TRADE_RFP_Section_J.12_Background_and_Problem_Statement.pdf

J12. Background and Problem Statement

1- BACKGROUND

To support Egypt's economic reform program, the GOE signed a historic agreement with the

IMF for a $12 billion loan facility that was approved by IMF’s Executive Board on November

11, 2016. This agreement underscores export promotion as a key focus area in Egypt’s reform program that includes fiscal consolidation and implementation of a market-based, flexible exchange rate, improving the business environment, and enhancing social protection and human development.

From 1999 to 2004, Egypt posted successive trade gains that almost eliminated its trade deficit.

Exports’ share of GDP continued to grow and peaked at 33% in 2008. Since then, Egypt’s trade gains have eroded, with the country’s trade deficit growing exponentially and exports’ share of

GDP shrinking to 10% in 2015. This was particularly true in the non-oil sector, where its single digit share during the period 2005-2013 paled in comparison to the 20% share of exports of emerging and developing countries, and the 40% share of exports of fast growing Association of

Southeast Asian Nations (ASEAN) countries. As a result, Egypt’s trade deficit quadrupled in recent years and created severe challenges for Egypt’s balance of payments which threatened the

GOE’s fiscal solvency and overall economic performance.

Egypt first attempted to address its balance of payments deficits by erecting more restrictive regulations to curb imports, but this approach ended with persistent and sometimes deeper trade deficits. Since a significant share of domestic production depended on imported inputs, making importation of inputs more difficult and costly contributed to a further erosion of Egypt’s competitive edge and led to the drop in the share of exports. Egypt’s investment relative to GDP also declined to approximately 20% and remained at this low rate during most of the last two decades. It continued to deteriorate after the 2011 revolution and stood at 15% in 2015, half of

Egypt’s goal of 30% by 2030.

Relationship to Mission Economic Growth Strategic Goals

Based on input from stakeholders in Egypt, USAID/Egypt’s Office of Economic Growth Office

(OEG) designed a Trade and Investment Promotion in Egypt (TIPE) Project that included activities to achieve the Development Objective of “inclusive economic growth accelerated” by supporting the growth of small and medium enterprises (SMEs). The importance of SMEs in the growth of developing countries stems from the fact that they are the biggest contributors to employment (World Bank survey 2011). The experiences of many countries have shown that

SMEs form, grow, and expand quickly when the enabling environment provides these enterprises with market opportunities, adequate access to inputs and competitive services to take advantage of such opportunities. USAID aims to stimulate economic growth in targeted sectors through the procurement of this new TRADE contract.

Accordingly, the TIPE Project adopted three mutually reinforcing sub-purposes: 1) Small and

Medium Enterprises (SME) Development and Entrepreneurship supported; 2) Technical

Education and Vocational Training and Workforce Development improved; and 3) the

Macroeconomic Foundation for Growth improved. The new TRADE Activity will contribute to achieving sub-purpose 1, by improving the competitiveness of new and expanding export-ready enterprises to succeed in international markets in a floating exchange rate environment, and take full advantage of the GOE’s economic reforms. The activity also contains two additional components that will augment the technical assistance to NEERE’s.

USAID subscribes to the development hypothesis that if enterprises seek expanded market

(export) opportunities, have the required sector-specific export capacities (such as relevant technology, high-quality products, ability to penetrate export markets), sound trade development services, and operate in a low-cost and low-risk business environment, they will invest and employ more workers as they form, grow and expand in order to take full advantage of those expanded market (export) opportunities and thereby contribute to inclusive economic growth in

Egypt.

2- PROBLEM STATEMENT

Egypt critically needs to improve its trade competitiveness and export revenues to earn hard currency and support a job-rich economic recovery.

Since 2011, Egyptian firms have faced enormous trade impediments that created macroeconomic imbalances and a trade deficit that has quadrupled while the share of exports to GDP dropped from 33% in 2008 to only 10% in 2015. The root cause of Egypt’s declining export performance can be traced to a number of factors, including an overvalued currency as well as low productivity, an unfriendly trade environment, restricted and costly access to imported inputs, poor sector-level marketing, and the limited export capacity of enterprises, especially among

SMEs, all of which prevent new enterprises from becoming exporters. In fact, the contribution of new exporters to Egypt’s total value of exports, which indicates the dynamism of Egypt’s tradable sector, dropped from 19% in 2012 to only 1% in 2015.

