Capital expenditure is an investment in future economic growth. Representing profits spent on machinery and equipment, capital spending leads to increased future production and, in turn, higher income and profits. This article will examine the impact of monetary policies in recent years&mdash;from 2016 when the Egyptian pound was floated to the coronavirus crisis&mdash;on capital expenditure, specifically in manufacturing, a sector with substantial impact on development. In order to get a better picture of the manufacturing community in these circumstances, we need to take a closer look at the performance of industrial firms in recent years.&nbsp;
We will look at data on capital expenditure in manufacturing companies listed on the main stock exchange index<a href="#ref_1">[i]</a> and calculate this spending<a href="ref_2">[ii]</a> as a percentage of sales revenue, which indicates the total of revenue spent to expand future production. The paper will also show how the declining value of the local currency and attendant interest rate increases had an adverse impact on this type of investment spending.&nbsp;
<h3>&nbsp;Why is industry important?</h3>
Manufacturing substantially influences the trajectory of economic development. Some of these industries create as many jobs as tourism and agriculture, but with the additional advantage that manufacturing jobs are permanent&mdash;not seasonal or casual&mdash;which makes it easier to regulate workers&rsquo; rights as well. Like real estate and other construction activities, industry generates sizeable profits, but unlike these sectors, manufacturing reduces our need for hard currency. We don&rsquo;t need to import villas and buildings, but we do import household goods, mobile phones, and other commodities. In addition, manufacturing creates substantial economic value compared to other economic activities thanks to technological development, which is constantly increasing industrial production.&nbsp;
&nbsp;As such, continually expanding manufacturing entails a lower trade deficit, plenty of stable jobs that the state can more easily regulate for compliance with labor rights given the political will, and high value products that exponentially increase our national income.&nbsp;
<h3>&nbsp;What Is the impact of monetary policies?&nbsp;</h3>
Aggregated data for private investments in Egypt show a clear decline in industrial investment in recent years. Since 2016, non-petroleum industrial investment as a share of total private investment has declined by nearly half.&nbsp;
Figure 1: Non-petroleum industrial investment as a share of total private-sector investment
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1609835420imageScreen Shot 2021-01-05 at 10.27.24 AM.png" alt="" width="500" height="261">
Source: Author&rsquo;s calculations based on data from the Central Bank of Egypt&rsquo;s Monthly Bulletin
&nbsp;Following the floating of the Egyptian pound, the currency lost nearly half its value. To counteract the inflationary pressures this created, the CBE drastically raised interest rates.&nbsp;Interest on savings and loans rapidly increased after November 2016 (al-Borsa News, 2016) in the face of inflation rates not seen in recent decades. As of July 2017, the CBE had raised interest rates by 7% since the float (CBE, 2017), which made it more costly to borrow for investment.&nbsp;The Federation of Industries that year issued a statement urging the CBE to cap interest rates (Masrawy, 2017), but their demand went unanswered due to inflationary pressures coupled with the CBE&rsquo;s desire to attract foreign investment to build up foreign currency reserves depleted after years of dollar shortages.&nbsp;High interest rates persisted until early 2018, when the CBE discounted rates by 200 basis points in February and March, but continued inflation precluded additional cuts (Gaballah, 2018). When inflationary pressures receded, the CBE again cut interest rates in February 2019.&nbsp;
With the onset of the coronavirus pandemic in the second quarter of 2020 and the institution of lockdown measures, business activity took a hit. The CBE responded by slashing interest rates by 300 basis points, followed by a smaller cut of 100 basis points in September and November (CBE, 2020). This brought the borrowing rate to 9.75%&mdash;3% lower than the rate immediately prior to the currency float.&nbsp;Interest rates discounts naturally had a positive effect on borrowing, but unfortunately this came at a time when several other factors were inhibiting manufacturers&rsquo; appetite for borrowing, most significantly weak consumer demand following the currency float. The inflation caused by the currency depreciation exhausted consumers, spurring them to cut down on purchases to stretch their income. The years after the float also saw successive hikes in energy prices, which put additional pressure on family budgets. In addition, the increased price of the dollar next to the pound meant higher prices for imported machinery and equipment, making it harder to find the money for capital expenditure.According to Finance Ministry figures, private consumption saw extremely poor growth rates of 1% from 2017/18 to 2018/19 (Ministry of Finance, 2020).
