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Cost of government debt threatens economic reform programmes - Daily News Egypt

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Cost of government debt threatens economic reform programmes

The government successfully controls the subsidies and salaries bills, but fails to handle the interest on government debt

The government is making a significant effort to control the expenditure on the public sector employees’ salaries and subsidies, and is drafting a number of laws for that aim. However, it seems highly inadequate in front of the excessive increase of government debt costs.

The cost of government debt has jumped to represent slightly less than one third of the expenses in the budget of the current fiscal year, becoming the biggest burden to the government, instead of the subsidies and the public sector employees’ salaries, as was the situation in previous years.

The interest on the government’s debts of the current fiscal year is about EGP 300bn—the highest spending item in the state’s general budget—representing approximately 9% of the gross domestic product (GDP).

The government has had to ask for help from the International Monetary Fund (IMF) to escape from the high cost of borrowing in local currency, and has taken measures to control expenditure in order to slow down the increasing rate of borrowing.

While the subsidies bill has shrunken to 6% of the GDP and the increase in government salaries was controlled through adopting a new law limiting the increase to only 7% annually, the government’s borrowing is still very costly. The government is depending on selling weekly treasury bonds and bills at a cost of 14-17%.

Analysts say that the cost of the government’s borrowing could have become a number of percentage points less if the government widened the base of its creditors. However, it has failed to do so over the years.

The government depends on the system of major traders to cover its financial needs in local currency. Fifteen banks exclusively buy the government bonds in return for guaranteed coverage, while they have the right to sell the bonds or keep them after that.

Public debt represents about 100% of the GDP, 85% of which is in local currency, which shows the influence that the major traders have.

The government and banks have held several discussions throughout the past years to activate a secondary market for government bonds. Ideas like obliging the major traders to sell a specific part of their purchases from the primary market have been presented. However, sources said that the Central Bank of Egypt (CBE), which manages government offerings, opposed the idea of conducting modifications to the current system.

Head of Research at Pharos Holding for Financial Investments, Radwa El-Swaify, said that in the coming period, the government will go towards foreign borrowing because of the increased rates of the domestic debt.

El-Swaify expected the foreign debt rates to increase to over 20% of the GDP, as a result of the current borrowing operations.

She noted that the government will move towards this policy in two to three years—the period of the economic reform programme. Therefore, there will be a direction to annually offer US dollar bonds abroad, if the next offering succeeds in reducing the financing gap.

She added that borrowing from the IMF, the International Bank for Reconstruction and Development, and the African Development Bank proves that the government is taking this new direction, in addition to the government’s intention to offer US dollar bonds in the international markets in the next months and the deposits coming from the Gulf countries.

She also said that the domestic debt is increasing compared to international norms, while foreign debt is within the safe limits, noting that the stability in the exchange rates contributes to decreasing the return on the instruments of the domestic debt, compared to the foreign debt.

She explained that the current return on the treasury bills has amounted to 16%, while the cost of borrowing from abroad ranges from 6-7% on the US dollar bonds.

El-Swaify noted that forming a secondary efficient market for the government bonds contributes to restructuring the domestic debt by including the involvement of huge investment banks.

She also said that offering treasury bills to be dealt by individuals and companies contributes to finding liquidity, but needs administrative work through setting up codes and bank accounts for the traders.

She added that offering financial instruments for individuals, such as treasury bills, creates several investment opportunities, besides the opportunities enabled through banks and the stock market.

El-Swaify said that the presence of a secondary market creates flexibility in the market and freedom for the investors, and also contributes to involving a large base of investors, especially since the return on it is guaranteed by the government.

She cited the success of the government in collecting EGP 60bn for the operations of digging the New Suez Canal through offering investment certificates to individuals with high returns.

El-Swaify added that the diversity of the maturity period of the debt instruments contributes to their success amongst investors. There are a number of insurance companies with long-term investments that need financial instruments with long periods, ranging between 10 and 30 years, while there are other companies willing to invest in short- and medium-term instruments.

She said that the government’s increased reliance on the short-term bills instead of the long-term bonds is attributed to the presence of more liquidity for the former. In addition to that, a number of companies invest in the bills because of the absence of a secondary market for trading.

The government is now trying to get out of that critical situation through moving towards increasing borrowing from abroad. Moreover, the economic programme that has been agreed on with the IMF includes increasing least expensive foreign financings and limiting reliance on the local financial regime.

Both parties have reached an agreement stipulating the borrowing of $12bn from the IMF over three years, and offering bonds worth $3bn in the next month in international markets, as well as the provision of $6bn from other foreign financing sources during the current fiscal year.