From 2011 until November 2016, Egypt also maintained its exchange rate at a fixed rate, while inflation reached double digits in most of the last decade. This induced a 25% appreciation of the real effective exchange rate from 2010 to 2015. In fact, by October 2016, foreign exchange bureaus exchanged dollars at a premium in excess of 100% in the parallel market. The artificially strong pound penalized Egyptian exporters, which in some cases even fully offset whatever preferential access they received from trading partners due to special agreements such as the Qualified Industrial Zone (QIZ) with the United States.

In addition, partly caused by the acute shortage of hard currency and the resulting macroeconomic instability, investment dropped to below 20% of GDP and remained at this low rate for most of the last two decades, compromising growth in productivity and the long-term economic prospects for the country. Egypt’s investment rate now stands at 15% of GDP. With such low investment, enterprises are limited in the ability to introduce new equipment or adopt improved technologies and new processes to increase productivity. For this reason, productivity growth in Egypt has been weak, growing by only 0.18% annually from 2004 to 2010.

Given the deteriorating economic situation and faced with a real possibility of bankruptcy, the

Central Bank of Egypt (CBE) took the critically important step of ending its weekly auctions of foreign currency to support the pound in November 2016 and allowed the currency to float by establishing an interbank foreign exchange trading system that determines the market exchange rate based on supply and demand considerations. The flotation of the currency corrected the overvaluation of the pound and restored competitiveness of Egyptian assets, products, and services in the world market. Since then, the market exchange rate has remained at approximately US$1=EGP18.

To date, the recent GOE-IMF economic reform program (including flotation of the currency) attracted more foreign direct and portfolio investment, and increased merchandise exports.

However, macroeconomic imbalances such as the fiscal deficit, public debt, and trade deficit remain large and still encumber the economy. Although Egypt’s international reserves have increased substantially, much of the reserves are borrowed and will have to be repaid at a later date. Furthermore, the private sector, which is expected to lead the recovery, has been weakened by an unfavorable business environment that persisted for close to a decade. Although new laws

(e.g., new investment and industrial licensing laws) have been passed to improve the business enabling environment, significant efforts are still needed for the new laws to make a difference to businesses operating in Egypt.

The GOE targets 30% of its GDP to come from investment by 2030 - double the current 15%.

Accomplishing this target will require additional reforms, removing impediments to trade and investment, and building the trade sector’s capacity to compete internationally.

According to the Ministry of Industry and Trade Strategy (2016-2020), the targeted annual rate of growth for non-petroleum exports is 10%. The strategy also specifies a set of priority targeted sectors/subsectors to be the focus of the Ministry’s promotion efforts.

The remaining critical impediments to trade and investment growth in Egypt are: 1) the lack of capacity of SMEs to adopt trade-oriented business models in order to take full advantage of the newly competitive environment created by Egypt’s reforms; 2) the underdeveloped capacity of trade service institutions (public and private) to provide effective and efficient trade promotion services to enterprises; and 3) challenges to operationalize an enabling environment that mitigates costs and risks to international trade and investment.

These impediments are further elaborated in the following three sections:

1) Lack of Capacity of Egypt’s SMEs to Adopt Trade-Oriented Business Models to Compete

Successfully in the International Market

Multilateral and bilateral trade agreements that liberalized trade have expanded export opportunities for enterprises in Egypt. However, many SMEs in Egypt have not developed at a pace necessary to successfully compete in the international marketplace, whether because of the constrained policy environment or their weak exporting capacities. According to the 2017 World

Bank Enterprise Survey (hereinafter “2017 WBES”) only 9% of Egyptian enterprises exported compared to 16% in most other countries. Further, Egyptian enterprises that exported derived a smaller proportion of their total sales from export revenue, 5%, as compared to 6% derived by enterprises in other countries. In addition, with respect to enterprise size, large Egyptian enterprises show a marked advantage in export performance as compared to SMEs in Egypt.

