CAIRO - 25 April 2018: Celebrating the monthly increase in Egypt’s foreign reserves has become a tradition by the authorities who consider it testament to the economic reform program. Yet, the increasing foreign reserves are clouded by an unprecedented surge in Egypt’s foreign debt, which has almost doubled in five years to about $81 billion in the first quarter of FY2017/18 from $43 billion in fiscal year (FY) 2011/12, according to the Central Bank of Egypt’s (CBE) latest data.
Fitch Ratings, however, estimated the figure would reach $100 billion or 44% of GDP by the end of 2017, saying that this is “sharply up from around 23% of GDP a year earlier.”
In its second review of Egypt’s economic reform program, the International Monetary Fund (IMF) revised its forecast for Egypt’s external debt to $86.9 billion by the end of the current FY, which is significantly up from the $74 billion in the previous review.
Meanwhile, the fund predicted the figure retreating to $85.2 billion in 2018/19.
Accounting for the $1 billion tranche received from the World Bank loan last March, the $500 million from the African Development Bank, the next $2 billion IMF tranche expected in June, and the sale of $4 billion dollar-denominated Eurobonds in February and €1-1.5 billion euro-denominated Eurobonds in April, the total foreign debt for FY2017/18 amounts up to around $90 billion, a figure close to that predicted by the IMF.
Diversifying funding sources was a key requirement in the country’s economic reform program backed by a $12 billion loan from IMF to secure cheaper financing at a time when debt servicing costs eat around a third of the budget, and Egypt’s domestic debt has been accelerating to an extremely high level over the past years to reach 96.7% of GDP by the end of FY2016/17.
IMF building- Reuters
The lesser of two evils
In June 2016, foreign debt stood at $47.7 billion, but in less than two months after the pound float on November 3, 2016, the figure jumped to $79 billion in June, 2017 and $80.8 billion in September from $67.3 billion by end of 2016, marking an increase of some $1.8 billion from its level in the previous quarter.
And despite their concern over the pace of foreign debt growth, most experts agree that the government had no other choice to finance its financial gap at a lower cost and provide dollar liquidity that would overcome one of the worst hard currency shortages.
“In order to enhance investors’ confidence in the economy, Egypt had to tap the international debt market to improve certain indicators, such as the volume of foreign investment in the local T-bills and foreign reserves,” CI Capital’s Asset Management Economist Noaman Khaled tells Business Today, defending external loans like those from the IMF and the World Bank. “It was impossible for foreign investors to enter the market and inject their money in the government debt tools with the pre-float level of foreign reserves.”
Khaled adds that the other option the government would be adopting more aggressive restrictions on imports, which would have a recessionary impact on the economy and violate international free trade agreements. “There are some terms in trade agreements which allow the countries to impose more aggressive restrictions on imports temporarily, but the government argued that it would give a negative sign for foreign investors,” Khaled explains.
Similarly, Head of Research at Pharos Holding Radwa el-Sweify says that the “level of foreign debt is not very alarming despite being doubled since the flotation.” She adds that the government has resorted to expanding its foreign borrowing to diversify financing sources, filling the budget deficit and the financing gap at lower rates from domestic ones.
“It was a bitter pill, [but] we had no other choice” el-Sweify says. “We are not worried because reserves have risen sharply after the float, the ratio of foreign debt to the reserves is roughly two to one, and short-term debt shapes about 15-20%.”
In a report, Mubasher International argues that foreign borrowing has some positive sides, including better terms of borrowing, a narrower spread, and adjusting to longer maturities.
“The yields on the latest issue (dated February 2018) compared favorably to last year’s issue back in January 2017. Indeed, 5, 10, and 30-year yields declined in a year’s time to 5.58% from 6.13%, to 6.59% from 7.50%, and to 7.90% from 8.50%, respectively,” the report read. Mubasher International attributes the improvement in borrowing cost to some favorable factors, including improvement of Egypt’s various macroeconomic indicators, such as growth and balance of payments, progress in fiscal consolidation process, and upgrading Egypt’s credit outlook by Standard & Poor’s (S&P) and Fitch Ratings.
“Egypt has been approaching different sources of finance to bridge the fiscal gap. Also, tapping international debt markets was an attempt to secure the needed flow of foreign currency,” economist Israa Ahmed from Mubasher International tells Business Today.
Among the bright sides highlighted by Mubasher International was external debt being “skewed” towards longer maturities, which is believed to ease pressures on foreign currency liquidity in the short-run. “During the three fiscal quarters between Q3 FY2016/17 and Q1 FY2017/18, short-term external debt has been receding, both in absolute and relative terms (versus total debt),” the report clarifies.
