Risk drivers and outlook

Since President al-Sisi took office 2 years ago the country has enjoyed a more secure political order, although this has not translated into improved economic fundamentals. On the contrary, his repression, terrorist attacks and weak macroeconomic policies are having a dramatic impact on tourism – a key source of foreign exchange earnings – and severe consequences for foreign exchange reserves, the current account balance, economic growth and unemployment. In addition, lavish megaprojects have been driving up the fiscal deficit and public debt, putting public finances in a dire state. Although the Gulf states came to the rescue with aid, when oil prices fell Gulf aid dried up while the economy further deteriorated, as illustrated by shortages of hard currencies and basic commodities. Imminent reforms appeared necessary. These bode well for the economy in the long term but are painful in the short term, possibly triggering widespread discontent. However, the waning economy also fuelled unrest. Egypt seemed to be stuck between a rock and a hard place. Multilateral organisations came on the scene. To secure a loan from the IMF, though, decisions had to be made: the exchange rate of the Egyptian pound was floated, representing a 50% devaluation, and fuel subsidies were cut, leading to a 47% price increase. In this difficult context, the recently secured IMF loan will support liquidity and recent and anticipated reforms will help the economy to recover. Nevertheless, political risk looms in a country where two presidents have been ousted in the last 5 years. For these reasons and as short-term and MLT external debt is on the rise, Egypt’s political risk classifications are in category 5 and 6 respectively for short-term and long-term political risk on a scale from 1 (best) to 7 (worst).

Commercial risk remains high given a difficult business environment characterised by red tape, weak credit supply, poor infrastructure, increasing lending rates and a depreciating currency and double-digit inflation. As a consequence, Credendo Group’s category for the commercial risk assessment is C (the worst).

Facts & figures

Pros

  • Relatively low debt service level despite rising external debt
  • Rather good relations with external donors
  • Improved macroeconomic policies (albeit from a weak level)
  • Floating exchange rate

Cons

  • Poor external liquidity
  • Difficult business environment
  • Dire fiscal finances
  • Heightened risk of social unrest

Head of State

  • President Abdel Fattah al-Sisi (since 8 June 2014)

Head of government

  • Prime Minister Sherif Ismail (since 12 September 2015)

Description of electoral system

  • Presidential: 4-year term; last election: May 2014
  • Legislative (for House of Representatives): 5-year term; last election: 16 December 2015

Population

  • 91.5 m

Per capita Income (USD)

  • 3.340 (2013)

Income group

  • Lower middle income

Main export products

  • Private transfers (36.4% of current account receipts), tourism (13.5%), Suez Canal receipts (10.7%), oil (16.7%)

Country risk assessment

Politics as usual

During the past 5 years, Egypt has been going through a period of dramatic change. In 2011 Egyptian protests erupted which were motivated by domestic discontent and the events in Tunisia where President Zine al-Abidine Ben Ali was removed. Following 18 days of deadly unrest, the authoritarian President Mubarak handed over power to the military after 30 years in office. Though mass demonstrations stopped, significant protests against the new military rulers continued. Nonetheless, a new political landscape emerged as the Islamist Muslim Brotherhood formed a political party, the Freedom and Justice Party, and in 2012 their candidate, Mohammed Morsi, was elected in the first presidential elections in half a decade. However, in the following months Morsi provoked controversy and many Egyptians began to believe that they had exchanged one authoritarian ruler for another. In addition, the lack of security and the deterioration of the economy fuelled unrest. The dismay boiled over into a new wave of protests. Only a few days after overwhelming demonstrations against Morsi’s first year in office, he was ousted by Egypt’s army. A new constitution was adopted in January 2014, abolishing the upper house of parliament. Instead, Egypt’s legislature now consists of a single House of Representatives which was elected in 2015 for a 5-year term. In addition, Mr al-Sisi, a former leader of the armed forces, won the presidential elections in June 2014 with 97% of the vote.

Since al-Sisi came to power, Egypt has enjoyed a more secure political order, although the country has slipped back into authoritarian military rule. Indeed, the military and security forces retain tight control over policymaking while still controlling key areas of the economy. Furthermore, since Morsi’s ousting there has been a crackdown on the Muslim Brotherhood. The Muslim Brotherhood leadership was detained along with thousands of its members, a court banned all Muslim Brotherhood institutions and more than 100 presumed Muslim Brotherhood sympathisers, including former President Morsi, were given the death sentence. Anti-government protest numbers have consequently dwindled, but at the same time, terrorism incidents have risen sharply given the lack of other channels for political expression for Islamists in combination with spillover effects from regional sectarian conflicts. Terrorism incidents are having a dramatic impact on the tourism sector as illustrated by the downing of the Russian aeroplane in November 2015 by a local group that claimed allegiance to Islamic State, after which tourism revenues plummeted. In addition, support for the popular al-Sisi is waning due to his inability to respond to the ongoing economic crisis, in particular persisting unemployment and high inflation, as well as to deteriorating public services, increasing police brutality, rampant corruption, and energy, food and water shortages. Nevertheless, unrest seems limited for now but economic recovery will be critical for political stability in the coming years.

