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Egypt: Financing Strains Mount
By Ayah El Said
The ongoing political transition in Egypt is exacerbating an already weak fiscal position, which is typically stressed by high commodity prices and spending needs. The mounting demands from those employed by public sector companies as well as rising debt service costs will add to these strains and there is a risk of a negative feedback loop as lower growth reduces revenues, necessitating more costly stimulus. As noted in recent analysis, Egypt will be facing financing challenges as it attempts to contain the rising unrest through populist policies--larger subsidies on wheat, sugar and vegetables and key staples, a 15% wage and pension increase for civil servants and effectively shelving plans to introduce new taxes, including a new property tax. All these steps will increase the budget deficit which stood at an estimated 8% of GDP in 2010.
These demands will further shift the composition of the government budget to subsidies and wages relative to infrastructure investment in 2011 as policy makers seek to get more bang for their fiscal stimulus buck. While this might help in terms of political stability, assuming the government also manages to stabilize the increasingly uncertain the security situation, it will hamper long-term growth prospects.
We expect Egypt, despite relatively (modest) debt levels relative to MENA oil importers, to face further difficulty in funding in 2011. The political uncertainty and potential fiscal deterioration has kept international bond markets prohibitively costly and instead Egypt has continued to focus on short-maturity debt. This preference extends a trend since the global financial crisis that reduced the average maturity of Egypt’s debt and increased rollover risk.
Pressure on local institutions to buy up T-bills contributed to relatively successful auctions, as noted in our recent Egypt analysis. However, with foreign investors (who held 23% of outstanding T-bills at the end of 2010) wary of buying bills, even with rising yields, moral suasion may be running thin, and several of the recent auctions did not have full coverage at desired prices. In February 2011, Central Bank Governor Farouk El Okdah met with the heads of local banks and instructed them to purchase the T-bills issued by the government. The first sale, on February 6, sold only LE 13 billion of a total of LE 15 billion. Since then, Egypt has been less and less capable of selling its planned T-bills. On March 8, Egypt raised 3 billion pounds (US$ 509 million) in T-bills, almost US$250 million less than planned as yields increased. Not only was the sale of T-bills weaker than desired, the cost of insuring Egypt’s debt has risen. Given forthcoming issuance, they could rise further.
Figure 1: Egyptian Yields Still Elevated
Beyond any changes in the budget, the government may need to borrow at least 30% more than it originally anticipated for 2011, which could push the issuance of T-bills and T-bonds to over LE130 billion (US$22 billion). To add fuel to the fire, Egypt has a high concentration of T-bills maturing in coming months, which means it will need to refinance this debts well as meet new financing needs. Of immediate concern is Egypt’s need to pay its import bill. With imports of roughly 10 million tons of wheat in H1 2011, Egypt is set to be the world’s largest wheat importer.
Higher oil prices will boost government revenues modestly, though Egypt has little scope to take advantage of higher oil prices given the lack of capacity. These revenues, in addition to those of natural gas and still strong Suez Canal revenue streams, could provide a partial offset. Not only do immediate revenue prospects remain weak due to collection issues and weaker growth, but new revenue sources may be on hold for some time. Fiscal consolidation may begin only in 2012/13 as growth picks up. As previously mentioned, the political situation effectively halts the introduction of newer measures such as the property tax. Moreover measures like public private partnership (PPP) initiative initialed in late 2010, and the lack of privatization could add further pressures on the government finances. The PPP initiative aimed to attract foreign capital and expertise, enabling the Ministry of Finance to decrease expenditure on infrastructure. This plan always seemed optimistic.
Although no talk has emerged about the possibility of an international financial package aiding Egypt’s economy, Egyptian authorities sought debt relief from the European Union at the end of February 2011 (outstanding debt to EU member states is roughly US$9 billion). They also sought a trade package as part of the EU’s wider plan on aiding North African countries. We expect the EU to be slow to respond, despite the potential costs from further destabilization in Egypt. With EU member states looking inward, they will be reluctant to write down debt. Should Egypt continue to face significant pressure on its FX reserves, which fell US$2 billion to US$33 billion in the month of February, it could turn to the IMF.
One other temporary upside is that the very same precautionary savings that are weakening consumption could cushion the banking system and effectively fund the government. This situation is not sustainable, given the low income levels in Egypt but it could further bolster the banks and if the political and economic situation stabilizes, these banks could gradually begin relending. Already, Egyptian banks are relatively liquid (loan-to-deposit ratio of 53%), providing a cushion against potential financial instability. Assuming they are not transferred abroad, higher savings will be translated into higher levels of deposits. This is only a temporary stopgap at best.