As the government continues to borrow from abroad and external debt reached more than 36% of Egypt’s GDP at the end of December 2017, amid successive increases in foreign exchange reserves reaching record levels, we need to find an answer to some questions.
Does Egypt need more foreign debt after it reached more than $82bn, equivalent to more than 36% of the country’s GDP? Do we need to increase Egypt’s foreign exchange reserve more than its current level? What is the optimal level of foreign exchange reserves for Egypt? What is the best way in dealing with high external debt, can the government convert those debts to long-term debts with the same value? Is it right to allow the government to borrow, as it likes or it needs to be regulated? And what are those regulations?
We posed these questions after the Central Bank of Egypt (CBE) had disclosed that the total foreign debt reached about $82.9bn at the end of December 2017, an increase of $3.9bn compared to June 2017.
Egypt’s external debt hit about 36.1% of GDP
Since the beginning of 2018, Egypt has received about $7bn through the issuance of two groups of international bonds—the first worth $4bn in January and the second worth $7bn in February 2018—which likely increased the size of external debt to more than $90bn currently.
According to the CBE, the external debt reached 191.3% of Egypt’s exports of goods and services by the end of December 2017. The short-term debt is about $11.13bn, equivalent to about 13.4% of the total external debt, while the middle and long-term loans account for about 88.6% of the total external debt, worth about $71.76bn.
The short-term foreign debt also reached about 30.1% of Egypt’s net foreign exchange reserves.
According to the CBE, the external government debt reached about $38.71bn at the end of December 2017, equivalent to about 46.7% of the total external debt, and about 16.9% of the GDP, pointing out that the external debt service reached about 60.2% of the country’s exports of goods and services, and about 36.6% of the current proceeds.
The CBE’s external debt reached about $27.4bn, while the external debt owed by banks operating in the Egyptian market amounted to about $6.09bn. The debts of some other sectors, which were not mentioned by the CBE, reached about $10.68bn.
According to the CBE, the external debt interests amount to about 3.9% of Egypt’s exports of commodity and service, and about 2.4% of the current proceeds.
In previous press statements, the CBE Governor Tarek Amer said that Egypt’s external debt and its services are at safe levels, and the country’s capabilities can bear more debts, according to global indices.
He added that the state uses these debts to finance huge development operations at the present time.
“For those who say that Egypt’s debt has increased, I tell them that our economy has increased as well, and the external debt does not represent any kind of concern,” Amer said, stressing that “Egypt has never delayed in paying its external obligations in the most difficult circumstances.”
He added, “we have an advantage! Egypt has a very long-term foreign debt, ranging between 15 and 60 years,” noting that “the last Korean loan for the establishment of the fourth and fifth stages of the Cairo metro will be paid over 57 years, with an interest of 0.1%.”
Concerns over growing external debt
Mohamed Abdel Aal, banking expert and board member of the Suez Canal Bank, said no one denies the achievements made through the implementation of the economic reform programme over a year and a half in cooperation with the International Monetary Fund (IMF), though there are concerns about the country’s growing external debt.
He said that the foreign debt jumped to $82.8bn at the end of December 2017, compared to $67.3bn at the end of December 2016—a growth rate of 23.17%. He pointed out that the IMF had expected that Egypt’s external debt would reach about 34.6% of the GDP, during the current fiscal year (FY), and to reach 33.3% during the FY year.
Standard & Poor’s affirmed that Egypt’s lack of control over its external debt could cause negative pressure on its credit rating in the future.
According to Abdel Aal, the risk of increasing the foreign debt can be measured by two indicators. The first is the ratio of external debt to the GDP; the more it is less than 60%, the more it can be in safe levels, in accordance with international standards. Egypt’s external debt ratio to the GDB is within 34-36%, which could still be considered as safe.
The second indicator is the ratio of the total external debt service to the volume of exports. In other words, the ability of Egyptian exports to pay all or part of the cost of external debt. This ratio in Egypt is gradually improving, especially with the recent increase of Egyptian exports.
