After nine months of negotiations, the International Monetary Fund (IMF) approved on 17 December a deal to provide Egypt with $3 billion in finance over 46 months, giving a breather to the economy struggling with the fallout of the Russia-Ukraine war.  

The first tranche of the loan, $347 million, will be immediately disbursed.

The deal is expected to catalyse additional financing of about $14 billion from Egypt’s international and regional partners, including new financing from Gulf Cooperation Council (GCC) countries and other partners through the ongoing divestment of state-owned assets as well as traditional forms of financing from multilateral and bilateral creditors, noted an IMF press statement.

Finalising the deal came on the back of Egypt’s adoption of reforms, including a permanent shift to a flexible exchange-rate regime, revisiting the privatisation plan, increasing the role of the private sector in the economy, tightening the monetary policy, and improving social safety nets.

Receiving the loan is a happy ending for a year that brought many challenges for the economy overburdened by high debt and limited foreign currency inflows.

GENEROUS GULF ASSISTANCE

Days before the end of the year, it was announced the Saudi Arabia’s Sovereign Wealth Fund is about to clinch a deal to buy the state-owned United Bank for $600 million in the latest in a series of deals through which Gulf sovereign funds have bought stakes in Egyptian companies as a way of injecting liquidity into an economy strained by the war in Ukraine.

Increases in oil and commodity prices in the wake of the war have hit Egypt hard, notably because the country is the world’s largest importer of wheat, much of which comes from Russia and Ukraine.

The sudden fleeing of portfolio investors from emerging markets in pursuit of the less risky and profitable US dollar after seven consecutive rate hikes by the US central bank, the Federal Reserve, has also seen Egypt losing $20 billion in portfolio investments.  

Assistance from the Gulf has been a lifeline for the Egyptian economy since the beginning of the war in February. In December, Saudi Arabia extended by one year $5 billion it deposited with the Central Bank of Egypt (CBE) in March. This came out of Riyadh’s belief of the importance of the deposit to Egypt’s bid to line up deposits and other lines of finance including an IMF loan, stated a statement by the Saudi Press Agency. In fact, the deposit was needed to support the country’s international reserve figure.

However, the marginal increase in the reserve figures at the end of November to reach $33.5 billion, compared with $33.4 billion at the end of October, does not offset the effect of three major declines in the figure throughout the year on the back of a drainage of foreign currency inflows. 

2022 witnessed a shift in the way the Gulf countries support the economy. After the 30 June 2013 Revolution, the Arab Gulf countries provided Egypt with grants, loans, and deposits. But this year they provided investment instead. Saudi Arabia, which set up the Saudi-Egyptian Investment Company earlier this year to manage its investments in the country, has pledged $10 billion of investments in the healthcare, education, and agriculture sectors.

It had bought stakes in four listed state-owned companies for a total value of $1.3 billion.

Saudi Finance Minister Mohamed Al-Jadaan was quoted by the US financial service Bloomberg as saying that the kingdom has started “investing aggressively in Egypt” and will continue “to look at investment opportunities, and that is more important than deposits. Deposits can be pulled, but investments stay.”

The Saudi move followed one of Abu Dhabi’s sovereign funds buying stakes in five listed Egyptian companies in April for $2 billion and the $1 billion deposit Qatar has sent to the CBE as a stop-gap while it undertakes due diligence in buying $2.5 billion worth of state-owned assets including stakes in the ports of Damietta and Safaga.

This is in addition to another $3 billion it deposited at the CBE earlier this year. Overall, the Gulf Arab states have pledged over $20 billion in deposits and investments for Egypt since March this year.

BRIDGING THE EXTERNAL FUNDING GAP

Resorting to generous Gulf investments was one of the ways in which Egypt had tried to plug its external funding gap throughout the year.

The improvement in the country’s current account deficit for the year ending in June, representing only three months of the war in Ukraine, did not compensate for its inflated imports bill and huge debt repayments.  

Egypt’s current account deficit narrowed by 10 per cent in the 2021-22 fiscal year ending in June thanks to the surplus in gas exports to the tune of $4.4 billion, the highest since 2010. The rise stemmed from increased European demand for natural gas coupled with the sharp rise in gas prices on the international markets.

The French bank PNB Paribas said that the increase in Egypt’s imports by 16 per cent was relatively moderate considering the rise in prices and the depreciation of the pound in March. It added that the CBE’s introduction of regulatory constraints on imports had probably hampered the increase.

Also, “while it has been thought that tourism would be the first victim of the Russia-Ukraine war, since both countries made up more than one-third of incoming tourists, it turns out that Egypt’s tourism may have benefited from the war indirectly, attracting tourists who would have otherwise targeted Ukraine or Russia, and even Ukrainians and Russians themselves seem to have targeted Egypt as a touristic destination, fleeing the implications of the war,” said a research note by investment house Prime Securities.

Egypt’s tourism revenues recorded a 120 per cent increase in the fiscal year ending in June compared to the previous year.