In spite of this news, the return on the government debt instruments kept increasing to the extent that the government had to cancel a number of long-term auctions.

Earlier, the Ministry of Finance had issued a medium-term strategy for managing the debt, with the aim of expanding the issuance and reopening of long-term treasury bonds gradually. This aims to increase the average lifetime of the debt that can be traded and to build a yield curve that combines government debt instruments, and thereby reduces the risk of refinancing.

The strategy also includes the diversification of financing sources through issuing new financial instruments, such as sukuk, in order to finance developmental and infrastructure projects, and attract more individual investors and financial non-banking institutions. This would have a great impact on reducing the cost of issuing government securities.

In order to develop the debt market and enhance the government’s transparency, the strategy aims to set benchmarks for the yield curve of three-year, five-year, seven-year, ten-year, and maybe even longer term treasury bills.

In addition to that, it aims to increase the number of instances of reopening treasury bonds to reach EGP 12-15bn for each issuance and regulating the treasury bond auctions in a way that prevents competition between the different maturity periods. This will occur through the issuance of three- and seven-year bonds in one week, and five- and ten-year bonds in a later week, particularly on Mondays.

4Moreover, three- and nine-month treasury bills will be issued on one day, and six- and twelve-month treasury bills will be issued on another day.

The Ministry of Finance now sells treasury bills with different maturity periods on Sunday and Thursday of every week, while on Monday it sells bonds with different maturity periods.

The total public debt, according to the most recent statistics from the CBE, amounted to EGP 2.4tr, representing 80% of net debt to GDP.

The domestic debt is divided into EGP 2.2tr in treasury bonds and bills, of which EGP 1.5tr are treasury bonds, and EGP 697.6bn are treasury bills.

The aggravation of the public debt is putting pressure on the state’s general budget deficit as a result of the high interest rate. The value of the government’s borrowing from the bills and bonds amounted to EGP 1.1tr during the previous fiscal year, while the high cost of debt is putting pressure on the budget deficit that is already high and has been expected to register 11.5% of the GDP by the end of the fiscal year that came to an end in June.

Deputy Minister of Finance, Ahmed Kojak, said to Al Borsa that the government has a plan to reduce the public debt to GDP ratio. The plan is based on a number of points, first of which is enhancing the first deficit rate to the GDP, in addition to increasing the rates of real growth through supporting the programmes of exporting and industry, and improving the investment climate.


He added that the other steps towards improving the debt depend on decreasing the average real interest rates through diversifying the sources of borrowing and issuing long-term bonds.

Chairperson of the Egyptian Financial Supervisory Authority (EFSA), Sherif Samy, said that restructuring the public debt needs a diversification of the financing instruments. There are many financing tools in the market that the government does not use, such as financial leasing, real estate funds, and issuance of stocks and revenue bonds for projects, which alleviate the pressure of borrowing.

He added that issuing bonds and keeping them without trading will not affect the public debt.

He also said that activating the secondary market of the government debt instruments would attract a new segment of investors; however, it does not reduce the public debt. He stressed on the necessity of financial engineering to provide the financing needs of the projects, whether through issuing revenue bonds,  offering company stocks as public offerings in the stock market, establishing a real estate investment fund to carry out schools, or financial leasing for the equipment.

The current laws enable the application of these financial instruments, he added. However, they require good pricing to guarantee that the cost will not increase in the future.

He stated that sukuk is one of the best financial instruments to attract a number of investors, such as Gulf institutions, takaful insurance companies, Sharia-compliant funds, and banks, and therefore, they should be utilised.

Egypt adopted a law for sukuk three years ago, but it has not used that instrument yet. It has aimed to attract investors to finance local projects. The law was amended; however, there are still unknown obstacles obstructing the activation the law.

Samy said that issuing long-term governmental debt with maturity periods of more than 10 years requires good pricing for the interest rate to guarantee that the cost of borrowing will not increase. England has bonds with maturity periods of 50 years, attracting life insurance companies that look for continuous long-term return, regardless of the origin of the amount, as long as the pricing is done in a correct manner. The US also has bonds with maturity periods of 30 years.

In the same context, chief analyst at UAE-based investment bank Arqaam Capital, Reham Al-Dessouki, said that reforming the public debt will not be achieved through activating the secondary market of bonds, but reducing the debt may be achieved through increasing repayment periods and reducing costs.

She added that reducing costs is done through the government expanding the issuance of bonds more than bills, but that would be linked to the return rates.

She said: “If the interest rate on the long-term items is higher than that of the other maturity periods, such as one-year, six-month, and three-month, it will attract more investors. However, since the differences between them are insignificant, we find that the demand rates are not high.”

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