Complicated friendships

Egypt has traditionally been an important ally in the Arab world as it is crucial for regional stability and home to the Suez Canal, an important waterway for world trade. Egypt has benefited from a strong improvement in relations with the Gulf countries (notably Saudi Arabia, the United Arab Emirates and Kuwait) since President Morsi was removed. This is explained by their aversion to the Muslim Brotherhood, which is seen as an ideological competitor (particularly by the regime in Riyadh). The Gulf states also provided the country with financial aid, but aid has been declining and has been given in the form of soft loans since 2016, which is attributed to the persistent low oil prices, disagreement about regional politics (e.g. Syria) and frustration about the lack of improvement in Egypt’s economy. In particular relations with Saudi Arabia look bumpy as illustrated by the halt in supplying 700,000 tonnes of petroleum products per month on generous credit terms. Nevertheless, Saudi Arabia and other Gulf countries look committed to supporting the country as they recently came through with deposits, estimated at USD 3 billion.

Relations with the IMF have been improving but also remain complex. In January 2015 the IMF published its first Article IV in 5 years, while during the summer Egypt struck a preliminary deal for a USD 12 billion IMF loan programme, which will be disbursed over 3 years. It took several months before the loan was approved by the IMF board. A first condition for approval was securing USD 5-6 billion in bilateral financing for the first year, which required several allies. Cuts in fuel subsidies and a further currency devaluation were also essential before a deal was struck but it took until the beginning of November to float the currency and cut these subsidies. Though it took some time to secure the loan, it is the first time Egypt reached an agreement. Two previous agreements with the IMF indeed collapsed in the past five years due to a lack of political will to implement reforms and fear of rising social tensions.

Wobbly economy

The Egyptian economy has been floundering since 2011. Annual growth since the Arab Spring has been 2.7% on average in 2011-2016, compared to an annual growth of 5% in 2000-2010. Egypt has been suffering economically from years of political turbulence, falling tourism revenues – a key sector and source of foreign exchange earnings – and investments and foreign exchange rationing. In addition, growth has been impeded by the rather difficult business environment (Egypt ranks 122nd out of 190 countries in the World Bank’s Ease of Doing Business 2017 ranking). Furthermore, slow growth has resulted in high unemployment, running at 14.5% in 2015/2016, with youth unemployment estimated at three times that rate.

In the longer term the picture looks brighter. In late 2015 a ‘supergiant’ gas field was discovered, estimated to be larger than Oman’s reserves according to EIA. Egypt is the largest non-OPEC oil producer and the second largest dry natural gas producer in Africa but it is also the continent’s largest oil and gas consumer. That is why it is a net fuel importer as of 2012. If energy company Eni’s estimates are accurate, the field will increase Egypt’s gas reserves of 65.2 trillion cubic feet by almost half. The gas can provide for Egypt’s own energy needs and renew the export trade. In addition, reforms requested by the IMF can also turn things around in the long term as reforms are likely to foster growth and create jobs.

