The Capital Markets, Mubarak’s Downfall and the Egyptian Transition
After two weeks of a back and forth between the regime and the demonstrators, the January 25th Revolution has finally established its complete victory over the Mubarak regime. And although Mubarak surprised the world when he failed to announce his resignation today, it only delayed the inevitable for one day.
That the Jan. 25th Revolution was able to defeat Mubarak despite what appeared to be a strong hand certainly came as shock to the many commentators who assumed that the longer the revolution took, the stronger Mubarak would become. There are many reasons Mubarak lost this confrontation, but one is the dependence of the Egyptian economy on private international capital. Its precarious fiscal position substantially limited the ability of the Egyptian state to suppress these demonstrations violently without also destroying the economy. The Egyptian government needed (and still needs) to attract $10 billion of FDI for fiscal year 2010-2011, and at least $20 billion over the next three years. Needless to say, it would be unlikely if not impossible for Egypt to achieve this goal in the face of continued civil strife. Indeed Bloomberg reported several days ago that negotiations between an Egyptian state-owned firm and a consortium of foreign banks for a five-year, $2 billion credit facility collapsed as a result of the political uncertainty. Egypt’s stock market also depends on foreign participation, with foreigners holding a 22.5% interest (by value) in publicly-traded Egyptian equity securities as of year-end 2010. Unless Egypt can continue to attract substantial levels of foreign direct investment, it will be impossible for it to achieve its fiscal targets, which assume, among other things, economic growth in the range of 7.7% annually. Indeed, as one emerging market analyst has noted, “Everything that has happened in the current political crisis is going to make it more difficult to reach the target[.] … Tax revenues will likely decline, subsidies are increasing, public sector wages are going up and interest costs are rising.”
In short, the weak fiscal position of the Egyptian regime substantially limited the ability of the Egyptian state to use massive force to crush the demonstrators. The leaders of the Egyptian military must know that crushing the demonstrators will do nothing to attract the foreign capital Egypt so desperately needs, and in fact, might increase the risk of capital flight. The triumph of the protestors, moreover, should be welcomed by foreign investors, at least if it results in the consolidation of democracy. The Egyptian workforce is one of the most unproductive in the world. This lack of productivity in turn is largely a result of the endemic corruption that discourages investment in human labor. (Egypt was ranked 98th in the most recent Transparency International Corruption Perceptions Index with a rating of 3.1, as of 2010.)
A democratic regime that is committed to fighting this corruption will result in a substantial increase in the productivity of Egyptian labor, which in turn will lead to greater revenues for both the Egyptian state and foreign investors in the medium to long-term. The Supreme Military Council should keep this in mind as it considers its options with respect to both the interim government and the new constitution that will mark the latest evolution of the Arab Republic of Egypt. Goldman Sachs appears to agree with my analysis.