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Egypt’s expected $68bn borrowing needs: Why sukuk can help reduce its debt

By Sherif Tarek
Posted on Thursday, 10 June 2021 18:34, updated on Monday, 19 July 2021 12:01

A view of Old Cairo with a mosque minaret and the Great Pyramids on March 21, 2020. REUTERS/Amr Abdallah Dalsh

A forecasted decrease in GCC sukuk, Egypt’s enticing yields, and business sectors that have thrived during the pandemic could guarantee the country an auspicious low-cost debut of the Islamic bonds. On the other hand, the sukuk could lead to a rise in utility bills.

Egypt’s impending issuance of the sovereign sukuk is widely hailed as a step towards attracting a new class of investors into the debt market. The move is also expected to bridge the country’s budget deficit at a lower cost, even though indicators of global economic recovery point to mixed signals ahead of the anticipated move.

The Islamic bonds could also set the stage for further austerity driven by the pressure of a free market, should state institutions that provide utility services begin to issue sukuk and consequently increase prices to ensure yields provision to debtors.

Sukuk: ‘structured in accordance with Islamic sharia’

Sukuk, a transliteration of the word ‘certificates’ in Arabic, are bonds structured in accordance with Islamic sharia. They were first introduced to the world in the 1990s and in recent years have been gaining momentum internationally, prompting Egypt to jump on the bandwagon.

On Sunday 6 June, the Egyptian parliament tentatively gave the green light for the sukuk draft law: it is likely to be implemented in the near future after a final nod from the lower house and an approval from President Abdel Fattah al-Sisi. This will then enable the government to securitise its assets and issue the Islamic bond.

The bill stipulates that a state company will be established to manage the sukuk offerings (which can be public or private) – whether domestically or overseas – in both local and foreign denominations. The finance ministry says the first sukuk offering will be launched once the law has been ratified.

Amr Hussein Elalfy, head of research at Prime Securities, expects Egypt’s first issuance of the Islamic bonds to be wrapped up no sooner than the next financial year, which starts in July and ends 30 June 2022. Such a time slot would be ideal for Egypt to step into the sukuk market, he adds.

Oil price hikes

Oil prices hit a two-year high as the global economy shows signs of improvement. This means that countries from the Gulf Cooperation Council (GCC) – which boasted half of the gross long-term global sovereign sukuk offerings last year amid plummeting oil prices – will likely need a lesser volume of the Islamic bonds to fulfil their financing obligations.

In a report issued in February, Moody’s Investors Service says gross “long-term sovereign sukuk issuance will ease this year from record highs in 2020 as financing needs narrow at a time of higher oil prices, lower coronavirus-related expenditures and accelerating economic activity in the main sukuk-issuing countries.”

Moody’s forecasts “overall sukuk issuance of $96bn in 2021, down from $109bn last year, that will be driven by the impact of higher oil prices on issuance by Saudi Arabia and other Gulf Co-operation Council (GCC) sovereigns”. The long-term growth trend will remain intact, the report adds.

There are legitimate concerns that the Islamic bonds could drive up the cost of public services in order for sukuk-issuing state institutions to ensure the fulfilment of their obligations towards debt investors.

Elalfy agrees with the analysis, saying that such a decrease in the GCC sukuk could ratchet up demand for Egypt’s Islamic bonds when they are issued.

But Egypt “cannot fill the entire gap,” he tells The Africa Report, adding that the north African country’s first sukuk offering is expected to be worth between $1bn and $2bn to “test the waters”.

However, Mohamed El-Sherbiny, private equity vice president at NI Capital, played down the effect of the Gulf sukuk issuances on Egypt, stressing that Islamic bonds will be of a different league and investment mandate.

“We are talking about different interests,” he tells The Africa Report. “Meaning for example the credit ratings of Saudi Arabia or UAE are [higher than] … Egypt, and thus the income spread will be different.”

Real interest rate

The Central Bank of Egypt (CBE) has paused monetary easing for four consecutive meetings, holding the benchmark deposit rate at 8.25% and the lending rate at 9.25%.

The CBE subsequently maintained the world’s highest real interest rate and kept the Egyptian debt market attractive, Bloomberg reported in late April, with other economies offering lower yields on the back of deep rate cuts instigated by the pandemic.

Elalfy believes that Egypt, which has the best carry trade in the world, should make the most of the status-quo before further recovery sees emerging markets raise interest rates that would beget higher yields.

“It depends on global interest rates and these days they are quite low, so it’s a good time for Egypt’s first sukuk issuance before they go back up upon the improvement of the US economy,” which could possibly urge the feds to increase rates and other countries would follow suit, he says.

Covid effect

Alalfy says that so long as a country’s economic indicators are reassuring, the effect of the pandemic could be negligible.

