US embassy cable - 05CAIRO6703

C O N F I D E N T I A L SECTION 01 OF 03 CAIRO 006703 
 
SIPDIS 
 
USTR FOR SAUMS 
TREASURY FOR MILLS/NUGENT/PETERS 
USDOC FOR 4520/ITA/MAC/SAMS, TALAAT AND JACOBS/WIEHAGEN 
USDA FOR FAS/SHEIKH/BERNSTEIN 
 
E.O. 12958: DECL: 08/31/2015 
TAGS: ETRD, EAGR, EAID, EG, ECON PGOV, USTR 
SUBJECT: THE NEW CABINET ONE YEAR LATER: REFORMS AND 
REFORMERS ON THE MARCH 
 
Classified by A/DCM Michael Corbin for reasons 1.4 (b) and 
(d). 
 
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Summary 
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1.  (C) One year after the cabinet shuffle that placed Ahmed 
Nazif and other economic reformers into significant 
ministerial positions, President Mubarak (and in the 
background, his son Gamal) have gained strength from the 
concrete results of the economic reform agenda.  Overcoming 
skepticism from pundits and resistance from the "old guard," 
the new ministers enacted urgently needed reforms, balancing 
unpopular moves, like cutting subsidies on basic commodities, 
with more popular ones, like lowering tariffs on imports. 
The list of reforms is impressive, especially when compared 
to the anemic performance of every previous government. 
Investor confidence is up, GDP growth is expected to achieve 
five percent this year and the Nazif group will almost 
certainly be returned to the cabinet after the upcoming 
parliamentary elections.  However, every major reform 
initiative requires the acquiescence of the powerful security 
and old guard voices in the cabinet (Defense, Interior, 
Intelligence, Foreign Affairs, and Parliamentary Affairs) and 
whether the new cabinet shifts the balance further in favor 
of the reformers is a question that looms large as elections 
begin.  End summary. 
 
--------------------------------------------- - 
Setting the Bar High:  One Year to Get Results 
--------------------------------------------- - 
 
2.  (C) The success of the reformers over the past year 
surprised skeptics, and even some reformers, who questioned 
whether they could overcome resistance from the old guard and 
show tangible results before the 2005 presidential and 
parliamentary elections.  The one-year deadline for results 
was set by the reformers themselves, but understood to also 
be the expectation of President Mubarak.  The goal was 
ambitious, even audacious, given the years of economic 
problems the new cabinet inherited.  One prominent 
businessman, a close friend and political ally of Anwar 
Sadat, noted that the reformers were not left with just the 
economic baggage of the previous government, but with 
problems 50 years in the making. 
 
3.  (C) Understanding that they had to win over not only the 
president, but also the public, the reformers moved quickly 
to enact urgently needed reforms designed to make the economy 
more market-based and globally oriented.  Nazif and his 
cabinet allies understood that pain of the reform process 
would fall on the average Egyptian fast and hard, while the 
benefits would take longer to materialize.  They therefore 
tried to balance unpopular moves, like cutting subsidies on 
basic commodities, with more popular moves, like lowering 
tariffs on imports. 
 
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The Reforms:  Changing Laws,  Changing Minds 
-------------------------------------------- 
 
4.  (C) The list of reforms undertaken over the past year is 
long.  Since the installation of the new economic reform 
cabinet, the GOE has: 
 
- Developed and implemented an inflation-targeting monetary 
policy framework. 
 
- Established an inter-bank foreign exchange market that 
helped end foreign currency shortages and virtually eliminate 
the black market for foreign currency. 
 
- Signed and implemented an MOU with U.S. on financial sector 
reform, which includes privatizing one of the public banks, 
and addressing non-performing loans. 
 
- Taken concrete steps to privatize the Bank of Alexandria 
(the smallest of the public banks) by the end of 2005 or 
early 2006. 
 
- Sold shares in joint-venture banks such as National Societe 
General Bank and Egyptian Commercial Bank. 
 
- Enforced new minimum capital requirements for banks and 
have set a goal of reducing the banking sector from 52 to 21 
banks over a 3-5 year period. 
 
- Cut subsidies on basic commodities including diesel (a 50% 
increase in the subsidized price), industrial natural gas (an 
almost 18% increase in the subsidized price) and water in 
Cairo (an almost 100% increase in subsidized price). 
 
- Simplified the import tariff regime by reducing the number 
of tariff rates from 27 to 6.  Decreased tariffs on a range 
of imports, which reduced the average weighted tariff from 
14.6% to 9.1% and moved Egypt from 75th to 30th place on the 
World Bank's ranking of countries with the lowest tariffs. 
 
