Tuesday,25 September, 2018
Current issue | Issue 1306, (4 - 10 August 2016)
Tuesday,25 September, 2018
Issue 1306, (4 - 10 August 2016)

Ahram Weekly

Out of the comfort zone

An IMF loan seems to be the best option for the ailing economy, but are the benefits worth the potentially high cost, asks Sherine Abdel-Razek

Al-Ahram Weekly

“Egypt is getting serious at last” was how one investment banker commented on the news that the government was in negotiations with a delegation from the IMF about a loan.

The serious part is related to the cabinet’s adoption of policies that successive governments have been hesitant to introduce because of their potentially high political and social costs. Postponing these reforms, according to loan advocates, has worsened the state of the economy.

The government is trying to calm fears about the negotiations, stressing that the loan will be unconditional. A Ministry of Finance statement has even asked the media to stop referring to ‘’IMF conditions’’ when talking about the reform programme included in the government’s Year 2030 Plan.

“It might be true that the IMF did not dictate the reform programme, but we have been adopting a lot of its policies,” commented Omar Al-Shenety, managing director of Multiples Group, a regional private equity firm. Parliament has just ratified the new civil service law, for example, and the value added tax (VAT) law is soon to be passed.

A cabinet statement said that the policies to be implemented during the coming period will include fiscal reform, such as the introduction of VAT and the civil service law, subsidies reform, privatising state-owned entities  and strengthening the social safety net.

Most importantly, a more flexible foreign exchange policy will be adopted that will see the pound significantly devalued.

This is not the first time Egypt has come close to obtaining an IMF loan over the last five years. But this time the state of the economy perhaps makes it inevitable. “The economy is in a critical situation, with very limited options available to get us out of the current slump. We have huge fiscal and trade deficits, a pathetic forex exchange situation, and a ballooning internal debt,” Al-Shenety said.

According to figures from the Ministry of Finance, Egypt’s budget deficit recorded 12 per cent on average over the last four years. Local debt surged to the equivalent of 99 per cent of GDP. The deficits in both the trade balance and the balance of payments are increasing and exacerbating foreign currency problems.

The country is facing a serious foreign currency crunch that has brought trade and industry almost to a halt. The currency black market is thriving, with the gap between the official exchange rate and that in the parallel market reaching 40 per cent. The latter has shot up to LE13 to the dollar, its highest level ever amid increasing pressures to devalue the pound.

The deterioration in tourist numbers due to a series of unfortunate events has been reflected in a severe decline in receipts, going from $14 billion in 2010 to $5 billion last year. This has created a funding gap of $21 billion that the government has said it needs to bridge with the IMF loan and other facilities.

Finalising a loan agreement with the IMF is considered a stamp of approval for the economy, and it opens the door for more lending from foreign institutions and international markets, Al-Shenety said.

 In addition to the $4 billion annually Egypt will acquire from the IMF, Finance Minister Amr Al-Garhi said a further $2-3 billion would be secured per year between international bond issuances and budgetary support from the World Bank and the African Development Bank.

In addition, five or six public-sector entities will be groomed for listing on the local stock exchange, which might attract some foreign portfolio investment. This would provide the buffer of foreign currency needed to end the black market.

EFG Hermes, Egypt’s largest investment bank, has put forward a much higher figure for the funding gap, reflecting the difference between the current account deficit and the expected foreign investment, putting it at $30 billion.

It suggests the Gulf countries could also play a role in plugging it, and Saudi Arabia and the UAE have already pledged $4.5 billion in cash support over the next few months.

News about the magnitude of the annual IMF injection, coupled with other inflows, will help kill the parallel market once the liquidity hits the market and the availability of foreign exchange improves.

The announcement that the IMF will negotiate a loan has already pulled back parallel market rates and curbed activity. Black market traders speaking to Reuters said their volumes of business had fallen as people waited to find out more details about the IMF loan and the expected devaluation.

On Monday, transactions were limited to LE12.30-12.70 per dollar, unchanged from Thursday.

The loan flows, said William Jackson, a senior economist at Capital Economics, would make a sizeable dent in Egypt’s gross external financing requirement. That in turn would allow the Central Bank of Egypt (CBE) to remove some of the restrictions on access to foreign currency that have disrupted economic activity.

The CBE will probably need to devalue the currency again, however. In a note issued last week, Jackson expected the pound to drop to LE 9.5 per dollar by the end of this year.

Unnamed government officials quoted by the Al-Shorouk and Al-Masry Al-Youm newspapers on Tuesday said that while the IMF delegation had recommended a full floatation of the pound, Egypt was supporting a 20 to 35 per cent devaluation before the first tranche of the loan is disbursed.


Loan negatives: Reservations about the loan include fears of its adding to an already high foreign debt.

According to Al-Shenety, over the last three years there has been a tendency to acquire loans. Egypt has borrowed to build power stations, to buy arms, and it is about to acquire another $25 billion loan to build the nuclear power plant in Dabaa. It has resorted to the World Bank, the Bank of China, the African Development Bank and the international markets to acquire the loans. 

