Alphacast Highlight - Is Egypt heading to become the next Argentine?
War and inflation have shifted the global economic outlook and the rising tides of global interest rates are adding pressure to emerging economies. Among them, Egypt is beginning to stand out due to large imbalances and high global financial cycle exposure. How much is the margin to avoid a balance of payments crisis in the near future?
Egypt ranks at the top on typical macro imbalances ratios. They are, at the same time, in the top 20 ranks in terms of forecasted current account deficit for 2022 and in the top 10 in interest payment to GDP.
External short-term debt has risen to 4.5% and reserves are already dwindling, and now cover 5 months of imports, 5 years low. On the other hand, while gross external debt still looks in the safe zone (25%), the overall public debt is almost 90% of GDP and yearly gross financing needs account for 30% of GDP.
Since the onset of the war in February, Egyptian sovereign debt has been hit. The Yield Curve moved upward in line with global rates (about 300bp) but spreads vs the USA are hitting 4 years highs.
So, Looking forward, the hindsight provided by Argentina's 2017-2018 crisis looks like an interesting benchmark to evaluate Egyptian strengths and weaknesses.
On the strengths side, a number of features can be mentioned:
- About two-thirds of public debt is a local currency which makes fx an automatic stabilizer of any unstable debt dynamics
- Egypt has an ongoing successful program with the IMF and has over accomplished its objectives. Also, they have unconditional support from other countries in the Gulf. Argentina did not have a comparable international safety network. Further structural reforms will most likely show up down the road, including the privatization of many SOE.
- Egypt has a good recent track record in terms of fiscal prudence, and the government has shown a political grip to deliver fiscal consolidation.
However, the weakness is quite worrisome
- Egypt has been running a sustained and growing current account deficit for more than a decade and is highly dependent on nonresidential flows to finance it. Also, being a food importer is strongly exposed to war-derived agflation.
- From a macroeconomic policy point of view, Egypt's biggest weakness lies in its monetary policy. Even though monetary policy has moved in the expected direction in the near past, to deal with inflationary pressures, Egypt is still in the middle of a transition to a full inflation target regime.
The FX policy is hindered by the known "Fear of Floating" problem. With a recent double-digit inflationary history (inflation peaked at 35% in 2017), FX flexibility is limited by a high pass-through and the Egyptian Central Bank has proven reluctant to let the FX free float as a shock absorber in the recent past, and the -limited supply of - international reserves and the interest rates act as final buffers. However, with a debt/gdp ratio above 90%, small changes in the interest rates have big effects on the fiscal and debt dynamic.
Food for thought. Egypt seems to be in a typical multiple-equilibrium scenario. With limited policy room and few shock absorbers to maneuver, the government will have to deal with the political consequences of the high volatility that may come from external shocks while, at the same time, advancing the structural reforms process to maintain global political support.