Egypt’s economic growth is relatively strong, with real GDP growth projected to hit 5.3 percent in FY2022/2023 through FY2023/2024, according to Standard & Poor’s (S&P), the leading American credit rating agency.
In its recent report on Egypt’s economy conditions — with a special focus on the country’s monetary policy — S&P said that public investment in the country’s infrastructure and other projects will drive much of its expected growth, however, it will cause fiscal and external deficits.
S&P said that the report does not include rating-related figures.
“More sustainable economic growth would come from the private sector’s deeper engagement, which would be driven by structural reforms to improve competitiveness, governance, and the business operating environment,” the report elaborated.
On Egypt’s main external weaknesses, the report said that they stem from a low goods and services export base, which recorded 13 percent of GDP in 2020, adding that low exports make Egypt a relatively closed economy.
The report also attributed the country’s external weaknesses to the limited foreign direct investment (FDI) inflows into non-oil sectors.
In this respect, the report noted that Egypt’s net FDI inflows constituted only about 2 percent of GDP in 2020; expecting the country to continue to run a current account deficit as investment needs outpace its ability to generate domestic savings.
“However, keeping current deficits low will require much stronger growth in non-oil exports. Regarding funding these deficits, a shift in the composition of external financing away from debt and towards equity would support the exchange rate and allow the Central Bank of Egypt (CBE) to gradually cut the real interest rates further,” the report explained.
It added that attracting more FDIs is anticipated to attain structural improvement in Egypt’s economic growth model and fiscal position.
In this context, the report pointed out that a key pillar of Egypt’s macroeconomic strategy since 2019 has been to keep real interest rates high, which leads to robust portfolio inflows, foreign exchange reserve accumulation, and a stable exchange rate.
“However, high RIRs come at an elevated fiscal cost. Egypt’s interest-to-revenues ratio and its interest payments as a percentage of GDP are among the highest of all rated sovereigns,” according to the report.
The report projected Egypt’s foreign currency buffers to alleviate against capital outflows stemming from rising global interest rates in developed markets.
And yet, Egypt needs to maintain its path to put debt to GDP ratio on a steeper downward trajectory, according to the report.
On the other hand, the report perceives elevated risks regarding Egypt’s balance of payment if there were a sharp withdrawal of funds under the pressure of COVID-19 and the rising inflation globally while current account receipts remained weak owing to pandemic-related damage to tourism and export receipts.
“This could result in a substantial decline in foreign exchange (FX) reserves and reduce Egypt’s ability to service its debt,” the report underpinned.
On the flipside, the report expected Egypt to keep sufficient buffers and funding sources to manage liquidity.
“Moreover, Egypt’s high real interest rates (equal to nominal interest rates minus inflation) compared to other emerging markets will likely also maintain some investor interest. However, the government has a very high interest burden, and this will continue to weigh on public finances,” according to the report.
On why Egypt is vulnerable to rising US interest rates, the report said that Egypt’s external debt — particularly the share of short-term local currency government securities held by non-residents — has risen rapidly since 2017.
Non-resident holdings of local currency government bills and bonds increased to $33 billion (13 percent of total securities) in early August 2021, from a low of $10 billion in June 2020 and above the pre-pandemic peak of nearly $28 billion in February 2020, according to the report.
It added that these inflows have been supported by robust international liquidity, high real interest rates, and a more-resilient macroeconomic climate in Egypt than in many similarly rated peers in the region.
“Egypt is more vulnerable to sharp capital outflows today, compared with several years ago, because of its higher exposure to external debt and elevated government financing needs of more than 30 percent of GDP annually, which is partly driven by its large proportion of short-term debt. Egypt’s fiscal challenges are not unrelated to its recent external performance. The lingering impact of the pandemic on tourism, remittances, and global trade is also weighing on Egypt’s key sources of foreign currency,” the report explained.
“We estimate that Egypt’s total public and private external debt (based on residency) increased to nearly 220 percent of current account receipts (CARs) in FY 2021/2022 (ending June 30), from 176 percent in FY 2020/2021 and 110 percent in FY2016/2017, mainly on the back of higher portfolio inflows and lower CARs.”
However, the report noted that Egypt has sufficient buffers to guard against market pressures, including its sizable FX reserves of about $41 billion as of the end of July, albeit lower than the $45 billion at the onset of the pandemic.
It also found Egypt’s external liquidity is adequate, with reserves covering slightly more than five months of current account payments in the current FY2021/22 and close to 180 percent of short-term external debt.
The CBE had other foreign currency assets of around $7 billion deposited in banks as of the end of July which are not included in official reserves, according to the report.