More than half (56%) of large enterprises in Egypt had export sales, while only 9% and 16% of small and medium-sized enterprises did, respectively. Large enterprises also earned 21% of their sales from export revenues, while SMEs earned only 6% on average.

SMEs in Egypt have limited access to market information. Successfully competing in the international market is information-intensive and costly. Enterprises need to gather information about opportunities in targeted foreign market locations, market prices, trends in international demand, product specifications, prevailing business laws and regulations and international buyers. Despite advances in information and communication technology, this information gathering still can still be expensive, especially for SMEs. Firms that have the ability to gain access to this data still have limited capacity to translate it into market information that is useful for decision making, limiting their export potential and constraining their growth. For example, only 56% of firms in Egypt use e-mail to interact with clients and suppliers compared to 72% in the rest of the world.

On the technology front, many SMEs in Egypt have also failed to keep pace with worldwide advances and still use out-of-date equipment. With foreign direct investment (FDI) resting at

15% of GDP, about half of its pre-2011 level, few enterprises have introduced new equipment, adopted improved technology, or implemented new competitive processes. For instance, only

5% of firms in Egypt use technology licensed from foreign companies while 15% of companies in other countries do.

With respect to labor, Egypt’s workforce lacks the necessary skills to operate in high-tech international supply chain environments. As a result, enterprise productivity grew by only

0.18% annually, which severely compromises firms’ ability to successfully compete in international markets. Enterprises need to periodically train their workers in new competencies such as design and packaging that satisfy changing consumer trends, but only 10% of enterprises in Egypt offered formal training to their employees compared to 34% of enterprises in most other countries.

Additionally, enterprises have limited capacity to take advantage of export revenue due to their inability to meet international product quality standards or specifications demanded by an increasingly sophisticated international buyer. For example, only 9% of firms in Egypt possess an internationally-recognized quality certification, while nearly double - 17% - of firms in other countries do.

As for resource management, many SMEs inherited energy-intensive production systems that date to the period when the GOE implemented a subsidized energy policy to stimulate industrial activities. As these subsidies are being phased out, enterprises need to better manage and rationalize the use of their resources and upgrade their systems to be more efficient and remain competitive suppliers to the world market.

Access to market research and professional advice, attending trade shows, and trade financing are all examples of essential tools that enterprises need to compete in the international market.

Although these types of trade-related tools exist in Egypt, they are unaffordable for the majority of SMEs. For example, with respect to trade finance, the recent flotation of the currency resulted in a more volatile exchange rate, requiring firms to adapt their financing and pricing strategies in order to manage their exposure to this new type of risk.

World suppliers have increasingly organized their supply chains with independent and highly specialized sub-units that are scattered in various parts of the globe in order to exploit differential cost advantages and cater to the demand of increasingly value-conscious consumers. To be successful, enterprises around the world, including Egypt, need to develop the areas where they have a comparative advantage in order to contribute value in specific functions within supply chains and facilitate linkage arrangements with those chains.

2) Underdeveloped Capacity of Trade Service Institutions (Public and Private) to Provide

Effective and Efficient Trade Services to Enterprises

Small exporters, particularly new ones, must rely on a broad range of trade services they do not possess in-house to enter new markets outside of Egypt. These services include, but are not limited to, providing required regulatory and compliance information in order to sell to international markets, developing packaging and design options that appeal to consumers abroad, conducting marketing studies and consultancies to help firms compete in the target markets, organizing events to establish business linkages for trade and investment (e.g., trade shows), and using information technology to efficiently deliver these services.

