The timing seemed propitious when Egypt’s newly established sovereign wealth fund announced on February 3 that it was preparing to float shares in up to ten military companies on the country’s stock exchange. Both the Ministry of Finance and economists surveyed for a Reuters poll just days earlier expected the economy to grow by 5.8 percent in the current fiscal year, more than double the global average, and by 5.9 percent in 2020–21. Then the new coronavirus pandemic struck and the Egyptian Stock Market (EGX) tumbled, registering the biggest drop among all Arab stock markets by March 16 and losing 95 billion Egyptian Pounds (EP) in value in the week to March 19. Six days later, President Abdel Fattah el-Sisi announced the injection of EP20 billion ($1.27 billion) to support the EGX in a bid to revive share prices, but by April 4 it had lost a cumulative EP132 billion. It is no longer clear that floating military companies can go ahead, but Sisi and the relevant government agencies should grasp the coronavirus crisis as an opportunity to completely reconsider the whole idea—or do more to get it right.
Significant hurdles already stood in the way of floating military companies. Sisi originally went public with the idea in August 2018, and so the fact that nearly one and a half years passed before the sovereign wealth fund took over the task of assessing their suitability reveals the difficulties of listing military companies in the EGX and confirms the reluctance of government ministers to take it up. The delay in floating military companies stands in sharp contrast to the alacrity with which far more ambitious and costly megaprojects espoused by Sisi soon after coming to office were launched. Work commenced a mere three days after Sisi announced the Suez Canal expansion on national television on August 5, 2014, for example, forcing the Ministry of Finance to prepare the legal instruments to receive investments from the Egyptian public in record time. The new administrative capital, the final bill for which is on course to be many times higher than originally planned, moved nearly as swiftly from being announced in March 2015 to the breaking of ground at the selected site east of Cairo just a few months later.
In theory, floating military companies could mark a significant and positive departure from the financial opacity and dubious feasibility that currently characterize Egypt’s military economy. If properly done, flotation promises full disclosure of the finances of these companies and offers a plausible means of capitalizing them. But in fact, technical problems and policy challenges relating to transparency, profitability, unfair competition, and legal ambiguity raise serious doubts about both the eligibility of military companies for flotation and their commercial feasibility. Unless addressed first, these will skew the terms of competition in the market, pose risks to shareholders, and expose the ambiguity of Sisi’s economic reasoning and the contradictions inherent in his proposal. If the Sisi administration leaves these issues unresolved, listing will be little more than a device for sucking private funds out of the market to buoy up military companies that have murky accounts and boards that are beyond the reach of civilian law.
Prying Military Books Open
Full financial disclosure by Egyptian military companies is highly unlikely, and may be impossible. The thirty-four companies belonging to the Ministry of Military Production and the Arab Organization for Industrialization claim to subject their production of civilian goods and services to inspection by the Central Accounting Organization, but are not currently slated for public listing. The ten companies that may sell shares instead belong to the National Service Projects Organization (NSPO), a Ministry of Defense (MOD) affiliate whose accounts are kept secret in the name of national security, and which is not inspected by the Central Accounting Organization.
A special bureau of the Ministry of Finance checks the MOD’s books, but this is merely to ensure that incomings and outgoings are balanced. This does not involve routine verification of invoices and certificates, let alone constitute a full audit of affiliated agencies and their companies. Nor does it allow for effective evaluation of the feasibility of commercial activity or of economic return on investment. NSPO company accounts are otherwise off-limits to all government fiscal and audit agencies, as well as to parliament, as is the case for MOD finances and the defense budget generally.
So in order to be floated, NSPO company accounts would have to be opened up to the same kind and level of scrutiny as any other company listed on the EGX. This would reveal the source of investments in NSPO companies and their actual spending and capital, for example, as well as their debts or arrears and where any profits have gone. Indeed, popular TV host Lamis al-Hadidi commended Sisi’s flotation proposal enthusiastically during an interview with Minister of Public Enterprise Sector Hisham Tawfik in November 2019, precisely because it meant that military companies would open their books completely and come under good governance and reform, thereby “ending talk about them as a black box.”
