eco TV Week

Egypt: Increasing risk on foreign currency liquidity

3/18/2022

The sharp rise in soft commodity prices entails a deepening of the current-account deficit. It should accelerate the deterioration in foreign currency liquidity. In this context, a renewed international financial support could be needed.

Pascal DEVAUX

TRANSCRIPT // Egypt: Increasing risk on foreign currency liquidity : March 2022

The war in Ukraine will have a significant impact on the Egyptian economy. It should reinforce a deteriorating trend since mid-2021. The reliance on imports is very high and the rise in commodity prices will affect the whole economy: rise in inflation with adverse consequences on growth and fiscal accounts, and above all a deterioration in external accounts.

Egypt is the first wheat importer in the world and 80% of those imports come from Ukraine and Russia. Wheat price on international market has risen by 50% since the beginning of the year. The tourism sector should be affected as well as it is estimated that around 30% of the tourist frequentation comes from Ukraine and Russia. Those factors should deepen the current-account deficit. Moreover, the cost of debt issuance on international capital market has markedly risen since mid-2021, and the vulnerability to portfolio flows is increasing.

Egypt can rely on financial support from Gulf countries, but the liquidity in foreign currency has been deteriorating since mid-2021. Central bank foreign reserves are stable, but at a price of a fast rise in commercial banks’ net external debt, as they rely on foreign creditors to have access to foreign currency.

If the liquidity in foreign currency is acceptable in the short term, prospects are not good and a financial support from the IMF could be needed. It would entail a rise in foreign currency assets and would maintain the attractiveness of the Egyptian market to foreign investors.

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On the Same Theme

Deepening of external imbalances 7/5/2022
Currency liquidity in Egypt continues to deteriorate at a rapid pace. The banking sector’s net foreign assets (commercial banks and the central bank) are deeply negative (USD -16.6 billion in May 2022) and significantly exceed the lowest level reached during the 2016 crisis (USD -13.8 billion in October 2016). This deterioration comes as no surprise and the effects of the war in Ukraine on commodity prices have only exacerbated a pre-existing trend. Given a large recurring current account deficit (at least USD 20 billion this year) and significant external debt repayments (around USD 9 billion over a whole year), the Egyptian economy relies heavily on volatile portfolio investments. Since the third quarter of 2021, foreign investors have become more averse to Egyptian risk owing to the deterioration of the current account. It has resulted in a sharp rise in the cost of foreign currency debt and a fall in foreign investment in the local debt market. The start of the conflict in Ukraine has sharply increased the price of certain commodities (such as grain) of which Egypt is a major importer and has riggered a sell-off  from foreign investors. Against this backdrop, the financial support from Gulf countries in the form of deposits with the central bank (USD 5 billion from Saudi Arabia) and the investment in local companies (USD 1.8 billion from an Abu Dhabi sovereign fund), as well as the depreciation of the Egyptian pound by around 15% last March have not stopped the deterioration of external liquidity. While the situation remains sustainable in the short term (the central bank’s gross foreign exchange reserves remain equivalent to around five months of goods and services imports), further external support is essential to avoid uncontrolled depreciation of the pound. Negotiations are currently under way with the IMF for a new financing programme (as the country did in 2016 and 2020). Gulf countries have committed to renewing their support, but in the form of direct or portfolio investments, and the timing of which remains to be confirmed. 
Egypt: pressure on foreign currency liquidity 2/8/2022
Despite a significant improvement in macroeconomic indicators over the past five years, foreign currency liquidity remains a major source of vulnerability for the Egyptian economy. The net foreign asset position of commercial banks has steadily deteriorated over the past year and was in deficit by USD10 billion in December 2021, by far its lowest level for a decade. Meanwhile, gross currency reserves at the central bank grew only very slightly over the year. This deterioration of the external position of the banking system as a whole reflects that of the external accounts. The current account deficit is increasing following a sharp rise in imports. When it comes to capital flows, since last September, the increase in the spread on Eurobonds and the reduced vigour of portfolio flows have put additional pressure on external accounts. The situation is sustainable in the short term, thanks to satisfactory reserves at the central bank and only modest foreign currency debt service due in 2022. However, the outlook is deteriorating. The economic recovery will continue to drive imports higher, whilst the monetary tightening in the USA is likely to affect negatively capital flows to emerging economies. Egypt’s vulnerability to external shocks therefore continues to increase.
Egypt: persistent vulnerabilities 11/30/2021
So far, Egypt’s economy has weathered the Covid-19 crisis without any significant worsening of its main macroeconomic indicators. GDP growth has remained positive, and the country's budget and external balances are relatively stable. The macroeconomic stabilisation achieved in previous years and external financial support are the main reasons behind these positive performances. In the short term, the outlook is mixed. The rebound in inflation, if it were to persist, could trigger a cycle of monetary tightening, with negative consequences for public finances. In addition, Egypt's external vulnerability remains significant given structural current account deficits and dependence on portfolio investment flows. More fundamentally, the pace of growth is not sufficient to absorb the growing labour force, fuelling the informal economy. The main solution to these challenges lies in increasing private sector (non-hydrocarbon) investment and productivity, which are two recurrent weaknesses of the Egyptian economy.

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