Enterprises in Egypt, especially SMEs, have expressed their dissatisfaction with the quality of services they receive from providers. The generally underdeveloped state of trade services in

Egypt can be traced to demand and supply factors. On the demand side, the poor enabling environment weakened export performance of SMEs, which translated into weak demand for trade services. Hence, the development of the trade service sector has been partly constrained by a lack of effective demand. On the supply side, government and quasi-government organizations dominate the trade service sector with mandates outlined in the Export Promotion Law No. 155 of 2002. These institutions include the Export Promotion Center, Commercial Representation

Office, International Trade Points, the General Authority for International Exhibitions and Fairs, the Export Subsidy Fund, the Foreign Trade Training Center, export councils, and the Export

Development Bank. A number of these institutions have overlapping functions, operate with limited resources, and use business models that are not viable to support implementation of their extensive mandates in a sustainable manner, resulting in inefficient and ineffective supply of trade services for SMEs. For example, there are more than five agencies nationwide involved in export promotion activities, as well as around 15 export councils serving specific sectors.

Although the mandate of export councils is to be the leading trade service providers for their respective members in specific sectors, these councils primarily focus on sponsoring and organizing international trade shows. Moreover they are often severely under-staffed and unable to provide other mandated trade services.

The problem of inefficient and ineffective trade promotion services manifests itself in various dimensions, including differences in the accessibility of trade services by location and the scale of the business. Regarding location, although the underdeveloped state of trade services is generally a nationwide phenomenon, it is more acutely experienced by many SMEs outside of

Egypt’s largest cities, Cairo and Alexandria. For example, there are hundreds of potential SME exporters outside of Cairo and Alexandria that are not functionally covered in an export council service network. Additionally, other services (e.g., consulting, training, and export related technical assistance) are not available in rural governorates.

Regarding scale, large exporting enterprises have the highest representation in nearly all trade associations, which often grants them preferential access to trade services. Further widening the gap, large enterprises tend to have adequate means to overcome trade service-related problems, unlike SMEs, which are generally underrepresented in business associations and whose trade service resources are often very limited. Moreover, public and quasi-public institutions provide most of the trade services available to SMEs, while private sector providers are generally absent in the ecosystem. This lack of private sector participation in the supply of trade services means that the power of competition cannot be leveraged to induce market innovations that could improve trade service quality and drive down cost of trade services to benefit exporting SMEs.

The Ministry of Trade and Industry (MTI) is aware of these problems and as part of its restructuring efforts, issued a ministerial decree in May 2017 to merge three trade service institutions (Export Promotion Center, International Trade Point, and Foreign Trade Training

Center) into the Export Development Agency (EDA). This new agency has the leading jurisdiction over export promotion activities. The new authority is planning to work on enhancing and promoting exports, as well as building the Egyptian exporters’ abilities. It will also carry out structural and institutional advancements and strengthen links between the export sector and the concerned government bodies.

3) Challenges to Operationalize an Enabling Environment that Mitigates Costs and Risks to

International Trade and Investment

The poor trade and investment enabling environment in Egypt has elevated risk and raised costs faced by enterprises. In particular, Egypt’s poor trade facilitation efforts penalize Egyptian enterprises in terms of time and cost to import raw inputs and intermediate products, putting them at a disadvantage in the international market. For example, Egypt’s cost to import raw materials increased significantly in 2015, exceeding the cost of 147 (out of 152, or 97%) of potential competitor countries, up from 29 in 2008. While all private businesses face regulatory constraints in Egypt, these burdens fall more heavily on SMEs due to their lack of capacity, as well as a limited ability to access legal and other business development services that large firms can easily acquire. The complexity of the trade and investment regulations, exacerbated by overlapping jurisdictions of government agencies and the lack of coordination among them, raises the cost of trade and investment facilitation in Egypt. The costly and risky regulatory environment stems from a number of specific regulatory factors, including:

● Overlapping roles for border agencies: Sampling and inspection functions are mainly carried out by Egypt’s General Organization on Export and Import Control (GOEIC).

However, some products (mainly food) may be subject to inspection by other agencies.

For example, GOEIC is authorized to assume inspection and certification functions without referral to a higher authority. However, for the food industry, there are three to four additional agencies involved that have the right to take samples from an imported shipment. The government has issued Law No. 1, 2017 to establish a new National

Food Safety Authority in order to overcome overlapping roles and to task a single agency with control of the flow of all food products from farm and ports to table. The

GOE is organizing the new authority and expects it to be fully functional by the end of

2018.

