Seven Charts Show Egypt’s Debt Dilemma Ahead of Fed Tapering
(Bloomberg) -- Egypt’s reliance on foreign inflows has placed it among the emerging markets vulnerable to an investor exodus when the U.S. Federal Reserve begins tapering its pandemic stimulus -- but it’s better equipped than many to weather any volatility.
The Fed’s move is expected to spur interest-rate hikes in advanced economies, making them more competitive against Egypt’s high-yielding but higher-risk debt. That’s a challenge for the North African nation where record investments in T-bills and bonds have helped the economy withstand the pandemic.
Tempering concern among investors are Egypt’s foreign reserves; enough for about seven months worth of imports, they’d provide a cushion in a potential emerging market sell-off. One of the world’s highest inflation-adjusted interest rates comes with a high fiscal cost but gives it an edge over peers.
Egypt’s “growing reliance on capital inflows to fund its twin deficits, high gross financing needs and a large debt pool of 90% of GDP” put it among vulnerable countries, said Mohamed Abu Basha, head of macroeconomic research at EFG Hermes, though the risk-return equation for Egypt remains “lucrative.”
Below are seven charts showing Egypt’s strengths and vulnerabilities:
It Relies on Inflows
Key to Egypt’s position is the foreign investment that’s piled into the debt market since a 2016 currency devaluation. Overseas holdings in local bonds and bills tumbled in early 2020 due to the pandemic, before rebounding to reach about $33 billion in August.
That volatility exposed one of Egypt’s weaknesses -- its reliance on potentially fickle international flows.
Egypt’s recent inclusion on the Financial Times Russell Bond Index and plan to join JP Morgan’s Emerging Markets Bonds Index this year could reduce volatility in portfolio flows by shifting some investment to passive management, according to a report by S&P Global Ratings.
Real Rates Are Already High
Egypt has the highest differential between its key policy and inflation rates among more than 50 economies tracked by Bloomberg. That has made Egypt’s bonds a favorite among international investors, but means the cost of debt-servicing is already elevated.
If global rates rise, Egypt may face pressure to offer higher yields to keep inflows coming. The Fed is expected to tighten monetary policy at a moderate pace though, likely stretching into mid-2022, which gives Egypt room to adapt.
“Egyptian local rates have historically had low correlation with global rates,” said Shamaila Khan, head of emerging-market debt at AllianceBernstein in New York. “If other emerging markets are pressured, I would expect Egypt to still perform well on a relative basis.”
Bank Reserves Are Crucial
Egypt’s supply of foreign exchange will be key to handling any volatility -- and the picture is mixed. Net international reserves have held steady this year, recording $40.7 billion in August.
“Egypt has good buffers to deal with any potential capital outflows,” said Ahmed Hafez, research head for the Middle East and North Africa at Renaissance Capital. “More importantly, the real economy including tourism continues to improve.”
It’s different for local banks, whose net foreign liabilities swung to $1.6 billion in July from net assets of $1.7 billion the month before, as they used up liquidity to meet foreign-exchange obligations.
The Pound Is Overvalued
So what does that mean for the currency? Goldman Sachs Group Inc. recently called the pound “moderately overvalued” and said policymakers were apparently committed to maintaining a strong exchange rate. Sticking to that policy could have a negative impact on the competitiveness of Egypt’s exports.
Plentiful foreign reserves have so far offered reassurance to investors, however, while EFG Hermes said in a recent report that Egypt’s banks have the capacity to run much larger net short positions to cover short-term funding needs.
The pound’s been stable for over a year and is unlikely to see “meaningful” change in the next three to six months, Hafez said. “Longer term, we would optimally like to see some movement to maintain the real effective exchange rate and the competitiveness of the currency.”
It Spends a Lot on Debt Servicing
As one of the Middle East’s most indebted countries, Egypt’s main credit vulnerabilities are its weak public finances and debt-servicing costs that are among the highest of all rated sovereigns, according to S&P. That means Egypt may struggle to cope with a significant increase in borrowing costs.
It’s a situation authorities are addressing, with S&P saying the government had made “notable progress.” The proportion of budget spending dedicated to debt-servicing was 36% as of June, down from 40% a year before, with authorities targeting 32% by mid-2022, Finance Minister Mohammed Maait said in a recent interview.
The Economy is Growing Faster than the Debt
On the plus side, the ratio of debt-to-gross domestic product remains manageable, partly because the economy is growing relatively fast. After steep annual declines, the figure ticked up in the 2020-21 fiscal year as the pandemic took its toll.
The impact has partly been contained because the Egyptian economy continued to grow even as Covid-19 battered wealthier nations in the oil-exporting Gulf. It posted real GDP growth of 3.3% in the fiscal year that ended in June and is targeting 5.5% for the current year, taking it back to pre-pandemic levels.
After Turbulent Decade, Egypt’s Potential Growth Likely to Rise
It’s Extending Maturities
In managing the burden, the Arab world’s most populous nation is working to diversify the types of bonds it offers and to broaden its investor base.
It’s also been shifting toward longer-term debt, with average maturities climbing to 3.26 years at end-June from 1.3 years in 2013. That’s helped reduce the immediate pressure the government could face if foreign investors exit by spreading out its obligations.
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