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Macroeconomics under the microscope
Government policies will be a key to attracting investment and maintaining growth.
BY TAMER HAFEZ
Nearly a year ago, it was the bankruptcy of banks. Now that threat has shifted to sovereign states, such as Ireland, Greece, Portugal and Spain, investors are paying more attention to government policies and strategies.
Despite some flaws in Egypt’s economic strategy during the past five years, changes in policies and regulations – and the results – have been logical and predictable. While declining from the previous fiscal year, Egypt’s gross domestic product (GDP) growth of 4.7 percent in FY 2008-09 was within average of GDP growth rates from 1995 to 2006. Major contributors to GDP growth were manufacturing (16.3 percent), oil and gas (14.8 percent), and agriculture (14.3 percent).
At a time when assessing investment conditions in individual states is becoming more complicated, knowing a government’s investment priorities could be the simplest way to identify sustainable and profitable opportunities.
Go invest
Since its inception in 1972, the General Authority for Investment & Free Zones (GAFI) has been responsible for regulating and promoting investment throughout Egypt.
GAFI is focusing on industries that are labor intensive in addition to being geographically and socially diversified. The recently opened Red Sea-Aswan highway is a classic case of the type of investment GAFI is looking for,” says Siefallah Rabie, a GAFI economic researcher. The agency plans to open full-service branch offices around the country, with Upper Egypt a priority, and go online with some services. Cairo and Giza governorates account for 65 percent of the country’s investment capital and Upper Egypt as a whole just 5 percent.
Government expenditure will be the primary motivator of the economy for the near future, according to Rabie. As an example, Osama Saleh, head of GAFI, cites the Private Partnership Program, under which the government and private sector work together on large projects. The program “is very important to us because it will give potential investors a sense of security that the government is backing new investments,” Saleh says. “It will also make banks more comfortable giving loans to those private companies.” Projects will likely involve infrastructure, logistics and storage facilities.
Another priority will be sectors with significant potential, such as renewable energy. “The government has a plan that by 2020, investments in renewable energy projects will be comparable to oil and gas investments,” says Rabie. He also cites the engineering, electronics and semiconductor industries.
Investors have a choice of nine public free zones, 244 private free zones and 12 investment zones, all with infrastructure in place. “The investment zones are a new concept where an investment is surrounded by its feeding industries, facilitating transportation and logistics throughout the supply chain,” Rabie says. Saleh notes that “these zones enclose investments in industry, services, tourism [hotels, real estate] and trade. They provide new niche opportunities. They also are exempt from certain taxes, and there are no limits on size of capital or legal structure of the entity.”
In the free zones, there are 1,160 facilities representing a total of $14.1 billion in investments and annual exports of $6.7 billion in products and $5.1 billion in services. Only 8 percent of free zone space is unoccupied.
Made in Egypt
Branding Egypt as a manufacturer is becoming increasingly important for sustaining the nation’s economic model. The Industrial Development Authority (IDA) was formed in 2005 under the Ministry of Trade & Industry to oversee industrial infrastructure, approvals, land allocation and attracting investments, among other things.
“IDA is a facilitator,” says Ashraf Dowidar, head of the IDA’s central department for planning, marketing and information. “The marketing department offers sector research, market studies and customer service to show potential investors where opportunities lie, with whom they should partner, supply chain options and locations of facilities. We can even refer them to banks.”
The IDA is responsible for 120 industrial zones, 93 for light- and medium-scale and 27 for heavy industries. There are seven free zones, where companies pay no tax or customs on exported products. In addition, there are one private economic zone and one portside industrial zone in East Port Said. In 2006, the IDA started an Industrial Developer Program that allows specialized development companies to acquire entire zones, build infrastructure, and promote and sell them to investors. Badr Industrial City, Sadat City, Sixth of October City and 10th of Ramadan City are in the Industrial Developers Program. The first two phases of the program generated LE 30 billion in investments and infrastructure for 16 million square meters of land. Phase three was commissioned in March 2009 to provide 4.5 million square meters of infrastructure in the cities of Borg Al Arab, Sadat and 10th of Ramadan.
“Infrastructure in these zones is subsidized, as well as energy requirements for low and medium energy-consuming factories. High energy-consuming industries such as cement, steel, fertilizers and glass don’t get subsidies unless there is a strategic goal,” Dowidar says. The IDA also covers 90 percent of the cost of training workers and subsidizes 6 to 10 percent of the cost of goods exported to markets without trade agreements with Egypt.
The IDA focuses on the manufacturing of medical devices and car parts, as well as developing shipyards. “For medical devices, US investments are wanted to establish production facilities and share know-how,” Dowidar says. “The strength of Egypt is that it has physical as well as contractual access to European and Arab world markets, which makes it ideal as an export hub.” Agro-industry is also high on the agenda, with newly formed zones that combine agricultural land with processing and distribution facilities. (See cover story.)
Dowidar believes that as companies resume investing, desirable outsourcing locations will be crucial and “this will benefit Egypt greatly.”