● Burdensome requirements for foreign investors: Significant impediments to investment persist in Egypt and have slowed the response of international investors to GOE reforms. Business owners frequently complain about slow decision-making by the government, which has a negative impact on business activity. Frequently cited obstacles include policy uncertainty, excessive bureaucracy, regulatory complexity, and slow and cumbersome procedures. Furthermore, although Egypt is a signatory to international arbitration agreements, its courts do not always recognize foreign judgments. Dispute resolution is slow, with the time to adjudicate a case to completion averaging three to five years. In some instances, cases that have been long decided are re-opened for review. An additional hindrance that investors report is a delay of up to several months for legitimate transfers of foreign exchange to be executed. In the past this was due, in part, to the lack of availability of foreign currency, although access to foreign cash is improving. Labor rules prevent companies from hiring more than 10% of non-Egyptians (25% in “free zones”), and foreigners are not allowed to operate sole proprietorships or simple partnerships. Furthermore, a foreign company wishing to import for trading purposes must do so through a wholly Egyptian-owned importer.

● Ineffective conformity assessment and food safety system: Conformity assessments for exports and imports include a number of distinct operations: standards used, sampling methodologies, testing, and compliance. In the current system, these four functions are implemented by different government bodies and are not up to international standards.

According to current Egyptian regulations, every shipment must be tested to verify its conformity to standards, irrespective of whether the preceding shipments were accepted or rejected. This practice has increased clearance times and translates into higher costs paid by all importers, including those importing inputs to export final products. In addition, inadequate food safety regulation, enforcement, and compliance have compromised the export potential of the food sector, which has long demonstrated its comparative advantage in many products, especially under the floating exchange rate regime. Recently, Saudi Arabia, the UAE, and several other African countries banned

Egyptian exports of food products due to food safety concerns, endangering $100 million of export revenues during the coming export season.

● Outdated Customs Law: Customs procedures are governed by the customs law (Law

66 of 1963), which was amended in 2005. Egypt is a signatory to the World Customs

Organization’s (WCO) International Convention on the Simplification and

Harmonization of Customs Procedures (Revised Kyoto Convention) since 2008. Egypt has accepted all 25 of the Specific Annexes to the Convention. To fulfill its commitments, Egypt drafted a new customs law in 2011 that is currently under revision. The revised law should include all WCO requirements and other important trade facilitation measures to address unresolved issues.

● Burdensome Trade Facilitation Regulations: Many of the trade policies and regulations are considered as impediments to conducting trade in Egypt, posing as a significant burden to all importing/exporting firms. Therefore, trade facilitation has emerged as an important issue for the GOE.

● Unrealized Business Opportunities from Trade Agreements: Egypt is already party to a number of trade agreements intended to increase market access for Egyptian enterprises. These agreements include the: the Agadir Agreement, the Common

Market for Eastern and Southern Africa (COMESA) Agreement, the European Union-

Egypt Association Agreement, Greater Arab Free Trade Agreement (GAFTA), the

Egypt-Turkey Free Trade Agreement, and numerous free and preferential trade agreements with individual Arab countries. In addition, Egypt signed the Qualified

Industrial Zones (QIZ) protocol in 2005. The QIZs are designated geographic areas, within Egypt, that enjoy preferential status with the United States for certain products.

Enterprises located within such zones are granted duty-free access to U.S. markets for certain products, provided they satisfy the requirements under the rules of origin: 35%

Egyptian value-added, including a 10.5% Israeli component. However, because

Egyptian enterprises have faced an overvalued currency and a heavy regulatory burden, many SMEs have yet to take full advantage of Egypt’s trade agreements. Now, with the recent enhanced price competitiveness of SMEs resulting from the flotation of the pound and reform efforts to improve the enabling environment, opportunities exist for

SMEs to benefit from existing and potentially new trade discussions and agreements.

J.12 Gender Analysis Report produced by the Trade Facilitation Project