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Thursday, 28 May 2020

Analysis: Fallout of regional tensions on Egypt's economy

With tensions between the US and Iran reaching crisis point, how are the growing problems in the region likely to affect the Egyptian economy

Sherine Abdel-Razek , Thursday 9 Jan 2020
dollars, Egy Pound
Egyptian pound to US dollars (Photo: AP)
Views: 1849
Views: 1849

While sighs of relief could be heard as the phase one deal between the US and China was reached, calming fears of a fierce trade war, the world was taken aback as the new year began by developments in the Middle East, with a possible war looking to be in the making.

Less than a week into the new year, US-Iranian tensions are reaching a critical point, and Turkish troops have been deployed in Libya, a move that Egypt is unhappy with. The impact of these developments has been felt worldwide in the drop in global stock markets as well as a hike in oil prices.

Most stock markets around the globe ended their trading sessions in the red this week as investors are ditching shares in favour of safer assets such as the Japanese yen and gold.

In the longer term, it is believed that the global economy could come under further pressure. “A US-Iran war could shave 0.5 per cent or more off global GDP, mainly due to a collapse in Iran’s economy but also due to the impact of a surge in oil prices,” wrote Jason Tuvey, a senior emerging markets analyst at Capital Economics in London.

The resulting collapse in Iran’s economy could knock as much as 0.3 per cent off global GDP, equal to estimates of the damage from a US-China trade war. The impact on the other Middle East countries would ultimately depend on whether they got caught up in the conflict, Tuvey noted.

Could Egypt be affected? “We think the impact of such escalations would be of a temporary nature, just like geopolitical tensions have been recently,” Esraa Ahmed of Shuaa Capital, a financial firm, said.

He said there were four major ways to determine the potential impact on the Egyptian economy in case the tensions are not short-lived. These include the impact on inflows to treasuries, the exchange rate, oil prices, and economic growth.

Fears of geopolitical risks could trigger potential outflows or at least limit new inflows to Egypt’s treasuries, just like in other emerging markets, especially in the MENA region. “This reaction could push the US dollar/Egyptian pound exchange rate and treasury yields higher, thus reducing the expected easing pace in 2020,” Ahmed said.

Foreign holdings of Egyptian treasuries rose to $14.96 billion in October, compared to $11.7 billion in the same month the previous year, according to Central Bank of Egypt data.

The increase has been supporting the local currency against the dollar, with the pound appreciating by 10.5 per cent against the dollar in 2019. But these gains might not be sustained, since at times of threat investors tend to go for safe-haven assets, including currencies like the dollar and the Japanese yen and precious metals such as gold, an all-time favourite when there are fears of turmoil.

“A higher dollar could impact the Egyptian pound, especially if Egypt faces an outflow of foreign investments, particularly in domestic debt instruments,” Shuaa Capital said.

The tensions between Iran and the US will also likely fuel an increase in oil prices, and they jumped three per cent last Friday, one day after the assassination of Qassem Suleimani, a major figure in the Iranian regime, by a US strike to reach $68 per barrel.

The price had reached $70 a barrel on Monday. “If Iran tried to close off the Strait of Hormuz, we’ve previously estimated that Brent crude would jump to $150 a barrel,” Shuaa Capital commented.

Higher oil prices will adversely impact Egypt’s trade balance, and this could hurt the cost of Egypt’s oil-price-hedging contracts that are reviewed periodically. Costlier oil could result in the higher cost of fuel and higher retail prices, hence posing a threat of inflation.

Egypt has struggled with escalating inflation since the floatation of the pound as part of an International Monetary Fund (IMF)-backed reform programme, and it was only in the second half of 2019 that inflation rates started to ease down to reach 3.1 per cent in October, encouraging the Central Bank of Egypt to lower interest rates three times throughout the year.

A reverse in the trend would push the bank to consider hiking interest rates once again.

Moreover, Shuaa Capital pointed out that Egypt has been depending on investment for economic growth, and if the current developments hurt foreign investment, dent private investment, or push the trade deficit higher, this could undermine growth rates.

Egypt’s economic growth rate is expected to reach 5.5 per cent in the fiscal year that began on 1 July and 5.7 per cent next year.

*A version of this article appears in print in the 9 January, 2020 edition of Al-Ahram Weekly under the headline: Fallout on the economy

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