Both indicators confirm that the size of Egypt’s external debt is within safe limits, but what about the future?
“In my opinion, the risk of external debt in Egypt will diminish over time, as the GDP will grow at a higher rate than the debt,” Abdel Aal said.
He pointed out that there are several determinants that indicate the need for external borrowing. These loans are used to finance big projects, in line with the country’s economic development process, which must be carried out fast and require huge funding. He noted that the Egyptian government was supposed to prepare feasibility studies of those projects to know whether their future revenues will cover the loans and their interests or not.
“We went through various stages of political tension, wars, economic blockade, and counter-terrorism, which hindered the economic development plans. On the other hand, domestic saving is weak, which necessitated external borrowing,” Abdel Aal said.
He added that external borrowing will decrease depending on domestic debt and will decline the budget deficit, due to the low borrowing costs, which eventually reduces the risk of external debt.
Abdel Aal further added that Egypt’s expansion in exploration and discovery of natural gas will lead to self-sufficiency by the end of 2018, and then the state will begin to export the surplus, which will increase revenues in foreign exchange, and thus decrease the external debt.
He noted that the government plans to legalise the informal economy, which is estimated at 50% of the formal economy. If this integration occurs, the GDP will increase, and the ratio of external debt to the GDP will decline.
He explained that Egypt’s foreign debt is diversified. It consists of short-term loans that account for about 39% of the total external debt, while medium and long-term loans account for 61%. This diversification allows Egypt to repay its debt regularly.
“It has not been noticed at all that there was any political pressure from creditor countries that affect the integrity and independence of Egyptian sovereignty. Egypt has never delayed in repayment of its external debt and will not, which confirms the state’s ability to repay on time,” according to Abdel Aal.
He predicted that value of foreign debt will remain stable for several years, but it would decline compared with the GDP, due to the planned increase in domestic product, pointing out that the government targets to keep the external debt ratio of the GDP at 30-32% in the coming years.
“We fully agree with the governor of the CBE when he said that Egypt does not have any concerns about its external debt,” Abdel Aal said.
Egypt’s foreign exchange reserve reached highest level in its history
On the other hand, we noticed that Egypt’s foreign exchange reserves continued to rise, reaching $44.1bn by the end of May 2018—the highest level in its history.
Abdel Aal said that the rise of foreign exchange reserves is a positive step that increases confidence in the Egyptian economy; however, it also poses many questions, especially, as it comes in line with the increase of foreign debt.
He pointed out that the size, components, and sources of Egypt’s foreign exchange reserves, whether from foreign debt or other sources, are not the important sides at this time. He added that the importance of the increase and accumulation of foreign exchange reserves is linked to several other factors.
Firstly, the size of foreign exchange reserves is always connected with its ability to cover imports. Egypt’s foreign reserves are sufficient to cover the country’s imports for nine months, which is a safe and good level. In addition, it enhances investors’ confidence in the state’s ability to maintain stability of exchange rate, stock market, and financing requirements.
“If we pay our foreign debt instalments with their interest on time and cover our imports for several months, then why are we concerned over the rise of external debt knowing that it strengthens investors’ confidence in the local economy?” Abdel Aal wondered, adding, “in my view, the Brazilian case is very similar to Egypt’s, in terms of the size of foreign exchange reserves. We should continue developing our economy until the foreign reserves reach $135bn, provided that most of it comes from the national economy’s activities, such as exportation, tourism, and the Suez Canal,” adding, “we sometimes borrow with high interest rate of 6%. It usually happens when offering bonds, which is not related with interest rates in the market, but with the country’s solvency, and how confident the world is of its ability to pay its debts.”
Abdel Aal stressed that direct borrowing must be subject to careful studies, explicit approval of specialised authorities, and must be approved by the parliament, in accordance with the constitution.
