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The country has one of the highest ratios of interest-to-government revenue in Africa and “much of this goes to foreign investors due to the portfolio inflows into the local debt market”, says Mark Bohlund, senior credit research analyst at REDD Intelligence in London. Bohlund says he shares the concerns of asset managers and credit rating agencies with regards to Egypt’s external debt sustainability.
Foreign-held treasury bills accounted for around 70% of total forex reserve holdings as of October. Prospects for higher US interest rates in 2022 mean that foreign investors will have less incentive to buy them. The US Federal Reserve has said it is likely to raise interest rates in March. According to Reuters, the market has now moved beyond the previous scenario of three Fed increases this year, and rate futures indicate the chance of four or more hikes in 2022 is above 60% and rising.
“Egypt’s external position could be in big trouble should any sudden shifts in emerging market sentiment trigger market volatility and lead to an unexpected reversal in portfolio inflows,” Callee Davis, an economist at Oxford Economics Africa in Cape Town, says in his research. A sudden shift in emerging market sentiment could pose a serious threat to foreign reserves, she writes.
- During the first half of 2021, foreign direct investment entered Egypt at around half the rate seen before the pandemic, Davis says.
- Meanwhile, the current-account deficit had almost doubled, and portfolio inflows were only about 15% below their pre-Covid-19 level.
- A sudden drop in foreign reserves could force the central bank to stop intervening in the currency market and accelerate moves towards a flexible currency regime, Davis writes.
- A free-floating currency would be beneficial over time, but in the short term, a sharp deprecation would mean increased imported inflation and higher US dollar-denominated debt repayments, she adds.
Ammunition to hand
Egypt’s listing on the JPMorgan emerging markets government bond index has driven portfolio inflows in the local debt market in January, Bohlund says. He notes that Egypt’s foreign currency reserves are at a record high, meaning that it has “plenty of funds to defend the Egyptian pound’s peg to the US dollar if portfolio flows were to reverse”. This looks likely unless Egypt’s central bank increases its policy rate this year, he says.
Research from Krisjanis Krustins and Jermaine Leonard at Fitch Ratings points to factors that will support Egypt’s external resilience. These include strong relationships with bilateral and multilateral lenders and access to non-market financing. “We believe that another IMF programme is likely, particularly if Egypt were faced with a liquidity shock,” the analysts say.
Still, Davis calculates, if portfolio inflows were to turn negative this year, foreign reserves would fall by almost 30%. It would “not take much” for foreign reserves to drop to levels previously seen during 2015-16, just before the IMF intervened, she argues. In that case, “taking on more debt might be the only option” despite existing external debt repayments in the medium term.
- Unnamed government officials told the Mada Masr newspaper in late January that Egypt has been in talks with the IMF to discuss a possible new loan.
- Egypt is likely to continue to tap international bond markets during 2022, but for lower amounts than during the past five years, says Bohlund.
Egypt is likely to need to call on its relationships with foreign lenders as US interest rates rise.
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