Nonetheless, it is possible that the Sisi administration would seek to tweak EGX rules to allow military companies to be listed with less than full financial disclosure. Indeed, it may have already tried this route. Reviving his proposal at the end of October 2019, Sisi claimed “we have been working on it for three years, but listing in the stock exchange has many requirements that I don’t want to talk about.” Egypt has so far avoided international scrutiny so long as competition for market share in select sectors and crowding for state credit by military companies mainly affects Egyptian civilian counterparts, but tweaking the rules would raise their visibility and could cause severe reputational damage to the EGX. The Sisi administration thus has to tread cautiously if it wishes to attract foreign investment.
The Military’s Economic Advantages
Financial disclosure would certainly be welcome, and helpful, but is merely the tip of the iceberg. The Sisi administration must level the playing field between military and civilian companies if listing military companies in the EGX is to improve their viability and be more than a ruse for extracting capital from unwary investors. As detailed in “Owners of the Republic: An Anatomy of Egypt’s Military Economy,” military agencies enjoy significant economic advantages over civilian counterparts in both the private and public business sectors.
The list of advantages is lengthy. Foremost include the right awarded by Sisi to military agencies to use military-designated land as equity in commercial ventures, along with the formal power to award or withhold licenses for use of state land by any civilian individual or entity, public or private. Military companies generally are exempt from income tax, property tax, customs duties, and other government fees and levies. They also have significantly lower production costs: subsidies that benefit energy-intensive industries such as the NSPO’s cement plants, which Sisi proposed to float on the EGX; use of Egyptian Armed Forces (EAF) heavy transport vehicles and exemption from tolls levied on military-run national highways; easy access to foreign currency at favorable exchange rates; and, for NSPO companies in particular, use of virtually free conscript labor.
Arguably most important of all is that by law military agencies and their affiliated companies may receive, and in their turn award, contracts by what is known as “direct order”—on a noncompetitive, no-bid basis. This gives them a massive advantage over any civilian competitors in both the private and public business sectors, since it assures them of revenue streams even when their output of goods and services is below par. It also grants them leverage over civilian firms that expect to be awarded further contracts only if they accept unfavorable commercial terms now, and to be excluded from future tenders if they do not. Listed NSPO companies could not retain this advantage without dangerously skewing the terms of market competition. Indeed, even if they lost it formally, their close relationship with the NSPO and the MOD would make it hard to maintain the separation in practice, unless bidding processes and accounts are made fully transparent.
Military companies are also almost completely free from civilian audit, raising questions about whether listed NSPO companies would remain exempt or be obliged to comply with reporting and inspection requirements. Active duty and retired EAF officers, moreover, dominate the Administrative Monitoring Authority, the most powerful public audit agency in Egypt. Used by Sisi to spearhead his anticorruption campaign, it has been instrumentalized by successive administrations to intimidate officials and businesses into compliance with presidential wishes and policies and to reward loyalists by shielding them from investigation. Hundreds of retired EAF officers embedded in influential state agencies reinforce this power of compellence and dissuasion, enabling the MOD and other military agencies and companies to expedite or delay bureaucratic paperwork needed by civilian investors.
A Legal Gray Zone
That said, these advantages might not dampen investor appetite for shares in military companies. Tawfik observed in October 2019 that 95 percent of investors who had bought shares in a 4.5 percent stake of the state-owned Eastern Tobacco Company seven months earlier were foreign (in fact they were a single Emirati investor). In contrast, it is highly likely that most of those who might purchase shares in military companies will be Egyptian, partly out of patriotism, but mostly because they calculate that the government will not let these companies fail, and that they will continue to receive prime public contracts regardless of their actual efficiency or performance.