While Al-Garhi said that on acquiring the loan the country’s foreign debt would reach $53 billion, stressing that Egypt could repay it, Al-Shenety expressed fears that this would not necessarily be the case.

Over the last four years Egypt has acquired US$25 billion in Arab Gulf aid, according to the ratings agency Standard and Poor’s. These funds have failed to deal with the foreign exchange scarcity the country has been facing, however, leaving the foreign reserves hardly able to cover three months of imports.

“There are no guarantees that this won’t be the case this time round as well. I fear ending up in a debt trap like that in the late eighties,” he said.

Egypt’s foreign debt then was also around $50 billion, and the banks were unwilling to extend any new facilities to the government. Egypt’s exit came when the Paris Club of lenders cancelled a big chunk of the debt in return for Egypt’s participation in the 1991 Gulf War.

A devaluation would also need the pound to be defended through an interest rate hike. Radwa Al-Sweify, head of research at Pharos Holdings, said interest rates would need to go up by one to two per cent in an attempt to attract foreign portfolio investment into treasury instruments denominated in local currency.            

A further increase in interest rates would make life harder as the cost of getting credit would be higher, however. Private-sector credit currently represents seven per cent of overall bank loans.


Getting Poorer: An IMF-style reform programme would also see Egyptians from many income categories suffering. President Abdel-Fattah Al-Sisi warned on Monday that “tough and harsh” measures could be needed to improve the economy.

The expected devaluation would increase the already high inflation rates, and the rate hit a seven-year high of 14.8 per cent last week, eating up the income of the average Egyptian household.

Fuel subsidy cuts are also back on the agenda. The government is serious about curbing fuel subsidies, one government source told the financial paper Al-Borsa this week. Previous subsidy cuts in July 2015 saw inflation rates significantly grow.

Added to this are the inflationary pressures of the VAT, expected to add at least two per cent to the inflation rate, as well as the effect of planned hikes in electricity prices starting this month and the rumoured increase in Cairo underground tickets.

All the above would add to the sufferings of already burdened Egyptian families. Income and spending patterns prepared by the Central Agency for Public Mobilisation and Statistics (CAPMAS) have noted that 27.8 per cent of Egyptians are poor and live on less than LE482 per month, the highest poverty rate in the country since 2000.

Things are even worse in rural areas and Upper Egypt, with 66 per cent of people in Assiut and Sohag governorates classified as poor.

Heba Al-Laithy, a professor of economics at Cairo University, expects the poverty rate to increase to around 30 per cent of the population due to the new policies which she believes will add at least five per cent to the inflation rate.

Al-Sisi and the government are trying to calm such fears by promising to introduce new measures to strengthen the social safety net and support the poor. However, there is still a need for a social protection system that protects those who don’t have regular incomes throughout their lives and offers adequate spending on health and education services, Al-Laithy said.

The extremely poor and poor categories of the population will be the target of government plans in the coming period, with low-priced commodities expected to be distributed by the army and in government outlets and more attention paid by civil society organisations.

“The real problems will  be in members of the middle class who might not be able to make ends meet,” Al-Shenety said.



Listed beneficiaries

THE MARKET reacted positively to news of the IMF loan. The EGX 30 index increased by almost seven per cent in the two stock exchange sessions following the release of the cabinet statement on the loan on the back of hopes that it will encourage more investment, including portfolio investment, into the country.
There are a handful of shares that are expected to benefit most. Radwa Al-Sweify, head of research at Pharos Holdings, expects banks like the Commercial International Bank and Credit Agricole to enjoy high margins for the rest of the year, thanks to their high asset allocation in treasury instruments.
EFG-Hermes and Egypt Kuwait Holding are another two beneficiaries. EFG-Hermes focuses on high-growth strategies, and Egypt Kuwait Holding focuses on maximising profitability from existing assets and inorganic expansion into dollar-generating assets. Real estate developers like Medinet Nasr and Palm Hills are also set to enjoy high sales as investment in real estate flourishes as a result of devaluation and high inflation expectations.


Loan Facts

• THE GOVERNMENT has been in talks with the IMF for at least three months to secure support for Egypt’s economic reform programme.

• It is aiming to secure $7 billion a year for three years as a result of the IMF loan. Being disbursed over three years, rather than in one payment, will guarantee a long-term stabilisation plan, rather than represent a short-term lifeline, according to Arqaam Capital

• The new loan is much higher than earlier reports, which had put it in the $5.8-7.1 billion range. The scale of the IMF financing will depend on the mission team’s assessment of financing needs and the strength of the government’s reform programme, according to William Murray, an IMF spokesman.
• Egypt’s quota in the IMF is about $2.08 billion, and it has Special Drawing Rights (SDRs) equivalent to $2.9 billion. IMF regulations give member states the right to borrow up to 145 per cent of their quota for a year, or 435 per cent over three years. This translates into $4.2 billion and $12.6 billion, respectively

• Egypt should receive at least $2 billion within the first two months of finalising a deal. The loan must be repaid within five years, plus a three-and-a-quarter year grace period.

• Fund disbursement would need a staff level agreement, followed by IMF board ratification. The cost of the loan is expected to be in the 1.25-1.75 per cent range.

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