CAIRO - 24 February 2022: Egypt’s government looks set to continue its commitment to tight fiscal policy and bringing down the public debt ratio, according to Capital Economics’ Middle East and North Africa Economist James Swanston.
Swanston announced his concerns over the increasing levels of foreign currency debt that will be vulnerable if, as the organization expects, the pound weakens over the coming years.
“Over the past eight years, Egypt’s budget balance has significantly improved with the deficit narrowing from nearly 13 percent of GDP at the end of FY2012/13 to 7.4 percent by the start of FY21/22m” he noted.
The economist added that despite the COVID-19 pandemic, the deficit has narrowed further as the government provided direct fiscal support worth just 1.6 percent of GDP – well below the 8 percent average of most major emerging market economies. In turn, this has helped to maintain a primary balance surplus of over 1 percent of GDP.
He referred to the Finance Minister Mohamed Maait announcement that the government intends to rein in the budget deficit to 6.6 percent of GDP in FY21/22 and to 6.1 percent in FY22/23. It has been suggested that spending on public services and social protection will increase, but this will be more than offset by an increase in revenues. Alongside this, the government maintained its commitment to reduce the public debt-to-GDP ratio from 91 percent at the end of FY20/21 to 84 percent in FY22/23.
“Even if the government refrains from loosening policy and the debt ratio declines in the coming years, the composition of debt will remain a key concern. In particular, a large proportion of Egypt’s government debt is denominated in foreign currency – we estimate that it is equal to 24 percent of GDP, or more than a quarter of the overall debt burden. Of this nearly 60 percent has been issued externally,” he added.
He noted that the key risk facing the government’s FX debt burden is how policymakers manage the pound. Egypt’s external position has deteriorated and the currency looks increasingly overvalued. Our central scenario is that policymakers will gradually allow the pound to weaken by around 8 percent to 17.0/$ by the end of this year. A fall of this degree would, all else equal, increase Egypt’s public debt-to-GDP ratio by 1.8 percent-pts.
According to Swanston, there is a growing risk that officials hold onto the currency for too long and, as external imbalances build, a sharper and larger downwards adjustment in the currency is needed. We had argued prior to the 2016 devaluation that a correction of around 25 percent was needed and, if a similar fall occurred now, this would increase the government debt-to-GDP ratio by more than 6 percent-pts, pushing it towards 100 percent.
The increase in the debt ratio would probably lead investors to demand higher bond yields. Due to the short average maturity of government debt, this would quickly feed through into higher debt servicing costs and further worsen the debt dynamics over time. What’s more, sovereign dollar bond yields already stand at more than 9 percent so it wouldn’t take a significant rise to push them into a territory where other EM sovereigns in the past have refrained from issuing external debt. That presents rollover risks, he stated.
“For now, though, the risks are mitigated by the central bank’s FX reserves which, at around $41bn, cover the government’s FX debt payments over the next few years. What’s more, the government has established a good track record in pushing through harsh fiscal consolidation and the improvement in the budget position in recent years means that, in the event of a sharp fall in the pound, it might not take much extra austerity to put debt back on a downward trajectory,” he concluded.