Egypt in a good position as global conditions tighten

Egypt is in a good position to cope with the expected tightening in global financial conditions over the coming year, as developed market central banks start to ease back on their quantitative easing programmes and eventually consider raising their benchmark interest rates.  Finance minister Mohamed Maait has noted that the experience of recent years has left the authorities well prepared. Ongoing engagement with the IMF will continue to provide a policy anchor and reassure investors, even if this does not entail a new lending programme.

The prospect of the US Federal Reserve starting to taper off its substantial asset purchasing programme in the coming months has raised concerns of a repeat of the 2013 ‘taper tantrum’, when comments about tapering by then-Fed chair Ben Bernanke led to a sharp sell-off in some key EMs as the balance of risks for international investors turned with the prospect of higher rates available in developed markets. However, while the prospect of capital flight out of Egyptian local debt markets may be on the authorities’ minds, the country is in a relatively strong position at present, even despite the pressures exerted by the pandemic crisis last year. Gross official reserves remain down from their pre-pandemic peak of USD 45.5bn but have been ticking up modestly over the course of the year, and now stand at USD 40.6bn. This represents over seven months’ import cover and compares favourably to recent historical averages.

CPI inflation in Egypt accelerated more rapidly than anticipated in September, rising by 6.6% y/y, up from 5.7% the month previous, but the headline measure remains well within the CBE’s target range. Food and drink prices, which rose 10.6%, were the key driver of the acceleration last month which was at the fastest pace since January 2020. We expect price growth to moderate again from here even as energy prices remain high and forecast an average of 6.3% next year. As such, we expect that the central bank’s benchmark overnight deposit rate will remain on hold at 8.25% through the remainder of this year and into 2022. The next move will more than likely be higher, and we have pencilled in a 25bps hike in Q2 2022, as global conditions tighten, but we do not expect undue pressure to necessitate any rapid moves.

Foreign holdings Egyptian debt, USD bn

Source: Haver Analytics, Emirates NBD Research

Foreign ownership of Egyptian debt has held up well to now, still near record levels despite dipping slightly in August. This reflects a rapid recovery from the decline seen over March to May last year as the pandemic crisis began. While rising US yields will increase the pressure, Egypt is due to be included on JP Morgan’s EM local currency index from the end of January which will ensure a sizeable flow of passive investment from the USD 250bn that tracks it. Meanwhile, we also expect that Egyptian tourism will rebound in 2022, and with it an important source of FX inflows. Travel receipts remained substantially down y/y in Q1 (-42.5%) but as global restrictions ease, and the resumption of direct flights from Russia to Red Sea resorts take hold, we predict a robust recovery which would in part offset the effect of any portfolio outflows on Egypt’s external position. Our expectation remains that the pound will remain stable with only a modest deflationary bias; our end-2022 projection is for an exchange rate of EGP 15.8/USD, compared to a current level of USD 15.7/USD.

The prospect of higher rates does pose a challenge to Egypt’s fiscal position, given the high levels of government debt and the interest payment burden this incurs. Over January to May, Egypt’s debt servicing costs accounted for 36% of all spending, but this has already fallen from the previous year, and the issuance in September of USD 3bn in Eurobonds (following USD 3.8bn earlier in the year) enabled the locking-in of cheaper yields on longer-dated securities prior to any Fed hikes.