Devaluation, war to slow Egypt growth

KUWAIT: Prospects for a continued, steady post-pandemic economic recovery in Egypt have been cast into doubt by a combination of the Ukraine war and sudden currency devaluation in March, which will push up prices, hit consumer spending and investment, reduce tourism and widen the fiscal and external deficits.

We expect Egypt’s growth to be significantly reduced over coming quarters, slowing from a pandemic rebound-driven high of 8.3 percent y/y in 4Q21 to around 3 percent in 3Q22. Still, we expect a deep recession to be avoided. The economy’s resilience has improved since the reform program that began 2017 FX reserve levels are higher, inflation is well down from its highs and the fiscal deficit has narrowed - and the scale of the devaluation in the pound to date (15 percent) is much smaller than in 2016. Meanwhile, GCC countries have rallied to support Egypt with $22 billion in investment and funding pledged and a new IMF program (perhaps worth $7 billion) also looks likely. We expect growth to start recovering by the end of 2022 reverting to its pre-pandemic trend of around 4 percent by early 2023, assuming no major deterioration in the global economic picture and that the government remains committed to the economic reform process that slowed during the pandemic.

Fiscal deficit

The above pressures will also interrupt the trend improvement in the fiscal deficit of recent years albeit likely temporarily. Despite COVID, the deficit narrowed to 7.2 percent of GDP in FY20/21 thanks to cuts in the interest bill (due to lower interest rates). The deficit will widen again this year to 8.6 percent of GDP given fresh pressures on economic growth and spending, including from higher inflation and rising interest rates. Indeed, growth in spending (12 percent y/y) already exceeded revenues (9 percent) in February 2022. However, the deficit should be more stable in FY22/23 as commodity prices ease and the economy starts to recover.

Public debt stood at 87 percent of GDP in June 2020 and the devaluation will have increased external debt levels by around 3 percent of GDP in local currency terms. We expect the debt ratio to drift down over time, given high nominal GDP growth and the government’s commitment to cut the fiscal deficit. This, together with a combination of higher interest rates, a solid FX reserve cushion, a more competitive exchange rate and external backing from the IMF should help underpin access to capital markets. However, relatively high debt levels and the large interest bill (which absorbs some 38 percent of all government spending) will constrain the government’s ability to redirect funds to priority causes including infrastructure and poverty alleviation.

Drop in tourism revenue

The external position has been under pressure on a mix of the hit to tourism from COVID and the (previously) overvalued exchange rate. The current account deficit widened to 1.1 percent of GDP in FY20/21 amid a 51 percent plunge in export receipts from travel - previously worth around one-fifth of all trade income. This year the deficit will reach 2.9 percent of GDP with three additional factors weighing: depressed tourism due to the Ukraine war (Russia and Ukraine accounted for more than 30 percent of pre-crisis tourism to Egypt), plus the impact of both higher commodity prices and the cheaper currency on the import bill. A narrower deficit is expected in FY22/23 on import compression, an easing in commodity prices and improving tourism and trade supported by the cheaper pound.

The pound has been relatively steady at around EGP18.5/$1 since its March drop. The currency looks better supported at this level, though some uncertainty surrounds the outlook. Futures markets suggest the pound could ease further over the coming year and the IMF may emphasize the need for currency flexibility as part of any deal. The central bank’s net foreign reserves fell nearly 10 percent in March at the peak of the external pressures, but at $37 billion remain more than double pre-2016 levels and comfortably enough to finance external debt maturities of $7 billion this year.

Rising interest rates

Inflation accelerated to a near-three year high of 13.1 percent y/y in April driven in particular by rising food costs (+26 percent) which are one-third of the CPI basket. We see inflation rising further over coming months on both high commodity prices and pass through from the weaker pound, peaking potentially above 15 percent in3Q22 before falling back to within the central bank’s current 5-9 percent target range mid-next year, helped also by tighter monetary policy. The bank raised the policy rate by 100 bps in March and at least a further 200 bps of hikes is expected this year.

In terms of risks, while pandemic concerns are fading, Egypt’s economy would be hit by a prolonged war in Ukraine - which could jeopardize the external position and by higher or more persistent inflation, which would worsen consumer incomes and economic growth and require even tighter monetary policy. Meanwhile, aggressive Fed policy tightening could hit inflows to emerging markets in general, causing financial volatility. Moreover, the weaker economy could further delay progress on the government’s reform agenda, including key infrastructure projects, reducing public debt and increasing FDI. These remain critical to sustaining strong rates of growth over the longer term.