J.P.Morgan on Egypt: Parliamentary Elections Passed First Test

• Elections in Egypt

  High turnout for parliamentary elections offers an orderly exit from political turmoil

• Power sharing between the Muslim Brotherhood and the Military Council to raise downside risks
• Challenging backdrop to finance twin deficits and dwindling FX reserves could force a devaluation

Turnout at the first round of parliamentary elections, which kicked off on November 28, has been stronger than expected despite the country’s recent (and worst) wave of violence in Tahrir Square. The elections have been widely seen as relatively fair with violations broadly limited to non-stamped poll paper, delayed opening times, and campaigning during the vote. These elections have ;argely offered an orderly exit from the recent political turmoil, helping to ease tensions and risks of heightened violence. In particular, the Muslim Brotherhood and the Supreme Military Council insisted on keeping the parliamentary elections on schedule despite growing calls for delays. While the first round of the lower chamber elections in 9 out of 27 governorates has been relatively smooth, downside risks remain relatively high in 2012 due to an expected difficult cohabitation between the Muslim Brotherhood and the Military Council as well as a faltering economy and challenges to finance the budget deficit.

Muslim Brotherhood’s victory to face achallenging sharing of power

The preliminary results of the parliamentary elections from the 9 out of 27 governorates where the vote was held on November 28-29 suggest the Freedom and Justice Party (Muslim Brotherhood) and the Al-Nour party (Salafists) are taking the lead in most governorates. The widely expected strong performance of the Muslim Brotherhood is also in line with the regional trend after Islamists won 41% of the Constituent Council seats in Tunisia and 27% of the parliament in Morocco. Early indications suggest the FJP could dominate the lower chamber in Egypt, controlling 40%-50% of the seats. However, the stronger-than-expected showing of the Al-Nour party could give the Islamists a two-thirds majority in the lower chamber. The emergence of the Muslim Brotherhood as the country’s new political force and recent calls for the new government to be representative of the polls could result in rising tensions in 2012 since the Military Council is set to remain in power until at least June 2012, when the presidential elections are expected to be held. In the meantime, the formation of a government could take an extended period of time since final election results will be ublished by January 13. Importantly, articles 56 and 61 of the provisional constitution provide the Supreme Council with powers to set legislation and oversight over policies which could raise tensions with Islamists during the transition period.

New government to face challenging economic legacy

The slowdown in economic activity and the rapid deterioration in confidence have substantially raised the challenge to finance Egypt’s twin deficits. In particular, the rapid exit of foreign investors from the T-bill market and a larger budget deficit pushed domestic yields to new record levels. In addition, it has become increasingly difficult for domestic banks to raise their holdings of government securities. Higher yields and dwindling FX reserves pushed the central bank to raise its policy rates in order to reduce currency volatility and defend USD/EGP at the 6 mark. The central bank action (deposit rates were raised 100bp and lending rates 50bp) when the economy is slowing rapidly shows the commitment to defend the currency. However, we believe the probability of a large currency devaluation has substantially increased as the authorities are quickly running out of options. This will also push headline inflation higher due to a strong FX passthrough.

Egypt’s election guide

The vote in 9 out of 27 governorates on November 28-29 represents the first of three rounds of the lower chamber elections (9 governorates in each stage). This will be followed by a second round on December 5 and a third round on January 3, and final results will be announced by January 13. Two thirds of the seats in the lower chamber will be based on the proportional system and the rest of the seats elected through an individual system in which parties can also participate. The upper chamber elections will then be held between January 29 and March 11. The parliament would convene in March 2012 and chose a 100-person committee to write a new constitution within six months. The draft constitution will then be ratified by referendum, and presidential elections are expected to be held by June 30. Half of the 504 seats in the lower house will be reserved for representatives of workers and farmers. Note that according to the new law, 10 members of the parliament will be ppointed by the president or the military councilwhile the president will appoint two thirds of the 390 seats of the upper house. The minimum election age has been lowered to 25 from 30 previously. Individual candidates will be elected directly if they receive more than 50% of the vote in their constituency or through a second round between the four top candidates, in the absence of a clear majority.

Source: Economic Research, December 2, 2011