But this cannot totally obscure the risk to private shareholders. All military agencies come exclusively under military jurisdiction and are not subject to civilian courts. This does not apply to all military companies: those of the Ministry of Military Production and the Arab Organization for Industrialization are registered as public business sector companies, and so the civilian side of their activities should come under the same legal framework, at least nominally if not in practice. In contrast, the NSPO companies that may be listed are currently under military legal jurisdiction.
Consequently, joint ventures between military agencies and private companies—including foreign ones—come neither under Egyptian nor foreign company laws. Rather, they function in a legal gray zone where their sole real protection lies in political relationships. But no companies are known to have tested this. According to a commercial officer at a Western embassy in Cairo, cited by Reuters in 2018, foreign investors felt that there was no point in taking a business dispute with the military to arbitration: “You just leave the country.” Strong political relationships were also insufficient to prevent major Chinese and Emirati investors from pulling out of the new administrative capital project due to land price and profit sharing disagreements with the MOD and military companies managing it.
The absence of an applicable legal framework represents the most serious vulnerability for civilian investors, whether private or public, Egyptian or foreign. A UK government advisory last updated in 2020 warned British investors bluntly to seek payment in advance because “contract enforcement in Egypt is weak,” for example. Legal ambiguity skews the terms of market function and competition. As Egyptian journalist Mahmoud Khalid notes, Law 182 of 2018 on Regulating Contracts Issued by Public Entities means that the latter—automatically including military agencies and companies—may acquire companies, investments, or land without disclosing their price to external investors under the guise of national security.
Investors might care less about the disadvantages for competitors, so long as they are assured of a return on their investment. But they should be concerned about who determines their dividends. As for all economically active military agencies, the NSPO retains profits while transferring losses to the public purse. Senior managers, all of whom are active duty EAF officers, are moreover assured of a share of profits that, paradoxically, appear to be calculated regardless of whether companies are actually profitable. Listed NSPO companies would have to be redesigned to incorporate a new governance structure, including general assemblies, shareholder voting rights, and the power to appoint and dismiss boards of directors.
Besides clarifying the relationship of listed NSPO companies to MOD funds and the state treasury, investors would expect better assurance of transparency in company books and dividends. Even that might not ensure full recompense: a legislative decree issued in May 2011 by the head of the ruling Supreme Council of the Armed Forces, then acting with presidential powers, transferred the authority to MOD prosecutors to determine whether EAF officers accused of financial impropriety should be tried in military or civilian courts, even if they had retired from service. If this legal gray zone does not frighten off investors now, it will almost certainly endanger their profits and legal rights later.
Nonperformers
There is also a question about how profitable military companies actually are. There have been no official announcements about which NSPO companies might be listed, but in August 2018 Sisi proposed selling shares in the massive cement factory built with Chinese technical assistance at a cost of $1.12 billion in Beni Suef, which had gone into operation just six months earlier. The NSPO’s decision to increase production capacity in a sector that was already oversaturated, only to sell at least part of it shortly thereafter, raises serious concerns about its ability to assess economic feasibility and market needs. Indeed, the NSPO had just recently expanded capacity at its Arish Cement Company, which originally commenced production in 2011–12; the Beni Suef plant was reportedly suffering from 60 percent underutilization of capacity by September 2019.
Having incurred the sunk cost of building an additional cement factory, the NSPO presented itself with stark choices. On one hand, it could continue to underutilize capacity or else maintain a moderate production level and stockpile its output of intermediate and final materials, either of which would impose a constant financial drain. On the other hand, it could compete aggressively for market share in a sector dominated by private companies (both domestic and foreign) by producing at higher capacity and underselling competitors.
The NSPO could shield itself from the impacts of oversupplying the market since military agencies are also major customers of building materials for the public housing and infrastructure works they manage. But the NSPO’s massive foray into the cement sector has already damaged numerous private companies—most have posted significant losses for two years running and the public sector al-Nahdah company ceased operation—and alienated the private sector whose business investment and political support Sisi wants. The government had to pledge to compensate civilian cement manufacturers, adding to the net cost to the public purse.