Stemming unrest with an overvalued exchange rate

Egypt’s liquidity situation has deteriorated drastically since 2011. The foreign exchange rate was kept at an overvalued rate to keep import prices low as Egypt is a huge importer of basic goods such as wheat. Low prices of basic goods could stem unrest as in the past basic goods appeared to be an important trigger for discontent. In addition, sources of foreign exchange revenues were under pressure (see below). Consequentially, foreign exchange reserves more than halved from 5.8 months of import cover in the July 2009/June 2010 fiscal year to 2.3 months of import cover in June 2016. The Gulf countries came to the rescue in April 2015 with USD 6 billion in deposits, and again in the summer of 2016 with USD 3 billion in deposits. The Egyptian government also concluded a number of loans with the World Bank, the African Development Bank and also Saudi Arabia and China to support the Egyptian economy and increase the country’s liquidity. Nevertheless, the loans and deposits could only temporarily lift the reserves and devaluation was still necessary as foreign exchange reserves continued to fall. The devaluation of the pound by 13% in March 2016 brought no solace as the exchange rate was still overvalued. Indeed, there was still a huge difference between the official rate, which stood at 8.88 pounds to the dollar, and the black market rate, which stood at 18.25 pounds to the dollar at its peak. The overvalued exchange rate in combination with low foreign exchange reserves led to widespread shortages of imported (basic) goods such as sugar, baby milk and rice. As protests escalated, the Egyptian authorities even confiscated stocks of sugar at companies making soft drinks and sweets to sell them in outlets retailing subsidised food. Payment delays in hard currencies were also being reported as these were rationed. Indeed, the policy of keeping the exchange rate overvalued had the opposite effect of that intended by the government. As the pressure on the exchange rate was mounting, at the beginning of November the Central Bank of Egypt announced a free floating of the pound, representing a devaluation of about 50%. The flotation lifts pressure on foreign exchange reserves. However, inflation is also likely to increase as import prices will increase. Inflation was already at a high 15.5% year on year in August 2016, the highest level since 2009, due to the devaluation in March this year. The flotation of the Egyptian pound is likely to further increase inflation, which explains the past hesitation of the Central Bank to float the currency. In addition, anticipated subsidy cuts and tax increases will keep inflation elevated in the short term. The IMF expects a yearly inflation of 16.5% in July 2016/June 2017, though it would not be unrealistic for these numbers to prove higher.

Hit by multiple shocks

Since 2008, Egypt has had structural current account deficits which have been widening to elevated levels over the years. Though the low food and oil prices of recent years should have benefited Egypt as it is an importer, the country’s export revenues have waned in recent years. Indeed, pressure on the key sources of foreign exchange earnings has led to increasing structural current account deficits. Firstly, tourism hit a decade low this year. The sector was already suffering from the upheavals of 2011 and 2013, but has taken another hit due to security concerns following the terrorist attacks targeting tourism in the past 2 years. Secondly, remittances – the most important source of current account receipts – are falling sharply due to weaker GDP growth in the Gulf countries which depend heavily on oil. Thirdly, the revenues of the Suez Canal, which was recently expanded, have decreased as global trade slows on the heels of the worldwide downturn. As a result, the current account deficit is expected to reach a high level of more than 50% of current account receipts in July 2016/June 2017, a narrowing compared to the huge deficit of more than 70% posted last year. On top of that, official transfers are in decline, reflecting the drying up of grants from the Gulf states. On the positive side, the current account balance is expected to narrow in the coming years as the flotation of the overvalued Egyptian pound will strengthen competitiveness and hence bolster exports. Tourism revenues are also expected to increase as the effect of the terrorist attacks wanes, but only if political stability remains. In addition, remittances are likely to recover in the coming years in line with the expected modest recovery of oil prices. Moreover, as the IMF programme is approved, it will become easier for Egypt to finance its current account deficit.

Egypt faces substantial external debt repayments as short-term external debt has increased substantially in the past year to more than 25% of current account receipts in 2015/16. The total external debt has also been increasing, especially in the last 2 years, due to bilateral and multilateral loans. In the coming years debt is likely to increase further as recently an IMF loan was concluded while additional bilateral financing has been secured. On top of that, Egypt is also in the process of finalising its USD 3-5 billion sale of Eurobonds. As a result, Egypt’s total nominal external debt is expected to increase rapidly by 32% in 2016/2017 to a high of more than 180% of current account receipts and to level off at less than 200% of current account receipts in 2018/19.

Weak public finances

Public finances are in a dire state. Egypt has had structural deficits for decades and though the fiscal deficit has been decreasing since its peak of 13.4% of GDP in July 2012/June 2013, the expected fiscal deficit of July 2016/June 2017 remains high at 9.7% of GDP. Egypt is spending a large part of its budget maintaining costly food subsidies and a bloated civil service, and interest payments are very high while tax revenues are low. In addition, the government is investing in huge construction projects such as the new Suez Canal and a new city near Cairo. The flotation of the Egyptian pound is likely to worsen the fiscal balance in the short term as the state is the main importer of food and fuel. In addition, the fiscal deficits have been financed by accumulating debt which is expected to stand at more than 90% of GDP in June 2016/July 2017. So far, Egypt’s public debt has largely been financed by the domestic financial system, which has impeded the capacity of the banking sector to finance the private sector, and recently by budget financing with the support of the Gulf countries. However, Egyptian banks are already highly exposed to the public sector and the willingness of the Gulf countries to continue their support is waning. Therefore, fiscal reforms to cut the fiscal deficit will be of critical importance. Egypt has already hiked electricity prices by 20-40% and fuel prices by 47% and approved a VAT of 13% as of September. Nevertheless, more reforms are necessary. Fiscal consolidation is likely to be painful with further subsidy cuts on the cards, which could exacerbate popular discontent.