He pointed out that the only determinant of the necessity of dependence on loans or sources of external financing is the use of these loans to finance direct investment, bridge the financing gap of sustainable development process, and exclude financing the budget deficit, subsidies, or luxury spending, with the obligation to pay the debt instalments, and interests on time, according to the repayment programme.
Foreign borrowing must stop
According to Tarek Metwally, a banking expert, the economy needs foreign borrowing at the beginning of reform and preparing the investment infrastructure, as it becomes the right solution; however, it must be within safe limits that do not exhaust the state’s budget or the upcoming generations.
Metwally believes that as foreign loans reach their current level, borrowing must stop, and work to attract investment over the upcoming period must take place depending on the positive results from the economic reform. It is also important to retain the same level of debts without increases.
He noted that we should take the countries that borrowed too much as an example. They borrowed to fund national projects to refresh the economy, and now they are suffering from many issues as a result.
“Increasing foreign reserves is good and required, based on future projections for local and global economy; however, I see no need for increasing reserves through borrowing now that reserves reached $44bn, which is sufficient for more than nine months commodity income, given that the optimal level is three to six months of commodity income,” Amer said.
He added that in some cases, there are costs that the state budget bears for reform, including building reserves, and borrowing costs. This is why it is necessary to keep the loans within reasonable limits to avoid more burdens.
Before January 2011, the volume of foreign debts reached $36bn, and reserves $36bn as well. Foreign debt represented 51% of the national income, which did not represent a burden on the state budget and was one of the most important strengths of the economy at that time.
He added that the trend to convert short-term debts to long-term ones while focusing on not increasing the debt is the most important part.
“The government is not free to borrow from abroad, as the approval of the parliament is required. However, the upcoming period requires more rules and control for this issue especially, in light of the political conditions and the importance of political independence, which requires a comprehensive economic and political vision,” Metwally said.
Local, foreign disagreement on risks of foreign borrowing
For his part, Hany Aboul Fotouh, a banking expert, said that the level of Egypt’s foreign debts is one of the issues around which there was disagreement between different bodies. Each body has a different point of view.
“It is clear that expanding foreign borrowing was justified by funding the economic reform programme and the budget deficit, especially with the increase of local borrowing because of the interest rate increase,” Aboul Fotouh said.
He pointed out that, according to the eurobonds bulletin recently launched by the Ministry of Finance, Egypt’s foreign debts reached $82.9bn in December 2017. Additionally, based on Fitch Credit Ratings, the debt was estimated to be $100bn by the end of 2017; however, Fitch said that a large part of these debts came with facilitated conditions.
Former Finance Minister Amr El-Garhy explained that the difference between the estimations of Fitch and the CBE, regarding the value of the foreign debt, by saying that the definition of debts in the CBE is different from the definition in Fitch, as the investments of foreigners in government debt tools is not calculated as part of foreign debts in the former.
“Abstract numbers are used within the limits of the known economic indicators. They are a percentage of foreign debt in the GDP,” Aboul Fotouh said.
He explained that according to international standards, the same limit for foreign debts is deemed to be 60% of the GPD. Hence the percentage reaching 36.2% in Egypt by the end of September 2017 shows that it is still safe. The government seeks to reduce this percentage to 30% and 32% in the future as economic indicators improve.
“The CBE governor has recently pointed out that the situation of the Egyptian economy can handle foreign debts in much higher values than the current ones, as long as instalments and interests can be paid on time; however, it is better not to expand foreign debts unless this is highly required. This would ensure not exhausting the state budget and adjusting the structure of foreign debts in favour of medium and long term with lower interest rates,” Aboul Fotouh said.
He stressed that all this is necessary to avoid making foreign debts form negative pressure on Egypt’ credit rating in the future.
He added that foreign reserves in Egypt reached $44.03bn, by the end of April 2018, noting that all countries of the world, regardless of the size of their economy, own large foreign-currency reserves and use them as a support during possible crises.