In short, private shareholders may find themselves simply helping the MOD and NSPO make up for bad investment decisions, with little control over future ones. However, other NSPO companies might offer better commercial opportunities. For example, the Beni Suef complex also comprises seven marble and granite factories, with five more planned in rich quarrying areas under MOD control in other parts of the country as of mid-2019. NSPO companies are involved in the production of phosphates, heavy metals (from black sands, which the NSPO now monopolizes), and even gold. These are all extractive industries based on the mining and sale of natural resources, in which the MOD has established several quasi-monopolies since the armed forces took power in July 2013.
Clearly, private shareholders stand to earn lucrative dividends should these companies be among those listed in the EGX. NSPO ventures in cultivation and agribusiness, livestock, fish farming, and general supply should also offer good commercial opportunities, as could its construction and contracting businesses, thanks to their assured flow of public contracts. But problems could easily arise: the viability of the relevant NSPO companies hinges substantially on privileged access to so-called desert land—a sore point with the private sector and with the World Bank and International Monetary Fund—and to increasingly scarce freshwater sources for land reclamation, agriculture, and fish farming. Many of these activities, along with much of the extractive industries, take place in military zones to which the MOD controls access, providing even greater incentives for nonperformance.
Investors Beware
These considerations may explain the evident reluctance of government ministers to pursue flotation of military companies. Sisi clearly sees things differently. Trying to tempt private investors in October 2019, he assured them that “you don’t have to get involved in feasibility studies or in licensing, that’s all ready for you.” But this was also the president who, less than a year earlier, had been scathing about feasibility studies, stating that “if I had allowed them to be a decisive factor in resolving matters in Egypt, we would have achieved only 20 to 25 percent of what we actually achieved.”
Minister of Public Enterprise Sector Hisham Tawfik was careful, if not downright evasive, when asked about Sisi’s renewed proposal on national television a few days later. “The idea is excellent,” he said, “but has not been implemented because as you know, in their initial phases of production, companies, most companies, require some time to acquire market share in their sector of products or services until they prove their profitability. And so for most ventures [read: military] we need some time until they prove their profitability and can then [succeed] in the stock exchange.”
There is good reason for caution. When Sisi announced the Suez Canal expansion in 2014, he decreed that funding would come entirely from domestic sources, and invited citizens to purchase investment certificates that would be repaid five years later. Approximately 1.1 million Egyptian investors obliged, investing EP64 billion—and withdrawing EP32 billion from domestic banks to do so. However, the project cost more than doubled due to Sisi’s insistence on completing it in one year rather than three, and the expected increase in shipping through the canal and in transit fees failed to materialize due to a decline in global trade that had already been under way when he launched the scheme. The 50 percent devaluation of the Egyptian pound in late 2016 is the only reason such faulty economics did not end disastrously when repayment of the investment certificates fell due in 2019, as it enabled the government to draw on growing foreign currency reserves and repay domestic investors at half the cost. This suggests that a similar fate could be in store for investments in military businesses floated on the EGX.
Egypt’s Sovereign Wealth Fund Steps In
In theory, selling off significant stakes in NSPO companies could offer private counterparts operating in the same sectors the means to upgrade their own businesses. For example, they could move from producing raw materials to finished ones in sectors such as marble and granite, increasing the value they add to exports and to the economy as a whole. Private investors might also relish a chance to buy shares in the NSPO’s intermediate and industrial chemicals companies or its Tolip hotels chain. But unless the terms of flotation allow private investors to acquire controlling stakes or buy out NSPO companies entirely, then even profitable ones that are listed will require strict ring-fencing in order to separate their finances completely from those of the NSPO. Otherwise, without full transparency and a robust legal firewall, listed companies could become cash cows for loss-making parts of the NSPO business portfolio.
However, Sisi’s proposal appears to be about selling shares in select military companies and raising capital, without handing over management or control. Nor is listing on the EGX about privatizing them.
