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2011-2020: Egypt - Escaping the debt trap

The government is overhauling its decades-long problem of ballooning public debt

Sherine Abdel-Razek , Thursday 31 Dec 2020
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source: Pharos Holding
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Reports on the Egyptian economy over the last 20 years have highlighted inflated public debt as one of its main shortcomings. The problem started with the Open-Door Policy in the 1970s, remained during the neo-liberal system of the Mubarak era, and has survived all the reforms that have taken place in the years following the 25 January and 30 June revolutions.

 Even when the Ministry of Finance revealed a scheme to reduce the debt in 2018 and improvements started to show, the plan was thrown off course due to the outbreak of the Covid-19 pandemic this year.

Egypt’s total debt, both domestic and foreign, is projected to stabilise at 114 per cent of GDP in fiscal year 2020-21, hitting LE7.2 trillion compared to 115 per cent of GDP in 2019-20. Prior to the Covid-19 crisis, the authorities had made significant progress in reducing the public debt from nearly 104 per cent of GDP in 2016-17 to 85 per cent in 2018-19.

The plan focused on reducing the cost of borrowing by diversifying its sources and making the maturities of the domestic debt longer to reduce the cost. Egypt’s lowering its debt burden will ensure more funds are available for education and healthcare.
 

*A version of this article appears in print in the 24 December, 2020 edition of Al-Ahram Weekly



STREAMLINING TREASURIES: The Ministry of Finance has been working with the Central Bank of Egypt (CBE) to extend the tenors of Egypt’s treasury bonds, rather than relying on instruments with three- and nine-month tenors.

By the end of June this year, average maturities were 3.2 years, up from 1.3 years in June 2013.

Before the virus struck the government had succeeded in ending its reliance on short-term borrowing, a senior official in the Ministry of Finance told Bloomberg. In February, the Ministry of Finance realised the target of tripling the size of treasury bond sales and raising the share of longer-dated debt to 40 per cent of annual domestic issuance, double the level in the fiscal year that ended in June 2018.

Foreign investors have been drawn to Egyptian pound-denominated treasuries since its 2016 devaluation due to their high yields, the stable currency, and signs from the government that it was committed to further economic reforms.

Returns offered by Egypt’s local-currency bonds remain some of the highest among emerging markets. Overall flows by the first week of December reached $23 billion after plunging to $10.4 billion in May amid emerging markets sell-offs by foreign investors.

Egypt attracted $9.8 billion in foreign investment in domestic debt instruments in the 2016-2017 fiscal year, compared to $1.1 billion the previous year.

According to a recent research note by Pharos brokerage, while Egypt currently offers a world-beating one-year bond with a nominal yield of 14 per cent, thanks to the waves of Covid-19 stimulus the developed countries are almost universally offering negative yields, while rates in most other emerging markets are now below five per cent.

The Ministry of Finance is also working on the prerequisites for making Egypt’s local debt more accessible to foreign investors through its agreement with Europe’s biggest settlement house for securities, Euroclear. The agreement will link the government’s local-currency debt-issuance tools with Euroclear via a central securities depository to be established in Egypt.

This will make domestic Egyptian debt available to a larger number of foreign investors.

“This agreement will allow the market to maintain a large volume of liquidity and lead to a decline in borrowing costs, subsequently lowering yields on the debt bill and increasing the liquidity of local assets,” Minister of Finance Mohamed Maait said.



EXPANDING EXTERNAL DEBT: Shifting to external debt and expanding its share of overall public debt has been an obvious a trend since 2014-15, and it is a part of the government’s scheme to reduce debt servicing as foreign debt has proven to be less costly.

The external debt’s share surged from an average of 15 per cent of total debt during 2014-15 to 30 per cent in 2019-20. Pharos expects external debt to stabilise at 35 per cent of GDP over the 2019-20 to 2021-22 fiscal years. The effective interest rate paid on domestic debt stands at around 11 per cent versus two per cent on external debt, Pharos noted.

In its pursuit to secure cheaper foreign sources of borrowing to face up to the effect of the coronavirus pandemic, Egypt returned to the International Monetary Fund (IMF) during 2020 and signed two agreements according to which it got a $8 billion lifeline. This comprises emergency financial assistance of $2.772 billion to meet urgent balance-of-payments needs stemming from the outbreak of the Covid-19 pandemic and a stand-by arrangement (SBA) that gives Egypt access to $5.2 billion.

The latter will be repaid in instalments, the first of which will be 3.25 years after the disbursement date with an interest rate that hovers as low as three to four per cent.

These agreements came just a year after completing a $12 billion, three-year programme with the IMF. The latter was signed in 2016 soon after the devaluation of the pound and came attached to a number of reforms.

Egypt has tapped the international markets with a series of Eurobond issues, and for the first time green bonds were also on the table. In May, Egypt sold $5 billion in Eurobonds in its largest-ever international issuance. The issue was 4.4 times oversubscribed.

The issue included three tranches with yields of 5.75, 7.625, and 8.875 per cent. According to a Ministry of Finance analysis of buying orders from investors in Asia, Africa, North America, Europe, and the Middle East, nearly 60 of the 400 investors showing interest were newcomers to Egyptian Eurobond sales, a fact that helped in lowering the final yields on the three tranches by 0.5 per cent when compared to those at which the bonds were initially marketed.

