In the year following the implementation of an economic reform package from the International Monetary Fund (IMF), Egypt’s economy has witnessed the rapid unwinding of financial tensions that had been building up for more than a generation. Shortages of staple goods had been building up for some time, which made the floating of the Egyptian pound all but inevitable. Adding to the ensuing trauma, consumers saw cuts to fuel subsidies, a cumulative 7 percentage point increase in interest rates over the past year, and promises to move forward with tax increases and other austerity measures aimed at jumpstarting the economy.
In return for this dramatic and rare display of prudent policy, Egypt, or at least the financial position of its government, has been rewarded handsomely by multilateral development banks and investors. Over the past year, the country has received the first tranches of a $12 billion loan from the International Monetary Fund (IMF), more than $18 billion from private investors into Egyptian treasury bills, and $7 billion in U.S. dollar-denominated debt. Overall, debt from private investment and multilateral development banks pushed Egypt’s hard currency reserves to more than $36 billion at the end of October 2017—an almost $20 billion increase from June 2016.
While these numbers may seem impressive—and the government has been keen to tout them to anyone who will listen—there are still serious questions about the underlying resiliency of the economy and its long-term prospects for growth. In addition to the myriad political and security challenges facing Egypt in the coming years, three economic issues in particular are prompting investors to hedge their bets.
First, while Egyptian treasury bills and Eurobonds have had no problems finding buyers, foreign direct investment (FDI) inflows have been weaker than expected. Inflows rose only 6.5 percent to $13.35 billion during the 2016-17 fiscal year, which ended in June. In net terms, this amounted to $7.92 billion, more than $2 billion less than the $10 billion target the government had set. But more importantly, this indicates that while Egypt can generate cash quickly by selling these bonds, the money is not going into long-term business investments. Treasury bills—short-term government bonds that mature in less than a year—provide quick returns for domestic and foreign investors but are not long-term bets on the Egyptian economy. While the Eurobonds that Egypt has sold have maturities between 5 and 30 years, these bonds are denominated in dollars and euros, not the Egyptian pound. This means that investors are still leery of tying up money in the Egyptian economy in the medium and long term, in the Egyptian economy. over concerns about the future health of the pound.
The second potential pitfall is rapid accumulation of debt, especially debt denominated in foreign currencies. The IMF estimates that Egypt’s total debt-to-GDP ratio, which includes both domestic and foreign currency debt, will stand at 101.2 percent by the end of 2017. While this is a substantial increase from the 2008 low of 66.7 percent, the IMF expects the figure to drop in the coming years. Unlike Egyptian pound-denominated debt, however, where the government can inflate away the costs by simply printing more money to pay back its creditors, dollar- and euro-denominated debt does not lose value if the Egyptian pound depreciates. Regardless of what fiscal or monetary policy the government chooses to employ, U.S. dollar debt remains at the same value in U.S. dollar terms.
According to the most recent data from the Central Bank of Egypt (CBE), Egypt’s external debt-to-GDP ratio doubled over the course of the 2016-17 fiscal year from 16.6 percent to 33.6 percent. Part of this increase comes from the debt owed to multilateral organizations such as the IMF and World Bank and is unlikely to pose a problem due to the long maturities, low interest rates, and repayment grace periods. However, as Egypt has plans to purchase more Eurobonds in the coming year, the government could find itself in difficult position when these bonds mature if the economy fails to grow was expected or the value of the Egyptian pound falls. Indeed, investors remain skeptical as to Egypt’s long-term prospects, as is evident by the costs for insuring Egyptian debt against default.
The third challenge looming over the Egyptian economy is more easily avoidable if the government opts to be financially responsible and prioritizes its long-term interests. As natural gas exploration and extraction expands in the Eastern Mediterranean, the government can collect more rents from natural gas sales. Italian energy firm Eni discovered the massive Zohr field in August of 2015, and the government expects production from the field to satisfy domestic demand by the end of 2018. Egypt also expects to begin exporting the surplus gas from Zohr and other fields in Egypt’s territorial waters by the end of the decade. This allows the country to meet its own energy needs and avoid the rolling blackouts and power cuts to heavy industry that have plagued the economy since 2011. Despite this, if the rents collected begin to make up a substantial portion of government revenues, Egypt’s appetite for reform may wane. Cuts to subsidies could be postponed and plans to partially privatize Egypt’s natural gas market may end up revised to allow the government to play a larger role than expected.
While the large price surges from the currency devaluation are likely to die down in the coming year, Egypt is not out of the woods yet. Major obstacles potentially block an easy path toward a stable and growing economy, and it is evident that foreign investors are still tepid when it comes to tying their money up in Egypt. If, however, Egypt is able to keep its external debt under control, maintain fiscal responsibility, and bring in more foreign direct investment—not just from fund managers looking to cash in quickly on high-yield treasury bills—the country has the potential to find its path toward long-term growth.
Brendan Meighan is a macroeconomic analyst focusing on the Middle East. Follow him on Twitter @BrendanJMeighan.