Arab Republic of Egypt Private Sector Development for Inclusive Growth Development Policy Financing (Loan No. IBRD - 8915 EG) Tranche Release Document May 9, 2019 Recommendation 1. This Tranche Release Document (TRD) summarizes the progress in the implementation of the Egypt Private Sector Development for Inclusive Growth Development Policy Financing (DPF), comprised of two tranches of US$500 million each. It focuses on the actions taken by the Government of Egypt (Borrower) to meet the specific conditions for the release of the second tranche of the loan. The TRD concludes that the Borrower has made satisfactory progress overall in implementing the program supported by the loan as set forth in its Letter of Development Policy dated November 12, 2018, and that the Borrower has fully met two out of the four second tranche release conditions. In recommending the release of the second tranche, the Task Team agrees with the Borrower’s request to waive the Second Tranche Release Condition #3 - issuance of executive regulations relating to the ride sharing law - due to the recently announced merger between Uber and Careem (the two largest ride sharing companies in Egypt) which is expected to have a significant and unforeseen impact on the regional market conditions with major implications, including reduced competition. The above condition is proposed to be replaced with a new condition that supports the objectives under pillar 1 of the DPF (Financial Inclusion and Access to Finance), that is the adoption of the law regulating the use of non-cash payment (“E-payment Law”). The Task Team also agrees with the Borrower to amend the Second Tranche Release Condition #4 – issuance of a Ministerial Decree adopting and publishing an expanded medium- term debt management strategy - to reflect the changes to the institutional arrangements for the management of Egypt’s public debt and progress made to date. Background 2. On December 4, 2018, the Executive Directors approved a two-tranche Private Sector Development for Inclusive Growth Development Policy Financing of US$1 billion to the Arab Republic of Egypt. Following the Board approval, the loan was declared effective on February 18, 2019. The first tranche of US$500 million was disbursed on February 20, 2019. 3. The DPF aims at enabling financial inclusion, private sector development, and strengthening fiscal management for inclusive growth in Egypt. The first tranche of the operation included ten prior actions and progress made in implementation of said prior actions is deemed satisfactory: (a) Two licenses have been granted to microfinance institutions to use mobile services in microfinance transactions and make electronic payments; (b) The Borrower’s collateral registry has been launched, leading to an improvement of Egypt’s Doing Business Distance to Frontier (DTF) score on the Strength of Legal Rights Index; (c) The new Capital Markets Law is now enforced after the introduction of the amendments to its Executive Regulations in November 2018; (d) The Executive Regulations of the Companies Law are now enforced, and as a result Egypt’s Doing Business DTF score in the Value of Shareholder Governance Index has improved in the 2019 Report; (e) “Your Idea, Your Company” entrepreneurship support program is fully operational with a start-up support center providing business development services to entrepreneurs, investments in two incubators (Falak Start-ups and EFG-EV), and multiple financing vehicles to startups and SMEs now available (Egypt Ventures, Inma for Financial Leasing, Valu, and Tharwa Capital); (f) Draft executive regulations of the new procurement law have been prepared and the Bank recommendations have been discussed with the working group in charge. The new procurement law promotes the SME participation in public procurement; (g) The Executive Regulations for Law No. 27/2018 organizing property registration in the New Urban Communities have been already issued by the Ministry of Justice; (h) The Egyptian Tax Authority is gradually building its capacity to handle electronic tax filing. Tax paying firms that had to file their annual income tax in October 2018 faced difficulties, however, most of the VAT registered entities (around 200,000) managed to file and pay January 2019 VAT returns electronically; (i) The energy subsidy reform plan of the Government of Egypt is on track, as evident from the IMF Board approval of the fourth review under the IMF Extended Fund Facility in February 20191; (j) Finally, an inter-ministerial committee has been formed to specify the process for adopting and applying a formula-based