Egypt’s funding requirements – a time-bomb waiting to explode
Turmoil places onus on whichever administration holds power to rectify economic imbalances.
The political storm in Egypt – following the ousting of president Mohamed Morsi after just one year in office – is plunging the economy further into a black hole, as FX reserves start to run out and the Egyptian pound bottoms out.
Fears are growing Egypt is on the brink of a financing shortfall, unless there is urgent fiscal support from the IMF or neighbouring MENA states. And it needs to happen fast, as the economy is running out of firepower.
The crisis has added to the government’s extortionate financing needs. “External financing needs amounts to about $19.5 billion for fiscal year 2014 and on the fiscal side [its] deficit is expected to be well into the double digits for the year again,” says Raza Agha, MENA economist at VTB Capital.
“And adding to that is [its] absolutely massive roll-over requirements on domestic debt, which amounts to about a quarter of GDP, or $64 billion, so financing needs are extortionate.”
Egypt’s recently appointed and ousted regime failed to secure a new IMF loan arrangement in April, forcing the abandoned government to search for loans from elsewhere. In early May, a report by Capital Economics suggested an agreement with the IMF was slipping further away – and recent events have only confirmed this view.
“The longer it goes without securing an IMF deal or making reforms to reduce its dependency on foreign capital, the closer it will be to a full-blown crisis,” states the report.
Qatar, Saudi Arabia and Libya have all been cited as potential lenders, but the effectiveness of these loans is questionable, according to Gabriel Sterne, senior economist at investment bank Exotix.
“These loans were supposed to be one-off and over the last couple of years they’ve become two-off and three-off and ultimately it will be switch-off – because unless they do the policy adjustments it doesn’t really help in the end.
So what is more important than whether they get the loans is the adjustments needed to correct very severe internal and external imbalances within Egypt,” he says.
The government’s high financing needs will continue to crowd out the private sector, given that the government is the dominant borrower in the economy.
“With banks able to lend to government at 17% corporates are being crowded out; those that rely on the banks are finding it very difficult to source funding; if you are a corporate big enough to issue bonds it is very hard for you to finance lower than the sovereign so it does create a very difficult funding environment.”
Agha questions: “But how many corporates will want to borrow at this stage when the growth outlook is very uncertain, external demand very weak and domestic demand being further impacted?”
Egypt’s FX reserves have plunged more than 50% since the beginning of 2011, falling $14.4 billion in May – which amounts to just under three months of imports in terms of trade-cover – and reached an all-time low of $13.1 billion in March.
Time is running out for the government.
The FX reserves are weak and dangerous and the weakening pound was an inevitable response to the imbalances. If you don’t do the adjustments the market will do it for you. On the forward currency markets NDFs have weakened even more than the spot exchange rate.”
“So markets have no confidence that this represents an adjustment to a new equilibrium, what it represents is a rather uncontrolled response to falling reserves. Ultimately what is needed is a fiscal adjustment programme more or less along the lines of what the IMF suggested.”
The cost of insuring the country’s debt against default soared to a record high on Wednesday, after the country’s five-year CDS spreads peaked to 896 basis points from 878bp on Tuesday, according to data provider Markit (see chart below).
Nevertheless, analysts say Egypt’s vulnerabilities lie in the local economy, principally a collapse in the Egyptian pound, a financing crunch for corporates and high inflation. The dollar bond is not due until 2020.
The political situation is in flux and any governing party has substantial domestic obstacles to overcome before fleshing out an economic stabilization plan that is seen as democratically legitimate, says Agha.
“If Morsi came in with high expectations, one can only imagine the expectations being associated with the interim government,” he says. “In addition, the incumbent administration now faces a large segment of the population which stands disenfranchised because of the actions yesterday.
“So what we have seen since Mubarak’s exit is that not only do you need a credible plan to address these expectations but managing them is equally important. If you don’t manage these expectations, the situation does not end well.”
Crafting a stabilizing economic programme – that attacks vested interests by reforming fiscal subsidies – while agreeing to costly reforms in the short-term would be challenging for any country, not least an incoming administration that will be beholden to populist agendas.
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