Pleasing Investors Is Getting Expensive for IMF-Backed Egypt
(Bloomberg) -- Egypt is facing a dilemma that’s troubling policymakers across emerging markets: what pleases overseas investors isn’t always what’s good for the economy.
It needs to maintain high interest rates to keep attracting foreigners, who hold about $17 billion in local debt, and avoid being sucked into a crisis that has swept emerging markets this year. But Egypt’s high borrowing costs are hurting businesses and setting back government plans to cut one of the highest budget deficits among developing economies.
After lifting most capital controls in November 2016, Egypt raised interest rates to stabilize the pound and rein in inflation, which hovered above 30 percent for much of last year. The currency reform helped secure a $12 billion loan from the International Monetary Fund to support an economic overhaul that aimed to cut the budget deficit to 8.1 of gross domestic product by mid-2019. Now the government is saying it may have to adjust that target as debt servicing costs weigh on its finances.
The central bank was expected to ease interest rates by up to five percentage points this year as inflation slowed. It cut 200 basis points in February and March, but has stopped loosening due, among other factors, to the impact of “trade tensions” and tighter “global financial conditions” on some emerging market currencies.
Egypt’s Monetary Policy Committee is due to hold its next meeting on Thursday to discuss its benchmark rate. All 12 economists surveyed by Bloomberg said they expect it to hold the overnight deposit rate at 16.75 percent.
Below are the key issues on the minds of Egyptian policymakers:
High rates translate into more expensive debt for the government, threatening to reverse its success last year in reducing the budget deficit to below 10 percent of GDP for the first time since 2011.
Expecting significant rate cuts in the 2018-19 fiscal year, officials had budgeted that yields on local debt would average 14.7 percent versus 18.5 percent in 2017-18. Instead, the government has issued T-bills and T-bonds at an average yield of about 19 percent since the fiscal year began in July. That’s creating a “huge problem” as servicing costs mount, Finance Minister Mohamed Maait said this month.
On Monday, the government canceled the fourth T-bond auction in a row because rates requested by investors were too high.
In the current 2018-19 budget plan, interest payments are forecast to grow to 541 billion pounds ($30.2 billion), making up 38 percent of total expenditure and 70 percent of tax revenue. However, every 1 percentage point increase in average rates raises the debt servicing bill by 4-5 billion pounds, according to the state budget.
The government is seeking to reduce its financing costs by tapping international debt markets and relying less on pricier Egyptian pound-denominated treasuries. The troubles in emerging markets have made bonds more expensive for Egypt, but not necessarily prohibitive, according to Bank of America Merrill Lynch economist Jean-Michel Saliba.
The pound’s relative stability has helped position Egypt as a refuge from volatility amid the meltdown in emerging markets. Nonetheless, at least $6 billion worth of foreign holdings in local debt left the country in the three months from the end of April, and the recent rise in yields suggests interest from foreigners is dwindling. After rising rapidly following the 2016 currency reform, foreign reserves have stabilized at an all time high of $44.4 billion.
Investor jitters have yet to make a significant impact on the pound, though. Given that most of the foreign inflows were parked in a special fund at the central bank and were not financing the current account deficit, the direct impact of portfolio outflows on the pound will not be as severe as in other emerging markets, Mohamed Abu Basha, head of macro analysis at Cairo-based EFG-Hermes investment bank, said.
“The EGP made minimal gains on the way up and will make minimal losses now that the flow has reversed,” he said. “We see the spillover into Egypt largely resulting in higher domestic interest rates for longer.”
Higher rates have shaped the way the economy expanded over the past two years. Foreign investments in the real economy are lagging targets, while high borrowing costs are impairing the recovery in the domestic private sector.
Companies are “reluctant to borrow for expansion because loans are expensive,” said Monsef Morsy, head of financial analysis at CI Capital in Cairo. “Credit is indeed growing, but it’s mostly to fund working capital, and not for investment.”
While the economy grew by about 5.3 percent in the last fiscal year, the fastest pace in a decade, that expansion was mainly driven by government infrastructure spending, including building a new capital city east of Cairo, a recovery in tourism and gas sector investments, according to Omar El-Shenety, managing director at Cairo-based investment bank Multiples Group.