52605 FAST TRACKBRIEF JUNE 20, 2008 Based on the IEG report Egypt Country Assistance Evaluation, To: Robert Zoellick Fiscal 1999-2007, which will be From: Vinod Thomas, DGE presented to CODE on July 14, cc: MDs, VPs, EDs 2008. Egypt: Country Assistance Evaluation Between fiscal 1999 and fiscal 2007, the period under review in this CAE, Egypt's economic performance improved substantially, particularly after 2004, following improvements in economic management, structural reforms, and correction of the exchange rate. The GDP growth rate averaged about 5 percent per year over this period, rising to almost 7 percent in 2006 and 2007, translating into a per capita income growth of almost 3 percent per year, a strong performance. The Bank's financial assistance to Egypt has been modest (providing only about 4 percent of total official development assistance) compared to that of other donors, particularly USAID. From FY99 to FY07, IDA/IBRD commitments amounted to $2.1 billion for 18 investment credits and one policy-based loan. The country graduated from IDA in June 1999. The Bank's assistance program largely met its objectives and contributed significantly to policy and institutional changes, especially in the financial sector, privatization, pension system, and private sector development. For three decades the Bank has been Egypt's principal development partner in irrigation and water management and the largely renewed irrigation system has contributed to recent increases in agriculture productivity and exports. Bank efforts in rural finance have been less successful. The Bank has also contributed to improvements in Egypt's human development indicators, although large income disparities persist between Lower and Upper Egypt. Future Bank strategy should reflect Egypt's middle-income status by including a flexible lending program and an emphasis on knowledge services, including reimbursable technical assistance. The Bank can further strengthen the recent successful partnership by: (i) identifying direct and indirect interventions that could help reduce income disparities through improving the targeting of social safety nets; (ii) focusing analytic work on macroeconomic analysis and income disparities, and improving its dissemination; (iii) pursuing further financial sector reforms and promoting reforms that indirectly combat corruption (public financial management, simplification of taxation and business procedures, and an information act); and (iv) emphasizing sectoral strategies and policy and institutional reforms in infrastructure and energy. Background 97 percent of the population lives in the narrow strip of the highly fertile Nile valley and its delta, and population Egypt is a country of over 74 million people and a per density in these areas is high. There are major differences in capita income of $1,580 (as of 2006), occupying a crucial poverty and inequality across regions in Egypt, with the position in the geopolitics of the Middle East. Less than highest poverty in Upper Egypt (south), both rural and 5 percent of Egypt's total land area is cultivated, the urban, and lowest in metropolitan areas and Lower Egypt remainder being uninhabitable desert. Thus, more than (north). Social equity and political stability have been Task Manager: Ismail Arslan (202) 473-3982 Director, IEGWB: Cheryl Gray (202) 473-9188 continuing concerns, reflected in the allocation of The late addition of a large airports development project in significant public resources to social spending. FY04, not foreseen in the CAS, changed the dynamic, and combined with a new reform-oriented government, the Prior to the period under review, Egypt had begun a Bank's assistance began to ramp up. The Bank provided key program of stabilization and structural reform, supported analytic work in poverty, investment climate, financial sector, by donors. The combination of fiscal discipline, exchange energy, and environment, partly through a new instrument, rate and modest trade reforms, some price liberalization, reimbursable technical assistance, and established fruitful and selected privatizations yielded results: inflation came policy dialogue in a number of key ministries. The Bank made down from over 20 percent in 1991 to below 10 percent in a large development policy loan in support of wide-ranging 1995, while GDP growth rose from the stagnation of the financial sector reforms. The quality of the Bank's portfolio early 1990s to 4.7 percent in 1995. In addition, partly as a improved dramatically, with a reduction in the portfolio at result of the 1991 Paris Club agreement on external debt risk and an improvement in disbursement rates. Over the restructuring, the debt was reduced from very high levels CAE period, the IFC was active, with loans and investments (Egypt was one of the most heavily indebted countries in totaling $842 million across a diversified portfolio, and the world in the late 1980s) to a modest 60 percent of GDP delivery of advisory services totaling $12 million. by 1995. In 1996, the