However, the exodus of foreign investments from treasury bills and bonds and huge debt repayments weighed down on Egypt’s finances and was translated into three major declines in the CBE’s reserves throughout the year. Sales of short-term treasury bills to foreigners, a key source of government finance until the Ukraine crisis, remained relatively stagnant at around LE4 to LE6 billion, according to Reuters.

The pressures of the war also depleted the banking sector’s dollar liquidity, bringing down total net foreign assets (NFAs) to negative ($22.8) billion in October 2022 down from a surplus of $2.4 billion in December 2021.

According to Reuters, Egypt will need to pay $33.9 billion in foreign debt over the coming three years.

KNOCKING ON THE IMF’S DOOR

It was announced in March that Egypt would be asking for the IMF’s assistance for the fourth time since 2016.

The news came one day after the CBE devalued the pound by 15 per cent to hover around LE19 to the dollar.

But the devaluation was not enough for the IMF, which said in July that “decisive progress on deeper fiscal and structural reforms is needed to boost the economy’s competitiveness, improve governance, and strengthen its resilience against shocks.”

In particular, it asked for a more flexible exchange rate, which means allowing supply and demand to determine the value of the Egyptian pound against other currencies.

After the 2016 devaluation that saw the pound losing half its value to reach LE16 to the dollar, then CBE governor Tarek Amer used to interfere in the markets by withdrawing dollars from the country’s foreign reserves and injecting them into the market to support the pound. The main drive behind this policy was fear of the inflationary pressures that might result from the pound losing momentum versus the greenback.

Applying the same protectionist approach, Amer introduced restrictions on imports in March to limit the pressure on foreign currency.

However, the move backfired as it restricted factory inputs and hindered businesses and travellers from transferring foreign currency abroad and led to imports worth billions of dollars being stuck at the ports.

In late August, the CBE announced the appointment of a new governor, Hassan Abdallah, who introduced a bit-by-bit devaluation, leaving the pound to lose marginal value but on a daily basis.

Seven months after the first devaluation, the CBE said on 27 October that it was shifting to “durable exchange-rate flexibility” in line with long-standing IMF demands and devalued the pound again by another 14 per cent. The word “durable” hints that the CBE will not interfere again in the exchange market as it did in the two devaluations since 2016.

The news was followed by the announcement that the IMF and Egypt had reached a $3 billion funding deal that will run over 46 months. The deal was approved by the IMF’s board six weeks later, in mid-December.

The value of the loan came in at less than expected, but it is the maximum that Egypt can access according to its quota in the IMF. The deal is considered a vote of confidence in the economy and is expected to unlock billions of dollars of assistance from international partners.

STICKING TO A FLEXIBLE EXCHANGE RATE

The CBE’s compliance with a fully liberalised forex policy will be examined during the coming period. There are two factors that might put pressure on dollar liquidity in the coming days and would push the CBE to interfere to support the pound.

The CBE plans to remove the requirement for importers to acquire letters of credit to buy some goods abroad by the end of December, thus removing all restrictions on imports. It also needs to clear a backlog of requests from importers and companies to acquire dollars from the banks that amount to $5 billion.

“The agreement with the IMF aimed to achieve a flexible exchange rate” Deputy Finance Minister Ahmed Kouchouk said in a statement issued by the cabinet in early December.

The dollar has been trading at LE32 to LE33 to the dollar on the black market recently compared to the official rate of about LE24.6 to the dollar.

This gap is raising the possibility that the CBE might let the currency weaken again, possibly also hiking interest rates.

Israa Ahmed, a senior economist at investment bank Al-Ahly Pharos, wrote that even in the light of the imbalances and characteristics of the Egyptian economy, “the reported parallel US rates — above LE30 — are not fundamentally justifiable.”

“We reiterate our view that a great deal of the dollar rally is mere overshooting. The slow importing process, the abnormal stress on the current account, and the ‘bet’ on another devaluation have created speculative transactions,” Ahmed wrote.

She agrees with several other analysts that the pound has weakened to be lower than the fair value calculated by many economists, but an adjustment period might be needed as import backlogs clear and confidence returns.

“The de facto situation in the foreign exchange market might push the monetary authorities to respond accordingly, which might drag the pound further into the undervalued area,” she noted.

Could Egypt see a third but minimal devaluation before the end of 2022?

Ahmed said that the longer the CBE sticks to the current stand-by situation, the higher cost it will take to bring back balance to the market. She believes the CBE will adopt a mix of measures starting with a two per cent interest rate hike accompanied by 15 per cent further adjustment in the value of the pound to end the parallel market.  

“But more importantly, we think the government will capitalise on the IMF loan to mobilise other US dollar sources to secure the needed liquidity to finance daily current account operations and fully repeal the import-blocking measures, which is the most important step to assure the credibility of the foreign exchange system and rein in the parallel market,” she concluded.

*A version of this article appears in print in the 22 December, 2022 edition of Al-Ahram Weekly