capital allocation for governorates and districts. Recent Macroeconomic Performance 4. On February 4, 2019, the Executive Board of the IMF completed the fourth review of the three-year extended arrangement under the Extended Fund Facility (EFF) for the Arab Republic of Egypt. The IMF Executive Board approval allowed for an immediate purchase of SDR 1,432.76 million equivalent (or about US$2 billion). The three-year US$12 billion EFF remains on track. The IMF assesses Egypt’s macroeconomic outlook as favorable, supported by strong policy implementation. The IMF press release is annexed to this TRD. 5. Egypt’s economic reform program is showing signs of success beyond the gains from its initial focus on stabilization. In FY2018 2, real GDP grew by 5.3 percent, and expanded further to an estimated 5.4 percent in the first half of FY2019. This pickup in growth has been broad-based driven by public investments, private consumption, and exports of goods and services. Private investment is picking up, though from a low base, and the overall response remains muted as also evidenced by weak Purchasing Manufacturing Index readings. On the sectoral side, gas extractives, non-oil manufacturing, tourism, construction and the ICT sectors continue to be key growth drivers. Unemployment has decreased in tandem with economic growth, reaching single digits, but this has 1 https://www.imf.org/en/Publications/CR/Issues/2019/04/05/Arab-Republic-of-Egypt-Fourth-Review-Under-the- Extended-Arrangement-Under-the-Extended-Fund-46738 2 FY2018 denotes the fiscal year starting July 2017 and ending June 2018. 2 in large part reflected a decline in the labor force participation rate rather than pure job creation, signaling ongoing challenges in private sector activity. While high and volatile headline inflation remains a concern, it has declined to an average of 13.3 percent during December 2018—March 2019, compared to 15.4 percent in the previous six months. Additionally, core inflation has remained in the single digits consistently in the latter half of 2018 and through early 2019, indicating that volatile items (mainly food) as well as one-off adjustments to regulated prices have been the main drivers of headline inflation. 6. Recently issued budget outturn figures for the first eight months of FY2019 show a further improvement in the overall deficit as well as the primary balance. The deficit narrowed to 4.9 percent of GDP in the first eight months of FY2019 compared to 5.8 percent a year earlier. The primary balance, excluding interest payments, reached a surplus of 0.5 percent of GDP from a deficit of 0.3 percent. Reform measures on both the expenditure side (ongoing energy subsidy reforms and measures to rein in the wage bill) and the revenue side (in particular, the VAT regime and a scale-up of tax collection efforts) have helped achieve the turnaround in fiscal aggregates. The authorities remain committed to reaching cost recovery for most fuel products by mid-2019 and fuel price indexation has been adopted for the 95-Gasoline (which is generally consumed by the affluent). When combined with revenue enhancing reforms, these adjustments will help create fiscal space for high-priority spending on health and education. For the full FY2019, the surplus in the primary balance is projected to further grow to 1.8 percent of GDP (slightly below the IMF projection of 2 percent, due to a more cautious assumption by the Bank on debt service), and the overall fiscal deficit is projected to narrow to 8.6 percent of GDP, from 9.7 percent in FY2018. 7. The debt ratio fell in FY2018 and is expected to continue on a downward path. The debt ratio reached 97.2 percent of GDP at end-FY2018, down from 108 percent the year before. Total government debt is dominated by high domestic debt which accounts for 78.2 percent of GDP, although external borrowing surged following the November 2016 depreciation. The overall debt ratio is expected to continue on a downward path, but significant risks remain in terms of size, composition, contingent liabilities, and policy reversal. The large debt ratio has also translated into significant interest payments that have increased gradually to almost 10 percent of GDP, absorbing 70 percent of tax revenues. 