-equity tradeoff. Lastly, a long-term commitment and partnership between the state, universities and the financial sector, is needed to educate numerous, qualified graduates in finance and professionally certified financial analysts and managers. It is a skilled, interesting and rewarding profession, with very favorable demand and supply dynamics in Egypt. Through wide-ranging banking and modern finance reforms, and good education, a larger, more dynamic and successful financial sector is achievable.