- Passed a new income tax law which cut personal income tax 
rate from 32% to 20%, standardized deductions for all 
taxpayers, and created a flat corporate tax rate of 20% 
(reduced from an average rate of 40%). 
 
- Set up a "one stop shop" for foreign investors starting 
businesses in Egypt. 
 
- Published the GOE budget using IMF-approved accounting 
standards to provide greater transparency. 
 
- Privatized 19 public companies, including enterprises the 
previous government had deemed "strategic" and thus 
ineligible for privatization.  Plans are underway to 
privatize Eastern Tobacco Company and sell shares of Telecom 
Egypt on the New York Stock Exchange. 
 
- Broadened commercial relations with Israel by concluding 
with its neighbor the Qualifying Industrial Zones agreement 
and a gas export agreement. 
 
- Resolved long-standing trade and business issues of U.S. 
companies, including eliminating excessive sales taxes on 
soft drinks and removing restrictions on the import of U.S. 
beef products. 
 
5.  (C) In addition to these concrete steps, the reform 
ministers have pushed hard on changing the mindset of 
government officials and bureaucrats.  They have promoted 
government decentralization, by undertaking efforts to move 
some decision-making and control over budgetary resources 
from the central government to the local level.  They have 
tried, with mixed success, to overcome resistance within 
their own bureaucracies, which are chock-full of surplus 
workers who see reforms as a threat to their jobs and 
authority. 
 
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Tangible Results and New Momentum 
--------------------------------- 
 
6.  (C) Under any assessment, the breadth and depth of 
reforms accomplished in just one year would be an 
achievement.  But when judged against the anemic record of 
the previous governments, and recognizing the resistance put 
up by the old guard in the NDP and fearful bureaucrats in 
their own ministries, the reformers record is rather 
astounding.  GDP growth, which hovered around 3.2 percent 
from 2000-03 and only reached 4.3 percent last year, is 
expected to hit 5 percent in 2005.  Proceeds from 
privatization of public enterprises has generated $500 
million over the past year, as compared to only $14 million 
over the previous 16 months.  The Cairo and Alexandria Stock 
Exchange is the best performing stock exchange in the world 
among emerging markets.  The Egyptian pound has stabilized 
against the dollar and would likely appreciate if not for 
suspected Central Bank intervention to keep the pound stable. 
 
 
7.  (C) The best indication of the reformers' success, 
however, may lie less in the numbers than in a change in 
perception.  Few may remember now that when the cabinet 
shuffle was announced a year ago, speculation was rife that 
the reformers would not be able to deliver.  Rumors were 
circulating that the old guard was setting up the reformers 
to take the fall for not resolving the economic problems that 
their stability-promoting policies had in fact precipitated. 
 Failure seemed more likely than success, as every major 
initiative had to pass "the old guard test," and some 
reforms, like eliminating major subsidies, were completely 
off-limits from the start.  Field Marshall Tantawi openly 
resisted many of the reforms, and he found plenty of support 
in the cabinet parliament from those who saw reform as a 
threat to their political and personal interests. 
 
8.  (C) One year later, however, perceptions have changed. 
As a result of the reforms, the business climate has 
noticeably improved and investor confidence is surging. 
Local businessmen have remarked on streamlined customs 
procedures and greater responsiveness from ministries in 
addressing their business concerns.  A lawyer at one of 
Egypt's premiere law firms noted a dramatic increase in the 
number of inquiries from foreigners interested in setting up 
operations in Egypt.  As for the public, which the old guard 
predicted would react strenuously to disruption brought about 
by reforms, the reaction has been decidedly low-key.  Though 
facing higher prices and economic uncertainty, the public 
seems grudgingly resigned to accept the immediate pain for 
the promise of change. 
 
9.  (C) The reformers have been strengthened by their success 
and will almost certainly be returned to office following the 
upcoming elections.  The looming question, however, is 
whether President Mubarak will add to their number.  Rumors 
abound that the President will appoint new ministers after 
the parliamentary elections.  The betting is that the 
powerful defense and security ministers will remain in the 
cabinet, with the exception of Minister of Interior El Adly, 
the final casualty of the Sharm bombings.  Even then, 
however, no one expects anyone other than a trusted, 
like-minded ally of the President to take El Adly's place. 
With less than a third of the cabinet considered reformist or 
reform-friendly, there is ample opportunity among the 
remaining dozen or so portfolios to increase the reformers 
presence and power in the cabinet.  The decision, however, 
rests with Mubarak, who has been touting the desirability and 
value of reform in his recent election appearances, but will 
balance the push for reform with his perennial concerns over 
security and stability. 
 
 
Visit Embassy Cairo's Classified Website: 
http://www.state.sgov.gov/p/nea/cairo 
 
You can also access this site through the 
State Department's Classified SIPRNET website. 
 
JONES