8. To improve coordination within the government on public debt, a high-level committee chaired by the Prime Minister has been established to ensure an integrated and risk-based approach to borrowing from external and domestic sources. The role of this committee is described in more detail under the discussion of the related second tranche release condition below. Going forward, the government debt-to-GDP ratio is expected to decline steadily, as growth continues to pick up and as fiscal consolidation remains on track. Additionally, the authorities are currently working on clearing up backlogs and intra-debts among various government entities (notably between the Treasury and pension funds) which is expected to accelerate the decline in the debt-to-GDP ratio. 9. The positive impact of macroeconomic and policy reforms has markedly improved Egypt’s external position. The current account deficit more than halved to 2.4 percent of GDP in FY2018, down from 6 percent in the previous year, driven primarily by strong remittances and the recovery in tourism. Foreign direct investment remains modest and continues to be predominantly directed to the hydrocarbon sector. The start of 2019 has already seen greater flexibility in the Egyptian pound, following the abolition in December 2018 of a repatriation mechanism that had worked as 3 a form of guarantee for foreign investors wishing to secure foreign exchange. Market sentiment has also been buoyed by indications that inflows of portfolio investment have resumed after significant net outflows during 2018. Net international reserves reached US$44.1 billion at end-March 2019 (eight months of merchandise import coverage). Sovereign bond issuances of US$4 billion and EUR 2 billion (US$2.25 billion) in February and April 2019, respectively, will further support international reserves. Table 1: Selected Economic and Financial Indicators, 2012/13-2019/20 FY2012/ FY2013/ FY2014/ FY2015/ FY2016/ FY2017/ FY2018/ FY2019/ 13 14 15 16 17 18 19 20 Last Updated March 2019 Pre- Actual Actual Actual Actual Actual Forecast Forecast actual Main Macroeconomic Indicators Real GDP growth rate (y/y) 2.2 2.9 4.4 4.3 4.2 5.3 5.5 5.8 Population (in millions) 84.7 86.7 89.0 91.1 93.3 96.1 n.a. n.a. Unemployment rate (last Q of FY) 13.3 13.3 12.7 12.5 12.0 9.9 8.8 8.7 CPI annual inflation rate, (period 6.9 10.1 10.9 10.2 23.3 21.6 14.5 12.5 average) Central Government Budget and Debt Indicators (in percent of GDP) Total revenues 18.8 21.4 19.0 18.1 19.0 18.2 18.5 18.2 Tax revenues 13.5 12.2 12.5 13.0 13.3 14.2 14.5 14.3 Grants 0.3 4.5 1.0 0.1 0.5 0.0 0.0 0.0 Other nontax revenues 5.1 4.7 5.5 5.0 5.2 4.0 4.0 3.9 Total expenditures (excluding 31.6 32.9 30.0 30.2 29.7 27.9 27.0 25.5 NAFA) Current expenditures 29.5 30.5 27.5 27.6 26.6 25.5 24.4 22.7 Capital expenditures 2.1 2.5 2.5 2.6 3.1 2.4 2.6 2.8 NAFA 0.1 0.5 0.5 0.5 0.2 0.1 0.1 0.2 Overall budget balance, including −12.9 −12.0 −11.4 −12.5 −10.9 −9.8 −8.6 −7.5 grants Overall balance, excluding grants −13.2 −16.5 −12.5 −12.7 −11.4 −9.8 −8.6 −7.5 Primary balance −5.0 −3.9 −3.5 −3.5 −1.8 0.1 1.8 1.8 Gross budget sector debt 88.2 89.4 93.1 102.8 108.0 97.2 93.4 90.4 (domestic + external) External Sector Indicators (in % of GDP, unless otherwise stated) Trade balance −10.7 −11.2 −11.7 −11.5 −15.8 −14.8 −13.0 −12.6 Current account Balance −2.2 −0.9 −3.7 −6.0 −6.1 −2.4 −2.5 −2.5 Net FDI inflows 1.3 1.4 1.9 2.1 3.4 3.1 2.6 3.3 Capital and financial account balance (does not include 3.4 1.7 5.4 6.4 13.2 8.8 2.5 2.5 errors and omissions) Net international reserves (end of 14.9 16.7 20.1 17.5 31.3 44.3 44.4 44.4 period US$, billions) in months of merchandise 3.1 3.3 3.9 3.7 6.6 8.4 8.0 7.8 imports External debt 15.0 15.1 14.6 16.8 41.1 37.2 34.0 31.5 External government debt 10.7 9.7 8.0 8.0 18.1 19.1 17.1 14.1 Monetary Indicators (y-o-y growth) Broad money 13.7 17.8 16.2 18.3 31.9 27.3 20.0 16.5 Credit to the private sector 8.4 7.3 12.8 15.7 32.3 17.1 15.5 13.0 Credit to the private sector (in 1.5 −2.9 1.9 5.5 9.0 −4.5 1.0 0.5 real terms) Source: World Bank and Ministry of Finance (MOF). Note: FY17/18 data reflect pre-actuals. CPI = Consumer Price Index; FDI = Foreign Direct Investment; NAFA = Net Acquisition of Financial Assets. 4 10. Social conditions remain difficult. The erosion of real incomes continues to adversely affect households. At least 30 percent of the population lived below the poverty line in 2017. To mitigate the social costs of reforms and their disproportionate effect on those in poverty, the government has scaled up available social assistance mechanisms. The budget allocation for the Takaful and Karama cash transfer program grew by 400 percent between 2015 and 2018, expanding the program to reach 2.2 million households in December 2018. Similarly, the government has doubled the amount of the widespread food smart card programs. Progress on Second Tranche Release Conditions 11. The Borrower has made significant progress on the four actions to be carried out before the release of the second tranche listed in the Loan Agreement as summarized below. 