government further deepened earlier reforms. Although fiscal deficits began to increase again, Findings of the Evaluation private investment grew to almost 13 percent of GDP in 1998 compared to less than 10 percent in the early 1990s; Under the first pillar, promotion of higher, more sustainable growth growth was 5.3 percent per annum between 1995 and 2000; through structural reforms, outcomes of the CAS objectives and inflation continued to decline to less than 4 percent by were uneven, slower to materialize in the first part of the 1998. Thus, at the beginning of the period under review, period, but good in the latter period. Between 1999 and Egypt had been undergoing a series of economic reforms 2003, economic growth slowed, averaging only around that had yielded positive results. 3.2 percent per annum, accompanied by a decrease in both private and public investment. Fiscal deficits increased again after 1998, driven initially by declining public Bank Assistance revenues rather than rising public expenditures, which During the CAE period, Bank assistance to Egypt was remained stable. Capital expenditures declined, but public guided by three Country Assistance Strategies (CASs) in debt reached 80 percent of GDP and inflation surged to 1997, 2001, and 2005. Their dominant and consistent 8 percent in 2004. During this period, the exchange rate themes were: (i) promoting higher, more sustainable appreciated significantly, ad hoc controls were being economic growth through structural reforms; implemented in the trade regime, and public banks were (ii) development of water resources, infrastructure and the effectively bankrupt due large nonperforming loans. environment; (iii) development of human resources and poverty reduction. The focus of the CASs was relevant and The reformist government that took office in June 2004 set a consistent with the key development objectives of the major agenda for structural reforms including (i) simplifying government, but both the 1997 and 2001 CASs were overly the trade regime and reducing trade tariffs; (ii) improving optimistic about the amounts and focus of Bank lending exchange rate management and floating the currency; (iii) that could be put in place and the government's willingness reducing tax rates and simplifying the tax structure; (iv) to use policy-based lending. Although governance was not accelerating privatization; (v) limiting regulatory impediments an explicit objective of the Bank's strategy and program, to business entry and licensing; (v) streamlining cash and the Bank was able to find an entry point through the debt management; and (vi) partially adjusting energy prices. Investment Climate Assessments to provide input into Bank support for these reforms was primarily through anticorruption efforts. economic and sector work and reimbursable and other technical assistance, rather than through lending. From FY99 to FY07, IDA/IBRD approved $2.1 billion for 18 investment credits and one adjustment loan. This was The economy responded positively to the reforms. modest relative to official aid flows, representing only about 4 Economic growth accelerated from 4.5 percent in 2005 to percent of total (between FY99 and FY05, the latest year for 6.8 percent in 2006, largely driven by expansion of private which data are available on official aid). For almost four years investment and aided by a favorable external environment. following Egypt's graduation from IDA in 1999, the Exports and imports increased rapidly in 2005 and 2006, government was reluctant to borrow significant amounts on and foreign direct investment surged to 5.7 percent of IBRD terms, and lending declined to about $30 million/year. GDP. Private investment increased from 8 percent in 2003 During this period, the Bank focused on economic and sector to 11 percent in 2006 and Egypt's stock market was the work and cleaning up the problem projects in the portfolio. strongest performer in the region in 2006. The Bank's 2008 Task Manager: Ismail Arslan (202) 473-3982 Director, IEGWB: Cheryl Gray (202) 473-9188 Doing Business Report puts Egypt at the top of the "most investments helped bring about a fundamental change in improved business climate" list of countries. Privatization Bank-Egypt relations, and was followed by another large in 2005/06 exceeded expectations, and fiscal reforms loan ($270 million) to the power sector in FY06. The Bank progressed well, but primary and overall budget deficits produced a number of analytic and policy-oriented notes in remained high. Inflation was contained to single digits, energy, urban transport, railways, telecommunications, and except for fluctuations in 2006 and early 2007. information technology. Airport capacity, as a result of the Nevertheless, inflationary pressures from strong domestic Bank project, has been significantly increased, thus demand and rising world food prices persist. Employment reducing a potential barrier to tourism. In the energy sector, grew 4.6 percent per year between 1998 and 2006, more