Event

This month, the Egyptian government has completed its expected cabinet reshuffle, which resulted in nine ministers being replaced. The reshuffle is an attempt by the government to improve the economy’s performance. In light of a looming balance-of-payment crisis, the country was forced to accept an economic reform package in November 2016 in order to receive a USD 12 bn IMF loan. Therefore it was an important step for Egypt when at the end of January it succeeded in collecting money on the international financial markets via US dollar denominated bonds with a maturity of 5, 10 and 30 years. This was the first time Egypt returned to the debt markets since 2015. The bond attracted orders of USD 13.5 bn, thereby showing that investors believe in the government’s recovery plan. However, the highly speculative bond rating (B- for S&P) reflects the underlying weaknesses of the Egyptian economy. A further positive sign is the increased number of tourists that have arrived in Egypt. Tourism is indeed a very important source of foreign exchange for the country, but since the crash of the Russian airplane in 2015, the number of tourists had dropped sharply. Compared to the US dollar, the Egyptian pound has also regained 16% in February after losing half of its value following the November 2016 devaluation.

Impact on country risk

Ever since the revolution of 2011, the Egyptian economy has been struggling. Since November however, the Egyptian government has been making some important steps towards recovery. In return for an IMF loan, it has accepted a much-needed economic reform package. The central bank let the Egyptian pound float, which resulted in the pound losing half of its value but also in lower pressure on the country’s foreign exchange reserves. Fiscal reforms were introduced: most importantly a 13% VAT tax was introduced and fuel subsidies were cut. The aim is to reduce the fiscal deficit, currently at 12% of GDP, by half by 2020 and thus reduce the public-debt-to-GDP ratio from above 90% to around 80% by 2020 and thus improve public finances which are in a dire situation. The increase in the value of the pound will help reduce inflation which stood at 28% at the end of January. High inflation arises from the reduction in subsidies and the currency depreciation combined with the fact that Egypt imports more than half of its food needs. Inflation is expected to dip as the effects of the devaluation wear off. Compared to two earlier IMF programmes that were abolished in the last five years, the government now seems committed to push through further difficult reforms. The tax law is currently under review in order to broaden the tax base and improve compliance. Further increases in the VAT tax and the introduction of new taxes like a financial transaction tax are expected. Energy subsidies are supposed to be completely abolished by 2021. Economic reforms should however not be limited to macroeconomic stabilisation and fiscal discipline. The Egyptian economy is highly in need of labour market reforms, simplification of business regulations and a reduction of the government dominance in the economy. Especially the business climate is currently very difficult as Egypt ranks 131st (out of 189 countries) in the World Bank’s 2016 ease of doing business index. These structural reforms will be important in order to reduce high unemployment and provide jobs for the 700,000 Egyptians entering the labour market each year. If the current trend persists, an upgrade of the short-term political risk could be envisaged in the forthcoming months.

Analyst: Jan-Pieter Laleman, jp.laleman@credendo.com