Aiming to secure a financial gap projected to range between $10 to $12 billion during the current fiscal year 2017/18 (ending June 30), finance the budget deficit and bolster foreign reserves, Egypt’s Finance Ministry successfully raised $4 billion from selling dollar-denominated Eurobonds in the international debt markets in February.
The issuance was three times oversubscribed with an order book of $12 billion, a sign described by the authorities as a “vote of confidence” in the Egyptian economy.
Another sale of euro-denominated bonds ranging between €1-1.5 billion is also planned for April. The government has already nominated four international investment banks to manage the sale: Deutsche Bank, BNP Paribas Bank, Bank of Alexandria “São Paulo” and Standard Chartered Bank.
Following the Eurobond sale plans, parliament members expressed their concerns over the authorities’ appetite for borrowing from abroad, and the external debts’ pace of growth since the pound float. The CBE governor Tarek Amer, however, has expressed his satisfaction with the current level of foreign debt in a speech last October, affirming that there is no problems in seeking additional loans.
“We are committed to timely repayment and we have not defaulted at all,” he had told the media. Similarly, Amr El-Garhy, minister of finance, had also said last September that “the government is keen on keeping its foreign debt within safe boundaries.”
Not all experts, however, are as confident as the officials.
“We are ‘cautiously observing’ the hike in external debt,” Mubasher International’s Ahmed explains. In their report, Mubasher International also highlights the ratio of short-term external debt to net international reserves (NIR) as a source of worry, measuring the adequacy of reserves and external vulnerability, which is still high, albeit declining.
“Short-term external debt in Egypt hovers around the mid-30s%, much higher than the MENA region average of 18%, excluding high-income countries (according to World Bank statistics),” the report reads.
But CI Capital’s Khaled seems less concerned, saying that the recent increases in the country’s foreign reserves justify the foreign debt’s fast growth pace.
“We know where the borrowed money goes. The foreign reserves’ level is comfortable and there are sufficient for priority imports for eight months up from less than three months before the float,” Khaled says. “What we would be more concerned about is where the money is being spent; is it directed for imports and securing consumption needs instead of investment?”
Khaled calls for adopting a vision of using loans in promoting investment, infrastructure and developing industrial zones. “In Japan for instance, the country debt is around 270% of GDP, but creditors have no fears because they see their money invested in infrastructure and the country’s manufacturing sector.”
Despite officials’ confidence and experts’ wariness, there are universally agreed upon factors the government needs to address in order to ensure keeping the foreign debt rate at bay. GDP growth, current account performance, exchange rate regime flexibility, fiscal performance and non-debt foreign capital inflows are key factors for external debt sustainability.
If such factors did not live up to the government’s own expectations in the years to come, then long-term commitments can place high pressures on the economy, the Mubasher report warns.
Pharos Holding’s el-Sweify says the external debt ratios are believed to gradually improve over time, supported by the exchange rate stabilization, which would help bring the external debt-to-GDP ratio down.
The accumulation of external debt will be gradually outpaced by more sustainable foreign currency inflows, which is backed by the successful implementation of the economic reform program, she explains. “Yet, we forecast the pace of foreign debt growth to slow down in the coming period, specifically by the end of the IMF program in 2019,” el-Sweify adds.
“Our positive outlook for the economy, predicted to grow by 5.5- 6% in 2018/19 and the reform program’s progress, support our forecast for a slower growth of the debt in general.”
Ending on an optimistic note, el-Sweify projects that Egypt’s economic indicators will witness a big leap in the next FY2018/19, boosted by the surge of remittances, more FDI inflows, tourism recovery by the year’s end on resuming Russian flights in addition to more active industrial sector furthering exports.
The positive outlook is also extended to the general government debt to GDP ratio, which is Mubasher International predicts to dip to 93% in FY2017/18 from a peak of 103% in FY2016/17, reversing the upward trend since the 2011 revolution. “By the end of FY2018/19, which is likely to also mark the end of the current IMF program, we forecast general government debt-to-GDP [ratio] to have fallen to 88%,” Mubasher says.
But whether all the borrowing will eventually pay off is yet to be seen. “The coming period will determine whether the foreign debt is alarming or not after repayments of about $12 billion dues during 2018 as 18-20% of total external debt is short term, while the rest are five to 10-year terms. This will give the government a chance to take breath and work harder to improve economic growth and macroeconomic indicators,” Khaled concludes.