installed power generation capacity increased and chronic than the labor force (3.9 percent), leading to a decline in shortages were avoided. Energy reforms are underway, the unemployment rate from 11.7 percent in 1998 to about including unbundling and some regulatory strengthening, 8 percent in 2006. An ambitious financial sector reform although a large agenda remains. Despite recent program was undertaken, supported by the Bank with a adjustments, energy prices remain heavily subsidized. The development policy loan of $500 million in 2006 (which telecommunications sector has been liberalized, allowing mobilized a total of $2.2 billion, including other donors), private mobile operators and expanding telephone service based on a Bank-IMF financial sector assessment. The dramatically. In environment, the Bank had a small lending outcome of the first pillar of Bank assistance--promoting program of two loans and carried out several studies; since higher, more sustainable growth through structural 2005, air and water quality indicators have started to reforms--is rated as moderately satisfactory. improve. Outcomes of Bank assistance for this second pillar are rated satisfactory. Under the second pillar, development of water resources, infrastructure and environment, progress was good. The Bank For the third pillar, development of human resources and poverty has been Egypt's principal partner for three decades in reduction, the Bank's assistance strategy was less effective in irrigation, pumping and drainage, and community-based helping Egypt in implementing a broad range of social rural development, and Bank-financed projects account for programs. Outcomes are rated as moderately satisfactory, the renewal and improvement of a large proportion of although in the area of gender, disparities have been Egypt's water infrastructure. The Bank has generally been reduced substantially in education and health during the effective in strengthening institutions in Egypt's water review period. The Bank's inputs contributed significantly resources sector, specifically the Egyptian Public Authority to the present strength of the National Council of Women, for Agricultural Drainage Projects. The Bank has been less a focal point of government's gender efforts. Overall, Bank successful with efforts to build institutional capacity at the gender work in Egypt has been a pioneer and a model for Mechanical and Electrical Department of the Ministry of the MENA region. Water Resources and Irrigation. It has been instrumental in establishing water users association and their effective Education indicators improved over the period under involvement in water resources management. The Bank review. Compulsory education was lengthened from eight also played a significant role in helping the government to to nine years; net enrollment ratios in primary education implement its Integrated Water Resources Plan. As a result increased by about 9 percent for both boys and girls, to of this long-term engagement, agricultural sector growth 100 percent and 97 percent, respectively. Those in and export performances were impressive during the preparatory increased much more, 21-22 percent each, to review period. There was no progress, however, in reducing 84 percent for boys and 82 percent for girls. Thus Egypt disparities in living standards between Upper and Lower made good progress on reducing or eliminating remaining Egypt, even though the Bank's two rural development problems of access to basic education. Secondary projects (Matruh and Sohag) contributed to living standard enrollments increased faster, from 2.7 million to improvements in project areas. 3.2 million, or by 17 percent. The enrollment rate in secondary education rose from 33 percent to 39 percent. The Bank was absent from the main infrastructure sectors, transport and energy in particular, from FY99 until FY04. While Egypt has achieved considerable progress on But the Bank responded quickly to a government request indicators in health, nutrition and population, the Bank's for an Airports Development Project (FY04, $335 million), contribution to this has been modest, as Egypt did not preparing, approving, and declaring the project effective borrow from the Bank in this area after it graduated from within nine months. While the strategic relevance of Bank IDA. Nevertheless, the Bank financed both targeted funding of airports development in Egypt can be interventions--national schistosomiasis control (FY92); questioned on the grounds that the link to poverty population in Upper Egypt (FY96); and an innovative reduction is not immediate, the Bank's role in these Health Sector Reform Program (HSRP, FY98)-- Task Manager: Ismail Arslan (202) 473-3982 Director, IEGWB: Cheryl Gray (202) 473-9188 implemented during the review period with good work on poverty and was pro-active in improving the outcomes, and provided a series of policy notes on health performance of its portfolio. It also carried out other good- issues. The government has now requested