Egypt: Current Account Pressures Grow as Rate Hikes, Inflation Make IMF Support More Urgent

Thomas Gillet
Updated: May 23, 2022, 09:38 GMT+00:00

Egypt faces growing balance-of-payments risk as US monetary policy tightens, as the cost of food and other imports rises, a double-shock impacting multiple low- and middle-income economies.

Egypt: Current Account Pressures Grow as Rate Hikes, Inflation Make IMF Support More Urgent

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Egypt’s vulnerability to tighter financing conditions stems in part from prevailing pressure on its external accounts (external financing requirement of circa USD 30bn in 2022) from the Covid-19 crisis – which has reduced tourism revenue and remittances among other receipts – alongside from an acceleration of inflation this year. Repercussions of the war in Ukraine have pushed prices higher still, increasing the cost of imported food and fuel. These pressures are common to multiple emerging market economies, especially in Africa.

Tightening global financial conditions exert pressure on developing countries

The recent 50bps interest rate increase of the Federal Reserve comes as many low to upper-middle income countries have limited options to finance higher gross external financing needs. Depreciating exchange rates of African countries have resulted in declining foreign-exchange reserves, as measured by the number of months of import cover. This is especially the case this year for countries absent significant oil and gas exports (Figure 1).

Figure 1. Looking exposed: exchange rates and import cover for selected African countries

Note: IMF forecasts for international reserves in 2022. Foreign-exchange rate variation from 1 January to 1 May against the US dollar. Source: Macrobond, IMF, Scope Ratings.

Egypt is highly sensitive to global monetary policy tightening

While Egypt carries moderate gross external debt of circa 33% of GDP, the country is highly sensitive to global monetary policy tightening due to large and persistent current account deficits (of circa 4% of GDP per year on an average year) linked to structural reliance on food and energy importing. Higher prices (of wheat, oil) are expected to have a long-lasting impact on cost of imports, which could exceed USD 100bn (or more than 20% of GDP) in 2023 or about twice a 2000-18 average.

Egypt’s vulnerability to an appreciating US dollar is illustrated by large non-resident capital outflows that have intensified recently. Net foreign assets turned negative over February-March 2022 for a first time since 2016-2017, when authorities requested IMF financial assistance (Figure 2).

Figure 2. Egypt’s foreign capital outflows, 2010-2022

EGP bn

Note: Central Bank’s net foreign assets are mostly deposits in local banks; as of-end April 2022. Source: Macrobond, Central Bank of Egypt, Scope Ratings.

Egypt still has room to finance external deficits although foreign liquidity conditions remain challenging

Despite large foreign-capital outflows, Egypt still has some room to manoeuvre to fund its external imbalances, helped by its growing export of natural gas to Europe, a planned privatisation programme, continued remittances inflows as well as successful diversification of debt financing with a recent USD 500mn samurai bond issuance.

Nevertheless, foreign liquidity conditions remain challenging. Adverse market conditions make it more difficult to launch new Eurobond, Sukuk, or green bond issuances despite Egypt’s recent inclusion under the benchmark J.P. Morgan Emerging Market Bond Index.

The Egyptian Central Bank will likely try to clamp down on inflation by further increasing its policy rate (from 11.25% to 12.25%) in response to an inflation rate of 13.1% YoY in April, above a target range (of 7% on average ±2 percent). A rate hike would also ease downward pressure on the Egyptian pound while limiting drawdown of foreign-exchange reserves.

Shoring up Egypt’s external finances will require IMF financial support

Still, shoring up Egypt’s external finances requires IMF financial support, which is likely to be premised upon additional exchange-rate adjustments to avoid the unsustainable use of foreign-exchange reserves in defence of the pound. A weaker pound would support exporting-sector competitiveness and contribute to medium-run balance-of-payments stability. However, there are also inevitable political and social costs of further currency depreciation should this worsen food and energy inflation and set back economic growth – crucial in view of Egypt’s already high poverty ratios.

Negotiations between Egyptian authorities and the IMF could last longer than expected, since calibrating the assistance package – such as regards macro-fiscal assumptions, financing envelopes, upper-credit tranche conditionality and mitigating measures – will prove more challenging than usual.

Even so, approval of an IMF-supported programme over the coming months is likely, considering successful implementation of the previous IMF arrangement and good relations that authorities have with the IMF. Egypt is one of Fund’s largest exposures after Argentina. Renewed IMF cooperation would be favourable for Egypt’s external-sector outlook by containing foreign-capital outflow, supporting gradual building-up of foreign-exchange reserves and aiding resilience through the cycle.

Conversely, no deal with the IMF within a reasonable timetable would aggravate external risk, forcing authorities to tighten capital controls and seek extra support from bilateral official partners. In this scenario, persistent pressures and increasingly scarce foreign liquidity, with potentially more limited financial support from the Gulf Cooperation Council, will have negative credit implications for Egypt.

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Thomas Gillet is an Associate Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Thibault Vasse, Senior Analyst at Scope Ratings, contributed to writing this commentary.

About the Author

Thomas Gilletcontributor

Thomas Gillet is Associate Director in Scope’s Sovereign and Public Sector ratings group, responsible for ratings and research on a number of sovereign borrowers. Before joining Scope, Thomas worked for Global Sovereign Advisory, a financial advisory firm based in Paris dedicated to sovereign and quasi-sovereign entities.

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