The coronavirus pandemic struck just as demand began to recover in 2020 after the completion of the energy liberalization program and as inflationary impacts declined. The pandemic had a further adverse impact on family incomes and purchasing power, which in turn derailed numerous opportunities for investment expansion. At the same time however, certain monetary policies shored up producers&rsquo; ability to spend on manufacturing. Most importantly, the flotation of the pound helped ensure the provision of foreign currency in official exchanges, which in turn helped firms to collect the hard currency needed to import production equipment from abroad.&nbsp;While the inflation that followed the float spurred families to limit their consumption of manufactured goods, the demand for some basic goods is inelastic, meaning it is difficult for families to scale down consumption of them. For manufacturers of these basic goods, flagging demand is no obstacle to increased production.&nbsp;
<h3>&nbsp;A Closer Look at Firms</h3>
The financial statements of manufacturing firms from 2015 to 2019 show that most firms reduced capital expenditure as a percentage of sales, as shown in Figure 2.&nbsp;
Figure 2: Capital expenditure as a share of sales
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1609835491imageScreen Shot 2021-01-05 at 10.27.41 AM.png" alt="" width="600" height="258">
Source: Author&rsquo;s calculations based on annual financial statements of listed firms
The financial statements show that in this period some firms stepped up their investments in treasury bills, likely to take advantage of high interest rates following CBE increases, as is clear from Edita&rsquo;s financial statements.&nbsp;
Figure 3: Treasury bills in Edita&rsquo;s asset listings
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1609835599imageScreen Shot 2021-01-05 at 10.27.53 AM.png" alt="" width="500" height="300">
Source: Edita annual financial statements
But interest rate policies had an adverse impact on firms like Ezz Steel, which saw steadily increasing financing expenses in this period.&nbsp;
Figure 4: Financing expenses at Ezz Steel
<img style="display: block; margin-left: auto; margin-right: auto;" src="https://api-aps.aucegypt.edu/uploads/tinymce/1609836189imageScreen Shot 2021-01-05 at 10.28.02 AM.png" alt="" width="500" height="302">
Source: Ezz Steel financial statements
&nbsp;Various firms spoke explicitly about suspending expansions in the wake of the float. Juhayna, for example, said in its annual financial reports for 2017 and 2018 that it was suspending investment in new factories and directing spending to maintenance. In its 2017 financial report, Edita spoke of the need for capital expenditure to take advantage of increased demand in the market.&nbsp;The market diversity of firms like Oriental Weavers allowed it to continue capital expansion. In its financial reports from 2016 to 2019, the firm speaks of expansions in the US market as well as in Egypt.&nbsp;The activities of some companies like Elsewedy Electric are tied to the construction sector, which has seen strong growth in recent years thanks to national projects funded by the state even during the economic slowdown. Despite growing revenue, Elsewedy believed that capital expenditure in 2014&ndash;2018 was low, coming in at less than 4% (Elsewedy Electric, 2020).The different business postures of all these firms show the disparate impact of monetary policy on industrial firms, although capital expenditure was severely affected in all them in the recent period.&nbsp;
<h3>Small and medium enterprises and financing</h3>
The activities of listed companies do not give us a full picture of the industrial sector. There are thousands of small and medium enterprises (SMEs) that had difficulty accessing banking financing even before the currency float and the pandemic, and their limited production and modest marketing experience makes them less able than large firms to cope with these crises. SMEs were perhaps more willing to suspend capital expenditure in the period under review. According to a survey conducted the Egyptian Banking Institute, whose findings were published in 2013 by the Economic Research Forum, just 50% of SMEs deal with banks or take advantage of bank financing. There is a general impression that loaning to these enterprises is high risk and unprofitable. On the positive side, the survey found that 44.3% of SMEs who deal with banks are manufacturing firms, an indicator of small manufacturers&rsquo; ability to access financing (El-Said et al., 2013).
In late 2019, the CBE launched a EGP100-billion initiative to fund capital expenditure for manufacturers with annual revenues of EGP50 million or more, while continuing a 2015 program to provide easy-term financing for SMEs. But the CBE does not regularly disclose how many firms have taken advantage of these initiatives and how big the beneficiary firms are. This data would help us better understand the barriers to industrial financing and the types of administrative and legislative reforms needed (Badr, 2019).