ICT hub
The information and communication technology (ICT) sector is the proverbial cherry atop Egypt’s economic cake. In 2008, the ICT sector grew nearly 20 percent, and last year 14 percent, and its share of domestic capital doubled from 1 percent to 2 percent in 2009.
With the exception of mobile operators, the domestic market is largely overlooked by most ICT companies, and Egypt’s IT revenue model is based on international companies moving operations here to reduce expenses. The government entity responsible for developing the sector is the Information Technology Industry Development Authority (ITIDA), formed in 2004 by the Ministry of Communications & Information Technology.
Demand for offshoring “will continue to rise, even in a crisis,” says Amin Khaireldin, ITIDA strategy adviser and board member. In 2009, agreements were signed to upgrade two centers and establish seven. In addition, IBM and Stream each opened a center and Oracle established two, and Khaireldin notes that all four privately owned centers exceeded growth expectations for 2009.
Khaireldin says focusing on the value of doing business in Egypt is critical, noting that the country has the land, infrastructure and workforce to support continued growth. Egypt’s niche is “medium size service centers, with a maximum of 5,000 employees,” he says. “We offer multilingual options and we are in the same time zone as Europe and can serve them easily.” Nonetheless, Egyptian centers serving the US and Asia are not uncommon.
Centers with over-capacity – enough to meet forecast future demand – sometimes take a backseat to alternate approaches. Instead of one large center, for example, Oracle signed contracts for two medium-sized centers. But Khaireldin doesn’t see a trend: “There will always be demand for large and small centers in addition to medium-sized centers.” While China and India dominate the market for large call centers, companies shopping for medium-sized centers can also look at Egypt and eastern Europe. However, Khaireldin says costs are high and growth potential is low in eastern Europe.
This year marks the end of ITIDA’s first five-year plan and the start of a 10-year plan. While details have not been worked out, Khaireldin says the 10-year strategy will consist of an “aggressive growth plan... directed toward innovative services and moving higher up the value chain.” IT exports were LE 120 million in 2005 and more than LE 1.1 billion last year. “We have not yet calculated a target figure, but expect a big jump by 2020,” he says.
The offshoring market in Egypt consists of business process outsourcing (BPO) and information technology outsourcing (ITO), which have spawned customer and technical support centers. “For the future, we will focus on research and development as well as knowledge process outsourcing and Arabic content creation and management,” Khaireldin says. For ITO, the next step will be testing centers and remote infrastructure management centers, while BPO will focus on accounting, human resources and logistics centers.
Exported from Egypt
In the absence of an exclusive trade agreement with the US, working under the Qualifying Industrial Zones protocol is the only way to export to the US market outside its quota system. The protocol allows QIZ-certified products to enter the US with no custom duties under certain conditions.
The protocol stipulates that QIZ-certified factories – there are 20 so far – be located in Alexandria, 10th of Ramadan City, Al Mahala Al Kobra, Port Said, Minya or Beni Suef, or specified sites in Cairo. The protocol requires products to meet relevant US quality standards and include at least 10.5 percent Israeli content. Certification and auditing of factories, and management of QIZ parks is handled by the QIZ Unit within the Ministry of Trade & Industry.
The protocol was implemented in 2005 and now covers 750 factories, of which 260 are active. “Only 3 or 4 percent of these factories are foreign investments,” says Mohamed Ashour, head of the QIZ Unit. “The US only has trade offices in the QIZ. It would be more profitable for any importer in the US, paying a double digit [percentage] in customs, to come to Egypt and become QIZ [certified] and export to the US with zero customs.”
The textile industry dominates the QIZ. “We want something else,” says Ashour. “Appliances, and canned and dairy products are industries I believe will do very well if exported to the US market, especially as some of these products are charged 40 percent in customs if produced outside QIZ. Overall, we want labor-intensive industries.”
Ashour is particularly interested in the food-canning business: “It is a simple industry, and if 15 or 16 food-canning companies came from the US and invested in QIZ they would generate $4 billion to $5 billion annually.” Dairy and cheese production might also prove profitable in spite of dumping fees imposed by the US, Ashour explains. “US investors know the cheese and dairy production business well, and if it comes from QIZ this dumping fee will be revoked.”
He adds that the dominant textile industry still holds potential, as “we need US investors to introduce technology and design engineering know-how to produce high-end, high-profit products. It’s a win-win situation.”
Success of the QIZ protocol will largely depend on recovery in the US market. QIZ-certified companies can export to other countries, but some businessmen could abandon QIZ certification if exports to the US continue to decline and move to Europe where there is an exclusive trade agreement with Egypt. Says Ashfour: “We are already seeing a shift of exports to European countries. But I am sure that the importance of being QIZ-certified will not diminish even with the US market slowdown. QIZ is a guarantee to make money if an investor wants to go to the US market.”
Imports under fire
Customs fees on imported US products average 30 to 40 percent, says Gamal Abou-Ali, of Hassouna & Abou Ali Law Offices. “These figures will not affect the decision to import from the USA per se, though there are other considerations.”