support from quality analytic work in many sectors, and produced a series the Bank for health insurance reform. of timely policy notes. The Bank was responsive to the government's request for a rapid appraisal and approval of Egypt made some progress in poverty reduction during the an airport development project that had not been part of review period, but this has been disappointing overall. The the Bank's strategy. This responsiveness, combined with a poverty headcount fell from 19.4 percent (1996) to buildup of technical expertise in the Cairo office and the 16.7 percent in 2000, but following a period of slower ability to harness knowledge from around the world on a economic growth, by 2005, it had risen to 19.6 percent wide range of issues of interest to the new reform-minded again. With high GDP growth in 2005 through 2007, it is government, brought about a dramatic shift in the Bank's likely that poverty has fallen, but not necessarily role in the recent reforms and allowed the Bank to make everywhere and recent figures are not available yet. Upper substantive contributions to the recent progress on Egypt has lagged behind Lower Egypt, and both its rural structural reforms and economic growth. The risks to and urban poverty headcounts increased even during the development outcomes in Egypt would appear to be rapid growth of the late 1990s, and continued to rise slowly moderate at this time, but they remain real in view of the through 2005. The safety net in Egypt consists mainly of continued presence of large pockets of poverty and the subsidies on a small number of basic foodstuffs, recent unprecedented increase in international food prices. particularly bread. These subsidies have lifted some out of poverty, but they do not reach enough of the poor and are Future Bank strategy should reflect Egypt's middle-income not well-targeted. Finally, Egypt has made sustained status by including a flexible lending program and an progress toward achieving the Millennium Development emphasis on knowledge services, including reimbursable Goals related to education, infant and child mortality, technical assistance The Bank can further strengthen the maternal mortality, and safe water and sanitation. recent successful partnership by: In sum, there was progress on many of the objectives of Improving program focus on reduction of poverty and Bank assistance, and the overall outcome of the Bank's assistance inequality, with a view to identifying direct and program is rated moderately satisfactory, although the Bank's indirect interventions that could help reduce contribution to a number of outcomes was often very small income disparities between Upper and Lower in financial terms. On the other hand, the Bank produced Egypt, and including improving targeting of social well-timed and good-quality knowledge products which have safety nets through the introduction of a program been highly respected by both government and the donor of conditional cash transfers. community, and which have assisted in policy formulation Giving priority in analytic work to macroeconomic and reform. In lending, the Bank could have focused more analysis, water resources development, sharply on reducing poverty and inequality, particularly in infrastructure, and Upper Egypt, and on human development, aiming more of its interventions improving engagement of stakeholders around towards Upper Egypt, where poverty is more pronounced. findings and recommendations. In financial sector and public sector governance: (i) pursue The institutional impact of Bank assistance is rated as substantial. lending support for continued financial sector The quality of macroeconomic management improved, and reforms (banking reforms including specialized progress was made on the institutional reforms in tax banks, supervisory framework, capital markets, administration, customs, and the financial sector. In public and non-banking financial institutions); and financial management, progress was made in transparency (ii) continue promoting improvements to systems and public procurement. The Bank made significant that improve governance and indirectly combat contributions to institutional development in water corruption (public financial management, resources management by helping the government to simplification of taxation and business procedures, establish small and large scale water user associations. The and information act). present strength of National Council of Women benefited In infrastructure and energy: (i) assist Egypt in from the Bank's assistance program. developing its infrastructure strategy dealing with issues of public investment and public-private Although the Bank continued to be overly optimistic on partnerships; and (ii) move beyond capital Egypt's interest in borrowing or in using policy-based investments and focus on policy and institutional lending in the first part of the period, it did pursue analytic reforms. Task Manager: Ismail Arslan (202) 473-3982 Director, IEGWB: Cheryl Gray (202) 473-9188