On 11 August, the International Monetary Fund (IMF) and the Egyptian government announced that both parties had reached a staff-level agreement for a $12bn, three-year extended fund facility (EFF) that amounts to 422% of Egypt’s quota.
Last month, Moody’s investor service affirmed Egypt’s long term and senior unsecured bond rating at a stable B3.
Vice president and senior analyst at Moody’s, Steffen Dyck, told Al-Borsa that the IMF programme me will help Egypt gain access to other multilateral and bilateral funding. However, Dyck also noted that the task ahead is large and challenges in implementation remain.
Is this agreement with the IMF enough for the government to solve the economic crisis in Egypt?
This agreement is subject to approval by the IMF’s Executive Board, and we expect a decision within the next six to eight weeks. The focus of the programme me will be on fiscal consolidation [the target budget deficit for 2019 is 6.6% of GDP, while general government debt is projected to decline to 88% of GDP, from 98% in fiscal 2016], reducing inflation rates to single-digits, restoring growth, moving to a more flexible exchange rate regime and rebuilding foreign exchange reserves.
If approved, the agreement will be credit-supportive, because it will provide external funding and help re-start structural reforms. The EFF programme me will also help Egypt gain access to other multilateral and bilateral funding. However, while we expect delivery on most reform commitments in the early phase of the programme, the experience of other countries shows that slippage becomes more likely at a later stage. The IMF programme would take place amid a background of high, and rising, government debt and low foreign exchange reserves pointing to a balance of payments risks.
In your opinion, is the government committed to the reform programme agreed with the IMF?
The key reform areas outlined in the press release following the announcement of the staff-level agreement with the IMF are the same that were identified by the Egyptian government in previous medium-term strategy documents. Moreover, the government has stressed that the reform programme is a home-grown programme. This includes fiscal consolidation, improving macroeconomic stability, making growth more inclusive, and improving the investment and business climate, among other things. The government has already enacted some reforms, such as the fuel and electricity subsidy reform, some tax reforms, and the civil service bill. The most recent approval of the VAT law by the parliament, as well as the new tax dispute settlement regime, are also important steps. While we see that the government is committed to reform, we also think that the task is large and challenges in implementation remain.
What impact would a delay in implementing tax reforms and reform of the business environment have on the economy?
From a sovereign rating perspective, a negative rating action would be triggered by tightening domestic liquidity to fund government deficits, problems in closing the external funding gap, and any signs of delay, slippage, or reversal of fiscal and economic reforms agreed upon under the IMF programme. Further, a renewed intensification of political turmoil and instability would also be highly credit-negative. A delay in fiscal reform implementation would make reaching fiscal deficit targets more difficult, while business confidence and economic growth could be negatively affected by setbacks with regard to business environment reforms.
Is three years sufficient for the government’s economic reforms to be applied?
While we see the government as being committed to reform, we also think that the task is large and implementation challenges remain.
What are your expectations for Egypt’s economy, especially in light of the foreign currency crisis?
Egypt’s B3 government bond rating with a stable outlook reflects “moderate” economic strength, “low” institutional strength, “very low” fiscal strength, and “high” susceptibility to event risks. Egypt’s economic strength score is supported by the relatively large size of the fairly diversified economy, which provides a degree of economic shock absorption capacity.
Although growth slowed sharply following the 2011 revolution, economic activity has started to pick up under the government of President Abdel Fattah Al-Sisi. For example, GDP growth reached 4.2% in the past fiscal year [which ended on 30 June 2015]. For the 10-year period spanning 2011 to 2020, real GDP growth will average 3.4%, which is similar to the median growth rate of Egypt’s peer group of B3 and Caa1-rated sovereigns.
Offsetting those favourable factors are issues such as chronically high unemployment (especially youth unemployment), comparatively low levels of per capita income, and the negative impact on key sectors in the economy due to more than three years of unsettled political and security conditions, as reflected in very weak scorings of the World Economic Forum’s Global Competitiveness Index. The devaluation of the national currency in March put upwards pressure on already high inflation levels. Egypt’s national headline inflation rate peaked at 14.8% year-on-year in June and remained stable around this level in July. This compares to an average of 10.6% during 2015. Urban core inflation (which excludes fruit and vegetables and fuel) spiked to 12.2% in May year-on-year, compared to 9.5% in April and a low of 5.5% in September 2015. Prospects for further depreciation suggest that inflation is unlikely to fall rapidly.
To address high inflation, the Central Bank of Egypt (CBE) decided on 16 June to increase interest rates by 100 basis points (bp). This brought the overnight deposit rate to 11.75%, overnight lending rate to 12.75%, and the rate of the CBE’s main operation to 12.25%. The discount rate was also increased by 100 bp to 12.25%. This marks the second interest rate hike in 2016.
While a tighter monetary policy will help to address Egypt’s macroeconomic imbalances, the interest rate hike will also push up already high borrowing costs for the government.
How do you evaluate Egypt’s economic growth and what are your expectations for the budget deficit this fiscal year?
We expect a real GDP growth rate of 3.5% in fiscal year 2017 and a budget deficit of 12%.