12. Second Tranche Release Condition #1: The Borrower has issued a Ministerial Decree which reduces the number of steps required to establish a company in order to enhance the business environment. The Ministry of Investment and International Cooperation issued Ministerial Decree 39/2019 simplifying registration procedures of limited liability companies. The decree reduces the number of steps required from six to two steps by creating a single interface with investors and a deadline to conclude all steps in one day. The reform is a marked improvement from the current situation faced by limited liability companies and is expected to have a positive impact on Egypt’s Doing Business Distance to Frontier score for the Doing Business 2021 report. The condition is considered fully met. 13. Second Tranche Release Condition #2: The Borrower has issued a Ministerial Decree establishing investor facilitation services in two governorates in Upper Egypt and/or Frontier Governorates, to facilitate business establishment and operations and to improve transparency and predictability for investors. The Ministry of Investment and International Cooperation issued Ministerial Decree 38/2019 establishing investor service centers in Fayoum Governorate and South Sinai Governorate. These new centers coordinate with relevant stakeholders and help adhere to the processing time and service levels stipulated under the Investment Law and ensure transparency and availability of information for businesses. The new centers are also expected to alleviate the pressure from existing centers. This action supports the government’s decentralization efforts in line with other prior actions supported under the first tranche of the loan. The condition is considered fully met. 14. Second Tranche Release Condition #3: The Borrower through its Prime Minister, has issued a Prime Ministerial Decree specifying Executive Regulations relating to the Ride Sharing Law including the procedures for issuance of operations licenses, a framework for taxes and social insurance premiums, and data requirements for ride-sharing companies; leading to a framework for facilitating job creation. The draft Executive Regulations submitted by the Borrower for Bank review are technically satisfactory. However, the recently announced merger between Uber and Careem (the two largest ride sharing companies in Egypt) is expected to have a significant and unforeseen impact on the regional market conditions with major implications, including, possibly reduced competition. The implications of the merger are under regulatory review by the Egyptian Competition Authority as there are concerns over the creation of a monopoly in ride sharing services. Due to the various risks associated with possible monopolization of ride sharing 5 services, which may require significant changes in sector regulations, a waiver of this tranche condition is requested. 15. It is proposed to replace the third condition with a new policy action relating to reforms under the pillar 1 of the DPF (Financial Inclusion and Access to Finance), that is the adoption of the law regulating the use of non-cash payment (“E-payment Law”). The suggested wording of the new condition is: “The Borrower, through its President, has enacted Law 18/2019 regulating the use of non-cash payment as published in the Official Gazette on April 16, 2019 to promote the development of digital economy and improve financial inclusion”. The E- payment Law contributes to the Government of Egypt’s commitment in the Letter of Development Policy to launch “more ambitious and deeper structural reforms”, including to address “the key issues hindering financial inclusion” and “boosting integration of the informal sector into the formal system” while “factoring in the rapidly changing technological landscape”. The E-payment Law requires the Government, public institutions, and private companies to use a non-cash method when channeling payments above certain thresholds to be set by the Executive Regulations within the next 6 to 12 months. Payments that would be conducted electronically include taxes, customs, fines, fees to utility companies and other public entities, dues to suppliers/contractors/private sector service providers, dividend distribution, proceeds of sale, lease, exploitation or utilization of land, real estate or vehicles by the state's authorities and institutions and/or private companies. The E- payment Law requires the e-services to be priced the same as cash transactions