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Egypt: Carry trade could end in tears following food-price reforms

By David Whitehouse
Posted on Tuesday, 14 September 2021 18:30

Egyptian President Abdel Fattah al-Sisi plans to reform bread subsidies. (AP Photo/Evan Vucci)

Investors piling into Egyptian Treasury bills, yielding between 11% and 13%, risk disappointment as President Abdel Fattah al-Sisi seeks to push through the first increase in bread prices in decades, analysts say.

Al-Sisi said on 3 August  that he will reform the country’s bread subsidy system. It’s the first attempt to do so since 1977, when price increases imposed by President Anwar Sadat were withdrawn in the face of rioting.

Egypt has withdrawn most of its energy subsidies, but an estimated two-thirds of the population still benefit from cheap bread prices, which cost the government about $3bn a year.

The aim of the reform is to shift to a more targeted social transfer system to help poorer households. The IMF is forecasting a reduction in the food subsidy bill from 1.4% of GDP in 2020-21 to 1.0% in 2024-25. However, a policy reversal such as that of 1977 is “a distinct possibility if public opposition to the move escalates,” says Mark Bohlund, senior credit research analyst at REDD Intelligence in London.

Carry trade investors, who borrow money in a low yielding currency to invest in better yielding securities elsewhere, have been attracted to Egyptian debt due to high interest rates, increased foreign-exchange reserves and the prospect of inclusion in JPMorgan’s emerging markets government bond index (GBI-EM).

  • Foreign-exchange reserves are likely to rise to a record level in the second half of this year, Bohlund says.
  • A continuation of food subsidies wouldn’t in itself derail Egypt’s fiscal consolidation; however, combined with increasing energy and interest-payment costs, would keep the fiscal deficit close to 10% of GDP and push public debt towards 100%, he adds.

Debt repayments

Egypt was among countries that benefitted from a new Special Drawing Rights (SDR) allocation from the IMF on 23 August, with the country’s allocation worth about $2.8bn. However, this was offset by a 7.1% decline in foreign currency holdings in August to $33.6bn due to eurobond coupon repayments, with gold reserves also falling, says Callee Davis, an economist specialising in Egypt at NKC African Economics in South Africa.

  • The danger is that “hefty repayments on external debt will weigh on foreign reserves over the medium term,” Davis says.
  • Interest payments on government debt have increased from 42% of total government expenditure in 2012-13 to 58% in 2020-21, according to REDD Intelligence.
  • “A larger debt-servicing burden will make further budget deficit reduction harder to achieve,” Bohlund says. “This could, especially if combined with expectations of higher US rates, trigger a reduction of foreign holdings of local-currency debt over the medium term.”

Inflation is a further concern. Urban consumer price inflation rose to an annual 5.7% in August from 5.4% in July, its highest level since November. A further increase is likely in the near term due to base effects and rapidly rising global food prices, according to REDD Intelligence.

  • Failure by Egypt’s central bank  to react to those signs could unnerve some investors, especially those that fear global markets are underestimating the chances of the US Federal Reserve tightening its monetary policy, Bohlund argues.
  • While the allocation of SDRs could fuel the “carry-trade party” in the second half of this year, “the hangover could end up being severe,” Bohlund says.

Bottom line

If the assumption that Sisi can keep a lid on popular discontent, is proven wrong, carry trade investors won’t have much time to find the exit.

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