Background : Widespread protests have been ongoing in Egypt since Tuesday, January 25, 2011. Sparked by the protests in Tunisia, now known as the “Jasmine Revolution,” the demonstrations in Egypt were initially focused on the perceived unfair parliamentary elections held in November 2010, and have subsequently expanded rapidly in size and scale, with many demanding the resignation of President Hosni Mubarak and a complete change of the National Democratic Party (NDP) regime. While the overall thrust of the demonstrations was peaceful, they have recently become turbulent with some incidents of violence such as the torching of the NDP party headquarters and more recently with clashes between protestors and those supporting the current government. The deployment of the army initially restored security somewhat, as the military is well liked and respected by most Egyptians. Importantly, the army has so far refused to engage with protestors but still managed to protect key political assets.

Government Response : In response to the protests, last weekend President Mubarak dissolved his cabinet and made two notable appointments—Ahmed Shafiq as prime minister and Omar Suleiman as vice president. Mr. Shafiq, previous civil aviation minister and former head of the air force, is respected by the Egyptian elite, even among the political opposition. He is viewed as a moderate with strong business credentials and a military background, and he has been credited with the turnaround of EgyptAir. Mr. Suleiman, former head of military intelligence, led Egypt’s efforts in securing an Israeli-Palestinian peace deal and mediated an inter-Palestinian reconciliation.

Nominating Mr. Suleiman as vice president represents a first step taken by Mr. Mubarak toward laying the foundation for a succession plan to his 30 years of presidential rule. The appointments are not only seen as the first step in the process to end Mr. Mubarak’s presidency but also signal a shift toward a more liberal political system. Mr. Mubarak also stressed the need for political reform and promised that his new government would control inflation, maintain subsidies, fight corruption and create jobs. Meanwhile, the speaker of the Egyptian parliament indicated that an investigation would be launched into the legality of last November’s parliamentary elections.

Reaction from Protestors and the International Community: Mr. Mubarak’s announcements fell short of the expectations of protestors, who saw his appointments as a nominal gesture and a change of figurehead rather than a change of regime. The protestors seem to want to choose their own leader, and they are unlikely to accept a close ally of the president, appointed by the president. Increasingly, other international leaders have been calling upon Egypt to reaffirm the presidential elections scheduled for September 2011 and for Mr. Mubarak not to seek another term—this latter concession was made by Mr. Mubarak on Tuesday, February 1. That said, Mr. Mubarak’s role in steering the country through an orderly transition of power remains vital but uncertain.

Possible Outcomes : The political developments in Egypt have reached a crucial point likely to result in substantial change in the political landscape. If Mr. Suleiman were to take power and if he wishes to be accepted by the Egyptian people at large, he would need to position himself as a leader of the transitional cabinet and may need to distance himself from Mr. Mubarak and the old regime. Prior to the forthcoming September 2011 elections, there will likely need to be changes in the Constitution to allow non-NDP members to run in presidential elections followed by a dissolution of the parliament. In addition, we may see further broad-based measures undertaken to try to strengthen economic and political institutions.

Since the protestors do not seem to be united under one leader or common agenda, we think it is very unlikely that escalating protests on a massive scale will culminate in the replacement of the president and vice president by an interim military government. We also think it is extremely unlikely that the demonstrations will end in a violent standoff between the protestors and the army, given Egyptians’ long-standing respect for the military. While demonstrations and volatility may continue in the short term, we believe that Egyptians realize change is coming, and we believe they are willing to work towards lasting change rather than risk a complete lack of security in the short term.

Impact on Markets and Our Investments: Stock markets in Egypt have been closed since January 30 and those in the Middle East/North Africa (MENA) region declined substantially between January 25 and February 1 as sentiment among some investors turned negative amid the political uncertainty. Other investors have been seeking an opportunity to buy stocks at low prices. The geopolitical ramifications of this unrest are many, not only for Egypt but also potentially for the rest of the world, and for the most part will probably be positive since political reform has been long overdue in the region.

We continue to monitor the situation carefully, with regular updates from our analysts on the ground, and examine opportunities as they arise.

Mark Mobius
Franklin Templeton Investments