This is where the Egypt Fund comes in. Established in late 2018, the country’s new sovereign wealth fund offers ways around the more challenging legal and financial requirements of listing military companies in the EGX. The Sisi administration and the military may see this as a more effective way of generating capital, given both the stock exchange’s generally lackluster performance and the dubious commercial viability of military companies. On February 3, 2020, the Egypt Fund formalized a deal to place several NSPO companies in a portfolio of assets for promotion and investment.
The Egypt Fund serves Sisi’s purpose in several ways. CEO Ayman Soliman clearly shares the president’s desire to cut through government red tape, claiming in December 2019 that the fund will be “unshackled from all those bureaucracies, and improve the way of doing business itself and work with the checks and balances within the government management that investors cannot navigate.” Egypt Fund management of military economic assets also allows side-stepping thorny problems such as land title, which the MOD is especially reluctant to relinquish. Another is the legal status of investments in designated “strategic zones” around the country, where numerous military-owned ventures are located and where state land may not be transferred to private ownership. This grants the MOD, which controls land use in these zones, sweeping and permanent leverage when military agencies or companies contribute land as their share of equity in joint ventures with domestic and foreign companies.
The Egypt Fund also makes it possible to sidestep the issue of ownership and control, if only by muddying it. In an obvious bid to drum up foreign direct investment and private sector interest, Soliman has said that “investing in [NSPO] assets with the private sector may reach 100%. The fund may invest in these assets with potential investors or help the NSPO create partnerships in these assets directly.” But it is exceedingly unlikely that MOD or NSPO officials envisage a full-scale sell-off in reality. This is probably why neither they nor the Sisi administration pursued the third alternative for improving economic viability and raising capital, which is the government plan launched in 2018 to sell stakes in twenty-three state-owned companies as part of its privatization program.
Soliman’s statement that “we prefer to have unused assets in our portfolio” captures the difference. Had restructuring and recapitalizing inefficient public companies to improve productivity and market performance been the goal, it would have made more sense to focus on the twenty manufacturing companies belonging to the Ministry of Military Production, only six of which declared a profit in 2017, after many years of straight losses. Even they succeeded only thanks to using the military’s influential position to poach public procurement and works contracts that previously went to civilian competitors.
In short, turning this kind of military company around requires significant investment in increasing skills and productivity and in research and development to ensure better quality goods and services, higher local content, and greater economic value added. This is a tall order indeed in the Egyptian public sector, and a big part of why the government’s privatization program has stalled completely over the past two years (with the sole exception of the sale of a modest number of Eastern Tobacco Company shares).
Sisi’s Drive for Cash
The appeal of floating NSPO companies, in contrast, lies in their capture of natural resources and privileged political position, evidenced by the large number of NSPO projects Sisi has inaugurated. Their promise of quick and easy profit is probably why European, Arab, and Egyptian investors are already expressing interest in these “treasures,” as Soliman called them, even before knowing what is on offer.
The choice of NSPO companies for flotation is also motivated by the president’s never-ending drive to raise capital. The $12 billion loan disbursed by the IMF over 2016–19 generated a surge in foreign debt investors, but its effects are fading and foreign direct investment in nonenergy sectors has declined steeply since 2017. In pushing to float NSPO companies, Sisi is both catering to an important institutional constituency and casting about for additional ways of generating quick income. This may explain the haste with which the Egypt Fund is moving: Soliman’s comment to the Financial Times in late February 2020 that work was under way to “get our hands around the sizes of those assets, the valuations of those assets, and the market space” reveals that the decision to float military companies was taken before their inventories had been compiled and feasibility confirmed.
Rather than investing financial surpluses or significant domestic savings, which the country does not have, the Egypt Fund is set to act as an auctioneer for idle government assets, state debt, and natural resources. The NSPO’s share of the fund’s operating capital is modest, and even smaller when compared to the overall portfolio that the fund intends to amass. So, the significance of floating some of its companies should not be overstated. But the prospective flotation nonetheless demonstrates the model for what passes as public-private partnership under the Sisi administration, in which the former retains control while the latter accepts the risk.