These customs are governed by the General Agreement on Tariffs and Trade (GATT) and World Trade Organization (WTO) agreements, but there is no pact between the US and Egypt. Margaret Scobey, US ambassador to Egypt, was quoted in Al Masry Al Youm as saying there are no plans for a bilateral exclusive free trade agreement. Meanwhile, Egypt signed a trade agreement with the EU which will phase out customs and duties on EU products by 2019. “Businessmen will prefer to import products manufactured in the EU over those from the US,” says Abou-Ali.
The Customs Authority is preparing a new draft law that aims to “simplify and expedite procedures,” says Mohamed Naguib, head of the authority’s legal division. The People’s Assembly is expected to consider the proposal this summer and the changes could be implemented by the year’s end.
A major change in the law would be how the Customs Authority handles intellectual property rights violations. “The current legal IPR framework doesn’t give the Customs Authority much freedom or a fixed guideline on how to proceed if they discover an IPR violation,” says Naguib. “The new draft law will propose certain procedures so that we can initiate seizure and inspection of a shipment of fraudulent merchandise to confirm violation... We will also deal with the huge fee IPR owners have to pay [the Customs Authority] to file a complaint.”
Legal structures
“Investors view the legal system as a liability when it comes to assessing investment opportunities,” says Bahieldin El Ibrachy of the law firm Ibrachy & Dermarkar. The firm represented Lafarge in its $15 billion acquisition of Orascom Construction’s cement operation and H.J. Heinz Co. in its purchase of 49 percent of Cairo Food Industries from the Americana Group.
Legally, a foreign investor can own 100 percent of a production facility in Egypt. But if the entity acts as an agent or imports for the purpose of trade, then there has to be an Egyptian partner. In terms of workforce, any domestically operating entity must follow the 10:90 and 20:80 rules. The 10:90 rule mandates that non-nationals cannot be more than 10 percent of a company’s workforce; the 20:80 rule requires that total non-national compensation not exceed 20 percent of payroll. “These are not appalling conditions,” says Ibrachy. “Labor in Egypt is cheap and trainable – if not necessarily trained. It is pointless for an investor to employ 100 percent expats and not use the cheaper Egyptian workforce.”
Egypt’s judiciary is a nagging issue with foreign investors, according to Ibrachy. “The domestic judiciary is not as advanced as the systems in more advanced countries, but has kept Egypt in a good position among developing countries,” he says. Economic courts, formed in 2007, were an attempt to create a more specialized regulatory framework in which companies operating in Egypt could settle disputes. “These courts are still new, so their strength, effectiveness and efficiency... are still not proven. But they are a definite step forward,” Ibrachy says.
Business entities generally deal with three courts: administrative, for government-related cases; labor; and economic. International arbitration is used in contractual disputes with foreign partners. “It is expensive... and to execute the decision of the international arbitration court, there has to be approval from the courts of the country in which the entity operates,” says Ibrachy.
Improving the judiciary in Egypt is essentially a policy and political issue, according to Ibrachy, but the problems are not insurmountable. He says better training for judges, more transparency and greater research capabilities are necessary. Nonetheless, “there has been an ongoing development in the process of administration of justice as well as a dramatic improvement in the sophistication of laws dealing with investors,” he says.
A new tax era
With taxes set at 20 percent, “taxes and the tax system are not a primary concern for foreign investors. They hire a good adviser and auditor, and go on with their core business,” says Abdallah El Adly, a tax services partner at PricewaterhouseCoopers.
The tax system was last overhauled in 2004 after the appointment of Youssef Boutros-Ghali as minister of finance. Since then, corporate and personal income tax rates have gone from 42 percent to 20 percent and Tax Authority audit procedures have been overhauled. “Previously, 30 percent of Tax Authority income came from initial reports, the rest from auditing discrepancies,” says El Adly. “Now, 80 percent of income comes from initial reports, the rest from auditing disputes. This is a very healthy sign.”
More changes are being considered, including transfer pricing, permanent establishment laws, small and medium enterprise taxation based on invested capital, and replacing the sales tax with a value added tax. “The changes aim to replicate international laws – the majority of changes are adopted from the British tax system,” El Adly says.
The Tax Authority also is undergoing operational changes, according to Ashraf El Araby, head of the authority. “Previously, suppliers could deal directly with the domestic and international tax authorities. Now they will deal directly with us, and then we will communicate directly with other tax authorities overseas. This will ensure a more efficient tax operating procedure,” he says.
El Adly believes the Egyptian system has a lot to offer. “Regionally, other countries, such as Lebanon, might have lower taxes,” he says, “but Egypt’s strength lies in the way it manages the implementation process. That said, South Africa is ahead of us in that respect.” Meanwhile, free zone areas belonging to GAFI or the IDA exempt factories that export more than 50 percent of their output from taxes and customs altogether.
An era of corporate economies has begun, and for emerging markets such as Egypt, the way forward is simple: strike a regulatory balance that will promote fairness and stability, and create a free market-oriented environment with solid investment opportunities.
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