“Countries are involved in international trade, whereby foreign reserves are deemed important for them, to ensure that international trade relations continue. The rule central banks usually follow is maintaining at least three months of foreign currency incomes,” Aboul Fotouh said.
He pointed out that with increasing trade openness with globalisation, increased took place in serves, which is in line with the financial statement of the general budget that aims to increase reserves to more than six months of income in 2018/2019.
“Foreign financial flows, like direct investment and investing in the EGX, have become more important for economic growth. Additionally, usually financial flows are more volatile, which requires increasing foreign reserves. In addition, keeping reserves as a result of increased financial flows requires any state to maintain a flow that equals its foreign liabilities within a year,” Aboul Fotouh said.
He added that there are costs for maintaining a large balance of foreign exchange. Usually, fluctuations in prices in exchange markets lead to losses and wins in the purchasing power of reserves, as well as fluctuations in the exchange rate. Moreover, the purchasing power of currencies continuously declines, due to the decline in the currency value because of inflation. This is why central banks continue to increase the reserves, in order to maintain the same value to face exchange rate fluctuations.
“Foreign debt has reasonably developed over the past years before it took a rising turn since 2012. During that time it reached $34.38bn, and then it kept rising until it reached $48.06bn, $55.06bn, and $79.03bn in 2015, 2016, and 2017, respectively. The total burden of this debt was $5.61bn, $5.08bn, and $7.18bn, during these three years,” Aboul Fotouh said.
He pointed out that what matters here is the structure of debt terms, because long term debts are considered more dangerous if they form a large part of foreign debts, especially, with difficulties in cash flow from original resources, such as the proceeds of exports, tourism, and transfers of workers abroad. This would ensure repaying the instalments of a debt on time, so the Ministry of Finance aims to restructure foreign debt and replace short term debts with long term ones with a low return.
“Foreign debts are still within a safe limit; however, the real danger is the general debt. Borrowing must be for strong reasons and is greatly justified by the positive things it would bring. In the constitution, according to Article 127, the executive authority is not allowed to obtain any loans unless the parliament approves,” Aboul Fotouh said.
“Theoretically, foreign borrowing is okay, as long as it adds new energies to the production sectors and would generate revenues in the local currency, which will leave an impact on the growth of the Egyptian economy. However, if loaning was for the purpose of dealing with the budget’s deficit or projects that bring no revenues, this would be something that must be reconsidered,” he added.
He added that a declared plan for foreign exchange flows must exist to pay foreign debts. The parliament must also play its role in monitoring this plan and ensuring it is implemented through a mechanism to follow up the use of loans.
Foreign borrowing is temporary, necessary
According to Radwa El-Swaify, the head of the research department at Pharos Holding, even though borrowing is not positive, Egypt had to increase foreign loans temporarily, in order to get out of a difficult phase, as not enough resources existed to cover the financial gap that exists, which is estimated to be $10bn annually.
She expected that Egypt’s external indebtedness would increase over the upcoming period, in light of the state’s previous announcement to launch new bonds in foreign markets.
“The government is obliged to do this until natural resources for foreign exchange exist. It is also trying to reduce local borrowing to reduce the burden of debt service, and hence reduce the state’s budget deficit, as much as possible,” El-Swaify added.
She also pointed out that short-term loans represent only 13.2% of the total foreign debt of Egypt, which is deemed very positive as there are no short-term obligations that exhaust the state at the beginning of the economic reform programme.
In a response to the question about whether or not Egypt needs to increase foreign exchange reserves, El-Swaify said that they do need to increase, but from different resources. It is better to have self-resources, noting that Egypt has foreign obligations it must meet over the upcoming period, which requires strong reserves.
El-Swaify expected the volume of reserves to range from $40bn to $45bn over the upcoming 12 months, covering nine months of income, which is a very decent level, according to international standards.