Macroeconomics
DispatchesfromCairo:BitterMedicineforStrongerGrowth
7 mins
It is a medicine with a very bitter taste, but it will make us stronger." – Taxi driver commenting on the Egyptian government’s policies.
It was good to be back in Egypt’s capital to exchange views with locals and get a qualitative feel of the situation and outlook. Our meetings with government officials, multilateral organisations, private sector companies, and diplomats were encouraging. As usual, Cairo was buzzing with activity, but the traffic was flowing more easily than in the past thanks to a new network of highways and bridges—although staying in one’s lane remains an elusive concept for Cairo’s drivers.
We travelled there to find answers to three basic questions:
- How committed are authorities to the new growth model recently presented by the Prime Minister? And what are the implications for the fiscal outlook?
- Will the Central Bank of Egypt (CBE) allow the exchange rate to be more flexible?
- What is the state of negotiations for a new IMF program?
On Growth
On the growth model, the authorities are very committed to transitioning from a model based on large infrastructure projects financed via debt accumulation with a significant foreign participation to one based more on export promotion and import substitution with limited participation of “hot money” in financing a narrowing current account deficit. Foreign Direct Investment (FDI), particularly from the Gulf, is strongly encouraged to fund the privatisation of existing companies and as greenfield investments, especially in the exporting/import substituting sectors and in renewables. That said, the government has prioritized a handful of sectors for this strategy, introducing more than a whiff of 1970s European industrial policy (i.e., the government, and not the market, decides what sectors to develop) that might result in some disappointments, together with some success stories.
As always, the devil is in the details. How long will it take to attract FDIs? Some FDIs from the UAE have already taken place but more is needed to attract additional investment. The authorities have prepared a standard set of incentives, and some of these measures still need to be finalised. One potential issue is the existence of a number of agencies/ministries involved in attracting investments and in privatising existing assets. Everybody agrees that the Prime Minister and the government in general appear to have a firm grip on the process and differences of opinions amongst the different stakeholders should be ironed out quickly and decisively. The target is to privatise assets for $10 billion per year for the next four years, including the current fiscal year 2021/22. We were told that, thanks to the UAE investment and other deals being finalised, this year’s target should be reached.
Cairo's Impressive Network of Motorways
Giancarlo Perasso.
A bigger unknown is the fate of the assets controlled by the military as it is unclear whether these will be up for privatisation.1 Tackling the presence of the military in the economy will be a major task for the government but the new growth strategy is strongly endorsed by President El-Sisi and by the government. Therefore, we expect good progress to be made.
Finally, social stability is a strong imperative for the authorities who are aware of the potential social costs associated with the end of labour intensive, large-scale projects, the reallocation of labour, and the current increase in prices. The trauma of the 2011/12 social unrest is still very much top of mind and the government wants to avoid a repeat of those events. To this end, it has begun to streamline and strengthen the social safety net. The all-important bread subsidy will be better targeted to the neediest families and conditioned, for example, on families sending their children to school. “People must not go hungry” is the mantra we heard many times, and shelves remained well stocked even during the pandemic. Thanks in large part to new infrastructure leading to improved stocking facilities and less waste, wheat is available and stocks are sufficient for the next three months. A lack of any organised opposition should also be helpful in avoiding a repeat of 2011/12.
It is important to stress that the overall prudent fiscal stance will not be relaxed in the new growth model. The 2022/23 budget sets a primary surplus of 1.5% of GDP (1.3% in 2021/22) and an overall deficit of 6.1% of GDP (6.2% in 2021/22), resulting in a debt/GDP of 84% (86% in 2021/22). These ratios are based on a revised GDP that will be published shortly, after the full approval of the IMF’s Statistics Department. According to officials in the Ministry of Finance, about two thirds of the revision has been approved by the IMF, so there is a reasonable expectation that it becomes official.
The interest burden will remain elevated, and the government is very keen not to rely upon “hot money” after experiencing very large outflows earlier this year. We were told that the banking sector has ample liquidity and can absorb domestic debt issuance, although Egypt will keep coming to the Eurobond market, possibly in less frequent and smaller issues, depending on market conditions. Issuance in the form of Eurobonds, sukuks, private placements, and green bonds are all being evaluated. The budding local pension industry could also provide a source of financing.
Charming Old Town Cairo
Giancarlo Perasso.
Exchange Rate Flexibility
On the exchange rate flexibility, we sensed that the CBE is clearly defensive on this issue since a genuinely flexible exchange rate is the first condition for an IMF program. However, for reasons we do not understand, the CBE seems to still hold reservations about adopting a more flexible exchange rate. A fully flexible exchange rate, in our view, would also limit the inflow of “hot money” and, therefore, fit the government’s growth strategy.
The CBE also appears willing to restrict the FX market to importers and exporters, thus shrinking the market’s depth. The daily turnover is now about $200 million per day, significantly lower than a while ago. Also, the CBE has introduced administrative measures, such as obliging importers to have a letter of credit, that increases the cost for importers. That said, a good deal of demand for FX is from multinationals involved in intra-firm transactions, so it is not a means to limit imports. We understand that the CBE is in the process of revising this new regulation, so we will see what happens.
The CBE hiked the policy rate as inflation accelerated, sticking to its inflation targeting mandate. Going forward, it seems cautious about significantly hiking rates further, but this will depend on the inflationary trend.
IMF Program
Regarding the IMF program, everyone we talked to was tight lipped about the timing of the mission, and we believe this is largely due to the difficult negotiation around the exchange rate regime. Some mentioned that they expect a deal to be finalised by the end of July. It is not clear whether they meant a Staff Level Agreement or a Board approval. The latter seems difficult to achieve in that timeframe, but we will see. The IMF should be pleased with Egypt’s fiscal stance and the new growth model, and the World Bank is ready to provide its expertise in privatisation and structural reform. The program will be an Extended Fund Facility, as is widely expected, and should include a target for foreign exchange reserves. That said, official reserves barely moved in 2021 since the state banks intervened on behalf of the CBE. One possibility might be to set an “extended” target of CBE reserves plus the Net Foreign Assets of the state banks.
Investment Outlook
What potentially sets Egypt apart from many of the other credits in a similar predicament is a willingness to work with the IMF and enact reforms. Financial support from the Gulf and potential future FDI is another significant positive development. Vulnerabilities are likely to persist, and the implementation of reforms is still a big risk, but valuations now better reflect Egypt’s challenging circumstances and justify a reduction in our underweight positioning.
1Some of the companies owned by the military are formally “private companies.”