<hr>
<a href="#endref_1">[i] </a>State-owned firms were excluded from this analysis and only industrial firms listed on the main index are covered.
<a href="#endref_2">[ii]</a>&nbsp;Capital spending is expenditure for the purchase of fixed assets and projects under implementation.&nbsp;
<hr>
References
<ul>
<li>
Badr, S. (2019, December 15). CBE releases details of its industry support initiative (Mustanid) (al-Bank al-Markazi Yanshur Tafasil Mubadarat Da&lsquo;m Qita&lsquo; al-Sina&lsquo;a [Mustanid]). Almal News. [In Arabic]
</li>
<li style="font-size: 10pt;">
Al-Borsa News (2016, November 2). <a href="https://alborsaanews.com/2016/11/03/921907">CBE increases interest rate by 3% to reach 14.75% on savings and 15.75% for borrowing</a> (al-Markazi Yarfa&lsquo; al-Fa&rsquo;ida 3% li-Tasil 14.75% &lsquo;ala-l-Ida&lsquo; was 15.75% li-l-Iqrad). [In Arabic]
</li>
<li style="font-size: 10pt;">
Central Bank of Egypt (n.d.). <a href="https://www.cbe.org.eg/en/EconomicResearch/Publications/pages/monthlystatisticaclbulletin.aspx">Monthly statistical bulletins</a>.
</li>
<li style="font-size: 10pt;">
Central Bank of Egypt (2017, July). <a href="about:blank">Statement of meeting of the monetary policies committee at the Central Bank of Egypt</a>.
</li>
<li style="font-size: 10pt;">
Central Bank of Egypt (2020). <a href="https://www.cbe.org.eg/en/MonetaryPolicy/Pages/PressReleaseAllDocuments.aspx">Statements of the monetary policies committee at the Central Bank of Egypt</a>.&nbsp;
</li>
<li style="font-size: 10pt;">
Elsewedy Electric (2020). Investor presentation.
</li>
<li style="font-size: 10pt;">
Gaballah, A. (2018, February). <a href="https://fr.reuters.com/article/egypt-interest-mh6-idARAKCN1FZ2IY">CBE cuts interest rate 100 basis points as inflation recedes</a> (al-Markazi al-Misri Yukhaffid As&lsquo;ar al-Fa&rsquo;ida 100 Nuqtat Asas ma&lsquo; Inhisar al-Tadakhkhum). Reuters. [In Arabic]
</li>
<li style="font-size: 10pt;">
Masrawy (2017). <a href="https://www.masrawy.com/news/news_economy/details/2017/5/22/1091883/%D8%A7%D8%AA%D8%AD%D8%A7%D8%AF-%D8%A7%D9%84%D8%B5%D9%86%D8%A7%D8%B9%D8%A7%D8%AA-%D8%B1%D9%81%D8%B9-%D8%A7%D9%84%D9%81%D8%A7%D8%A6%D8%AF%D8%A9-%D9%85%D9%81%D8%A7%D8%AC%D8%A6-%D9%88%D8%AA%D9%88%D9%82%D9%8A%D8%AA%D9%87-%D8%BA%D9%8A%D8%B1-%D9%85%D9%86%D8%A7%D8%B3%D8%A8">Federation of industries: interest hike is a shock and the time is not right</a> (Ittihad al-Sina&lsquo;at: Raf&lsquo; al-Fa&rsquo;ida Mufaji&rsquo; wa Tawqituh Ghayr Munasib). [In Arabic]
</li>
<li style="font-size: 10pt;">
Ministry of Finance (2020, September). <a href="http://www.mof.gov.eg/English/publications/MOF_Publications/Pages/TheFinancialMonthly-September2020.aspx">The financial monthly</a>.&nbsp;
</li>
<li style="font-size: 10pt;">
El-Said, H., Al-Said, M., &amp; Zaki, C. (2013, May). <a href="https://erf.org.eg/publications/determines-access-finance-smes-evidence-egyptian-case/">What determines the access to finance of SMEs? Evidence from the Egyptian case</a> (Working Paper No. 752) Economic Research Forum.
</li>
</ul>

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