What lies in store during the countdown to the first review of Egypt’s IMF loan deal?

Sherine Abdel-Razek , Saturday 2 Sep 2023

In spite of the economic, fiscal, and financial reforms that the country has embarked on since signing the loan deal with the International Monetary Fund (IMF) in October last year, Egypt is still muddling through a myriad of economic challenges.

source: Capital Economics


They include a severe foreign-currency shortage, ballooning debt, a currency that has lost more than half of its value in the last 18 months, and skyrocketing inflation.

Last week, Moody’s Investors Services, a US rating agency, said it would extend its review of the Egyptian economy for another three months with a view to a possible downgrade of the country’s debt rating in case the economic challenges persist. The review started in May and was supposed to be concluded this month.  

“The continuation of the review balances progress on the government’s privatisation, fiscal, and structural reform agenda against evidence of a further weakening in external liquidity through a drawdown of the commercial banks’ net foreign assets at a scale that exceeds recently concluded asset sales,” said Moody’s in a statement.  

The deficit in the banking sector’s net foreign assets increased to negative $27.1 billion in June from negative $24.4 billion in May. The hike in the deficit exceeds the $1.65 billion in foreign currency expected from the privatisation deals announced last month.

This situation, according to Moody’s, will potentially “undermine the goal to sustainably replenish the economy’s foreign-exchange liquidity buffers ahead of increased debt-service payments in fiscal year 2024 and 2025.”

In response, Minister of Finance Mohamed Maait was quoted in a statement as saying that Moody’s decision to extend its review was based on “its understanding of the steps and reform measures taken by the government recently to encourage investments and improve the business environment in addition to empowering the private sector by increasing its role in the economy.”  

He pointed to some reforms in particular, including annulling preferential tax breaks for state-owned companies, a step that guarantees fair competition in the market, in addition to the government agreeing with local and foreign investors to divest five state-owned companies with a total value of $1.9 billion, out of which $1.6 billion will be in foreign currency.

He said the budget had realised a primary surplus and a growth in tax revenues.   

As a net importer of food and raw materials, Egypt has been hard hit by the economic fallout of the Russian-Ukrainian war, stripping it of much-needed hard-currency resources. In response, the government has agreed a $3 billion loan facility with the IMF, but this has come with conditions, the hardest of which has been adopting a flexible exchange rate, a goal that Egypt has not so far realised despite devaluing the pound three times.  

The IMF postponed its first review of the loan conditions, scheduled to take place in March, due to a lack of progress in privatisation and exchange-rate flexibility. This means that the much-needed second tranche of the loan is being held back.

While the country is accelerating the pace of privatisation, it is hesitant to fully liberalise the exchange rate of the pound as this will fuel the already high inflation rates adding to the burdens of Egyptian households. Inflation in July hit an all-time high of 36.8 per cent fed by an almost 70 per cent increase year-on-year in the prices of food.  

The inflation rate is expected to rise further as a result of an increase in electricity tariffs, supply bottlenecks, and the further weakening of the pound, according to Yasmine Ghozzi, a senior economist for strategy and planning at S&P Global Market Intelligence.

Ghozzi said in a research note that upward pressure on wheat and rice prices as a result of Russia’s withdrawal from the Black Sea Grain Initiative and India’s decision to ban rice exports would likely keep food inflation high.  

She expected that headline inflation will peak at close to 39 per cent year-on-year in October.

Rather than stick to the IMF-prescribed devaluation that would come at a cost but would help to remedy external imbalances in the long run, Egypt has been trying to access external financing by attracting investments or tapping the financial markets with bond issuances.

However, distortions in foreign-exchange policy, as manifested by the presence of a parallel market for the currency, have been driving investors and creditors away.  

The continued lack of movement in the pound has allowed pressure to build up for another devaluation. The currency is currently being traded at a 20 per cent discount to the official rate in the parallel market.  

Egypt now needs to build up foreign-currency buffers in order to be able to manage another expected devaluation of the pound to meet IMF conditions and access further loan disbursements, a move that would be seen as a stamp of confidence in the economy and would encourage investors and creditors.  

“Moody’s would consider lack of progress with the IMF review over the remaining review period as an indication of a potential weakening of external financial support, which otherwise provides a key support to Egypt’s credit profile at the current rating level,” according to the agency.

During the last few months, the government has launched many initiatives to access more hard currency to feed its reserves, including by offering dollar-denominated certificates of deposit with an interest rate of up to nine per cent, allowing foreigners to buy real estate in Egypt provided they pay in hard currency, and allowing Egyptians abroad to settle their military status against a payment of $5,000.

On Monday, the National Bank of Egypt and Misr Life Insurance announced the launch of dollar-denominated pension certificates for Egyptian expats that will encourage them to make additional retirement savings by depositing dollars in the banking system.

“With the first review of the loan still pending, we think progressing on the IMF programme will be important for the government,” said Ghozzi, who now expects that the review will be delayed to September or October.  

“This will be more likely to materialise if a considerable improvement in Central Bank of Egypt net reserves is seen on the back of a strong tourism season and further progress on initial public offering deals,” she said.

Besides a full liberalisation scenario, S&P Global expects that the authorities could artificially keep the exchange rate stable or flat by withdrawing from the country’s reserves to support the pound through the end of 2023. In this case, the currency would be strong enough to reduce inflationary pressure.

Aliaa Moubayad, managing director for emerging markets economics and strategy at the UK-based Jefferies International, seconded Ghozzi that the IMF review is expected in September or October and was optimistic about the outcome.

“The IMF will take into consideration the positive steps taken by the Egyptian government and undertake both the first and second reviews together,” she said in an interview with financial news outlet Bloomberg Al-Sharq.

The review probably will not lead to Egypt’s fully liberalising its currency, she said.

“We believe that after the presidential elections, Egypt will liberalise the pound further, and then the third review might be accompanied by a decision to increase the value of the new tranche of the loan,” Moubayad said.

What lies next for the country’s ability to secure external financing, according to Moubayad, depends on the outcome of Moody’s review of the economy. The increase in debt costs after a downgrade of the agency’s rating is not a concern, as already the international markets price Egypt’s debt at the CCC level.  

However, any downgrade would make it very hard for the government and the new cabinet that will come to office after the presidential elections to upgrade the rating and thus access loans at more favourable terms, she said.

Moody’s cut Egypt’s credit score to B3 in February, which is close to the speculative grade and is on the same level with Turkey and Nicaragua.

Besides Moody’s, the other big two rating agencies have also downgraded their stance on Egyptian debt since the beginning of 2023. Fitch Ratings in May cut its rating to B, while S&P in April downgraded its outlook to negative.

* A version of this article appears in print in the 17 August, 2023 edition of Al-Ahram Weekly under the title Countdown to the IMF review

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