with no additional costs. The implementation of this law will require investment and capacity building in infrastructure, processes and systems but is a critical step taken by the government to address informality, transparency and digitization of the economy, consistent with the Bank’s push for increased contestability by use of disruptive technology. According to the team’s estimate, the implementation of this law will help increase the number of cashless transactions per capita per year from 3.49 in 2015 to 10 by June 2020. The Borrower’s Ministry of Finance and the Central Bank will need to coordinate effective implementation in a gradual manner that allows government entities and small businesses to adjust to non-cash payment. 16. Second Tranche Release Condition #4: The Borrower has issued a Ministerial Decree adopting and publishing an expanded Medium-Term Debt Management Strategy for the period covering FY 2018/19 to FY 2020/21. The Borrower has prepared and published an expanded MTDS which is deemed satisfactory to the Bank. The Borrower has also made changes to the institutional arrangements for the management of Egypt’s public debt as detailed below: (a) Given the need to strengthen its public debt management, the government has established a high-level committee chaired by the Prime Minister and reporting to the President. The committee has already commenced its operations. Set up through Prime Minister's Decree No. 2003/2018 dated October 8, 2018, this committee is composed of the Ministers of Finance, Planning, and Investment and International Cooperation, and the representatives of the Central Bank and the Administrative Control Authority. This committee is tasked with managing the overall debt, setting annual ceiling to the external debt, studying feasibility of projects applying for loans, and liaising with the Ministry of Finance and the Central Bank to avail the government's own financing sources when possible. The committee, under the chairmanship of the Prime Minister, is required to provide quarterly reporting to the President. Since its establishment, the committee has been meeting regularly to monitor achievement of the debt management targets of the government. The government 6 has shared with the Bank the minutes of the six committee meetings held so far at the technical level. (b) These institutional improvements build on the mechanisms already in place to monitor sovereign guarantees. In July 2017, the Minister of Finance issued Decree No. 201/2017 to establish a committee that reviews and monitors the issuance of sovereign guarantees. The Ministry of Finance has already adopted a system to evaluate and decide on such guarantees and has developed a plan to limit new sovereign guarantees. (c) On the debt of state-owned enterprises (SOEs), the expanded MTDS includes references to the overall financial situation of SOEs, building on information that was published as part of meeting an IMF structural benchmark. Whereas the 2015 MTDS covered only tradable debt (domestic and external), the expanded MTDS extends its debt management framework to bilateral and multilateral debt within the budget sector (central and local governments plus various public authorities, but not most SOEs). The expanded MTDS has been further augmented to reference abridged balance sheets for SOEs, including total assets and liabilities, as published on the website of the Ministry of Finance. The government is committed to continue strengthening the quality of debt disclosure of SOEs and the audit procedures of the accounts, including introducing corporate governance principles in all SOEs. (d) The expanded MTDS has been published by the Borrower on the website of the Ministry of Finance on May 7, 2019 as part of the tranche release condition. 17. The Task Team assesses that sufficient progress has been made on policy, institutional arrangements and transparency through publication of the expanded MTDS. Given the progress made, this condition is proposed to be amended as follows: The Borrower’s inter-ministerial committee chaired by the Prime Minister responsible for public debt management pursuant to Prime Ministerial decree No. 2003/2018 dated October 8, 2018 has commenced its operations; and the Borrower has published an expanded medium-term debt management strategy which sets targets for domestic and external borrowing, includes guidance on risks related to the interest rate, exchange rate, and refinancing of debt, and provides reference to public disclosure of state-owned enterprise debt data. 7 Annex: IMF Press Release Dated February 4, 2019 8 9 10