Egypt’s first-ever green bond issue was five times oversubscribed. The issue, worth $750 million, will be used to finance environmentally-friendly and renewable energy projects. Earlier in the year, Egypt revealed a portfolio of $1.9 billion worth of potential green projects.

The sale “put Egypt on the map of sustainable financing”, the Ministry of Finance said.

According to a statement, interested buyers included a new investor base from Europe, the US, East Asia and the Middle East, as well as asset managers, pension, investment and insurance funds. It added that such diversified, long-term and high-quality investors would reduce the price volatility of the bonds.

In November, the cabinet approved a new law to issue sovereign sukuk or Islamic bonds. This is after the first corporate sukuk issuances by the Talaat Mustafa Group and Tharwa Capital were warmly welcomed by the market. The sukuk bonds target mainly Islamic banks and funds in Egypt and the Gulf. Using this Sharia-compliant tool will reduce borrowing costs given that yields on sukuk are less than on bonds.



MISSED OPPORTUNITY: Egypt’s debt problem exacerbated after the 2011 Revolution as this was followed by a period of political and economic turmoil.

In a research paper on Egypt’s debt trap, economic researcher Mohamed Mosallam notes that the 25 January Revolution was an opportunity to write off all or a substantial part of Egypt’s debt.

“The strong evidence available on how public funds and resources were corruptly managed presented the post-revolution governments with a rare opportunity to review and audit the inherited debt obligations from the deposed regime,” he said.

He explained that in international debt contracts when there is evidence of corruption and the misuse of public funds for the personal enrichment of the regime and its cronies, as was the case with the Mubarak regime, debt contracts can be audited.

“Post-revolution Egypt had inherited almost $37 billion of external debt that was incurred in circumstances that lacked transparency and in the absence of any monitoring mechanism of how these funds were used,” he said.

A movement called the Popular Campaign to Drop Egypt’s Debt was formed and succeeded in making a debt audit an official demand adopted by the Union of Independent Syndicates and the Socialist Coalition Party, as well as an important component of several presidential campaign plans. It was adopted by MPs in the first elected parliament.

However, fast changes in the political scene then overshadowed these demands.

Egypt’s post-revolution economic strategy focused on financing the expanding budget deficit and stabilising the Egyptian pound amid a growing balance-of-payments deficit by depending on short-term financing.

During 2011 and 2012, Egypt experienced an exodus of capital outflows, and the government resorted to the international reserves to repatriate foreign capital, service its debt, and repay foreign oil explorers and settle the inflated imports bill. Capital flight reached $12.8 billion from the government’s treasury bill market, the stock market, and the banking system. As a result, the country’s net international reserves dropped to $15 billion by December 2012.

To deal with its weak finances, the government favoured borrowing money rather than the socially unfriendly decisions of slashing subsidies or introducing taxes to finance its deficit. As a result, domestic debt rose from 76 per cent of GDP by the end of the 2011 fiscal year to 85 per cent by the end of 2014, which was primarily financed by the domestic banks. Debt-servicing payments on domestic debt alone had reached around 40 per cent of total expenditures in that year.

While governments following the revolution shied away from borrowing money from international donors, foreign assistance was poured in by pro-Muslim Brotherhood regimes like Qatar and Turkey in the form of deposits with the CBE. Meanwhile, funding from the Gulf countries over the 2013-14 fiscal year after the removal of Muslim Brotherhood president Mohamed Morsi by a popular revolution amounted to $20 billion in the form of deposits, grants, and in-kind aid.

Mosallam says in his paper that a foreign-currency crunch hit the Egyptian economy at the end of 2015 due to a retreat in foreign-currency resources. Suez Canal revenues stagnated on the back of the recession in international trade, tourism revenues contracted because of a series of internal and external shocks, and export earnings declined because of lower oil prices.

The financing of the new Suez Canal extension through LE65 billion worth of bonds at an interest rate of 12 per cent added to the already inflated domestic debt.

Egypt’s domestic debt kept increasing, reaching unprecedented levels when it reached about LE2.5 trillion in March 2016 compared to LE888.7 billion in June 2010. Similarly, the domestic debt-to-GDP ratio increased to 90.1 per cent in March 2016. Interest payments on government debt were the largest expenditure item in 2016, constituting around 97 per cent of the fiscal deficit, according to Mosallam.

The end of 2016 saw the heavy reliance on international institutions resume. Agreements with the IMF, World Bank, and the African Development Bank resulted in almost $16 billion in loans added to Egypt’s foreign debt soon after it devalued the pound.  

This was followed by several Eurobond offerings, with 2017 alone witnessing the offering of $7 billion worth of eurobonds.

While the value of the debt and its components are concerning, Mosallam points to another worrisome aspect: a lack of transparency in terms of the actual magnitude of the debt.  

“Several debt obligations that are covered by the CBE or the Ministry of Finance are not reflected in the debt balance disclosed in reports published by the two entities. These include the debt owed to the international oil companies and the Euro debt guaranteed by the Ministry of Finance to fund the Siemens electricity project,” he said.

  The $25 billion Russian loan to finance the building of a nuclear plant is another type of debt not reflected in the official debt figures disclosed by the CBE and the Ministry of Finance, he added.

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