Egypt is one of a few African countries to achieve a positive growth rate, which finance minister Mohamed Maait expects to stand at 2.8% in the current 2020/2021 fiscal year. Its average inflation rate is also “relatively low” and “does not place its local currency in peril,” Alalfy says.

Critics fear that the introduction of sukuk would be a stride towards neoliberalism that further puts the Egyptian economy at the mercy of vulture funds.

But apart from economic indicators, Egypt must take into account how different sectors have been affected by the pandemic while preparing for its first sukuk issuance, El-Sherbiny points out.

How successful the sukuk issuance will largely be “contingent on what these debt instruments will fund,” he says. “For instance, if a country is issuing sukuk to purchase planes,” with the aviation sector still weighed down by the pandemic, the demand will be modest and yields will be higher, El-Sherbiny says.

Sukuk structure

The sternest challenge, El-Sherbiny says, is “to have the projects and investments that Egypt wants to fund through the Islamic way ready,” as well as a sukuk structure that appeals to most sharia-compliant investors.

In Egypt, Al-Azhar – the highest Sunni seat – and Dar El-Ifta – the body responsible for providing religious edicts – are involved in shaping the structure of the sovereign sukuk alongside the finance ministry and other state institutions.

“Some investors abide by the standards of the AAOIFI [the Accounting and Auditing Organisation for Islamic Financial Institutions],” for instance, while others would follow other Islamic doctrines, El-Sherbiny says.

“Rushing into it without the proper structure would mean no appetite,” he says, adding that such a scenario for the debut sukuk could well take a toll on further issuances. “Egypt must conduct a roadshow to determine where the appetite is,” he adds.

Diversification of investors

El-Sherbiny rules out the possibility that Egypt’s sovereign sukuk could throttle back investments in its traditional debt instruments by luring investors into shifting. He instead argues that the Islamic bonds could be a boon to a “new type of investors whose investment mandate allows them to take the risk of investing in Egypt and the risk of the currency.”

“There are markets and investors that [Egypt sees] is far from their scope, such as Malaysia and the GCC … where there is a big appetite for sukuk, and they are not among the key players that invest in the Egyptian debt instruments,” he says.

Current foreign holdings of Egypt’s treasury bills and bonds are estimated at $29bn. “Egypt[‘s] debt has generally has been faring well, so there’s no reason sukuks won’t enjoy the same,” Mohamed Abu Basha, senior economist at Egypt’s largest investment bank EFG Hermes tells The Africa Report. It will “open a new market for Egypt and new investors can tap Egypt’s risk for the first time,” he says.

Debt service reduction

Abu Basha says diversification of investors “would allow the government to sell debt at cheaper rates,” which is one of Egypt’s key macroeconomic targets.

The Egyptian sukuk draft law states that the maturity of the sovereign Islamic bonds can be up to 30 years, in line with the government’s intent to rely more on long-term debt instruments to ultimately shrink its debt service.

“When you switch from short-term to long-term, the yield decreases,” Elalfy says. “Sukuk are not traditional bonds, which possibly make the yields even lower because of a higher demand.”

Egypt’s borrowing needs are foreseen to go up 7.1% to $68.1bn in the 2021/2022 fiscal year amid a budget deficit of 6.7% of gross domestic product (GDP), according to the state budget.

However, Mohamed Fouad, a former MP who was a member of the economic committee of the previous parliament, does not believe that sukuk will play a great role in reducing Egypt’s national debt.

“The viability and sustainability” of sukuk are the same as the other debt instruments, so “I don’t see how it could possibly” reduce Egypt’s debt service, he tells The Africa Report.

Adding to citizens’ financial woes?

Critics fear that the introduction of sukuk would be a stride towards neoliberalism that further puts the Egyptian economy at the mercy of vulture funds.

Economy writer and researcher Wael Gamal explains that sukuk is a debt instrument that is directly linked to the revenues of the issuers, unlike bank loans that state institutions recurrently take out under the auspices of the government to secure funding.

“This logic changes the way of thinking with regard to developing public services and relevant public policies,” Gamal tells The Africa Report. “Because not only will you be thinking how I [the government] can provide the best medical care in Sinai [for instance, but also] how this will affect the yields that need to be paid.”

Egypt has witnessed over the past year a bundle of austerity measures under its $12bn deal with the IMF in 2016, primarily in the form of a domestic currency float and lifting of energy subsidies. Economic reforms were also stated in the stand-by agreement that Egypt signed with the IMF in 2020.

Gamal believes the sukuk issuance goes with the essence of the IMF directives and the neoliberal philosophy “that there is no such a thing as public services … that the budget of a state is managed like that of a private company with the goal of making profits”.

Bottom line

Sharia-compliant investors have good reason to rush towards the Egyptian sovereign Islamic bonds when they come out, with the government hoping long-term sukuk could diminish its national debt.

But there are legitimate concerns that it could drive up the cost of public services for sukuk-issuing state institutions to ensure the fulfilment of their obligations towards debt investors.

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