This article first appeared in March’s print edition of Business Monthly.
Africa is witnessing unprecedented long-term economic complications as three global crises coincide, threatening the GDP growth outlooks and the continent’s countries under significant economic pressure.
Climate change will be a constant factor, disrupting food supplies and raising prices. Meanwhile, foreign currency inflows to the continent are declining as inflation increases and other metrics turn negative. The third crisis is that governments and central banks are maintaining loose monetary policies and allowing fiscal deficits to widen to stave off recession, as they can’t afford to enter a recession. “I call those the ‘Bad 3,'” David Cowan, Africa economist at Citigroup, said at a February AmCham Egypt meeting.
He noted Egypt is suffering from those crises. Annual inflation rates were more than 30% from February 2023 to December before dropping just 0.2% in January. Food inflation was worse, dipping below 60% only twice during the same timeframe. Meanwhile, Central Bank of Egypt (CBE) data shows FDI fell more than 35% from a 10-year high in December 2022., while the fiscal deficit remains above pre-pandemic levels.
Those events happened despite the CBE increasing rates twice from 16.25% to 19.25% between February 2023 and December.
Inflation and low foreign investments cause another massive problem in Egypt’s financial system: adding pressure on the pound’s exchange rate. “Inflation rates play a critical role in the confidence in the local currency,” said Cowan. “Egypt has very high inflation rates.” Meanwhile, a foreign investor exodus weakens the pound and strengthens foreign currencies. The departure also sends negative signals to other foreign investors considering Egypt.
Further compounding Egypt’s economic problems is that external (foreign currency) debts have been increasing in a near-linear trajectory since 2015, more than quadrupling.
That puts Egypt precariously close to a stagflation scenario, where GDP shrinks as prices increase, further fueling recession. In February, the IMF projected GDP growth below 3% for Egypt in 2024, down from 3.2% in the October forecast. That is a severe decline from 2022 when GDP grew nearly 6.5%. “There is a lot of pressure on GDP growth,” said Cowan, adding, “We are not yet at stagflation. But its causes remain.”
Egypt’s “peculiarities”
CBE’s foreign currency policy has always been to delay significant devaluations until it’s no longer feasible to keep rates nearly stable. In late 2016, the pound (which had lost 27% of its value over the previous two years) lost half its value in under a month to secure a $12 billion extended fund facility from the IMF. It halved once more at a slower pace from March 2022 to March 2023 after remaining mostly stable since September 2020.
That CBE policy didn’t significantly damage Egypt’s economy before 2020, as wealthy nations had near-zero interest rates with minimal movement. “That enticed Egypt to keep the foreign exchange rate stable to attract portfolio investors who were buying [interest-bearing emerging market] government debt,” Cowan explained. “At the peak, foreigners had invested $35 billion in the domestic debt market.”
That dynamic changed in 2021 as the world was coming out of COVID-19 lockdowns at various speeds, causing logistics bottlenecks that pushed up global prices. “At the time, the world increased interest rates to cut inflation by lowering demand for goods,” he said.
The U.S. Federal Reserve (Fed), whose monetary policy is a benchmark for emerging markets, increased its funds rate from less than 1% in early 2022 to 5.6% at press time. “Foreign investors pulled back from Egypt because local interest rates were not high enough,” Cowan said.
Despite those changing circumstances, CBE policy remained unchanged. “The problem with holding a currency at a stable exchange rate for that long [almost 12 months since late March 2023] is it tends to suck in imports,” he said. “Egypt’s import bill went from $6 billion to $8 billion at the time.”
Further adding to Egypt’s problems in 2022 was the war between Ukraine and Russia, which supply almost all the country’s grains and edible oils. The ongoing Gaza Strip conflict is indirectly causing the nearly complete blockage of the southern entrance to the Red Sea. “Egypt is losing $100 million a month in revenue from the Suez Canal because of the situation in the Red Sea,” Cowan said. “We don’t know how it will play out.”
That pushed the government to increase borrowing from local banks and international institutions to maintain foreign currency levels and finance government-led investments, notably the construction of the New Administrative Capital, Cowan said.
With Egypt’s foreign currency debt rising nearly 48% from 2020 to press time, markets became increasingly reluctant to lend Egypt in 2021 and 2022, Cowan said. He explained that one of the primary reasons for the exclusion was that nations with economic, social, and political structures similar to Egypt had either defaulted (Zambia and Ghana) or did not expect to meet their obligations in the short term (Pakistan, Kenya, Nigeria, and Tunisia).
IMF and Egypt
In mid-2022, the government sought IMF support for the fourth time since 2020 to counter foreign portfolio investors’ $20 billion exodus earlier that year. “That deal was for a small amount ($3 billion) over four years,” said Cowan. Meanwhile, $14 billion would come from “Egypt’s international and regional partners,” the IMF said in December 2022. They would invest mainly in divested state-owned assets, it added.
Cowan said one condition for approving the 2022 Extended Fund Facility was putting Egypt under “enhanced surveillance.” It requires the government to promptly share all requested data from the IMF. “The complexity with that is the general lack of transparency in Egypt,” Cowan said.
Egypt got off to a good start by privatizing several state-owned companies worth more than $5.6 billion and devaluing the currency by nearly 23% in early 2023. “However, those efforts nearly stalled,” said Cowan. First, there was a slowdown in the pace of privatization in 2023, followed by a complete “freezing” of all reforms during the presidential election. “The resulting delay meant much-needed foreign currency inflows to Egypt didn’t come,” he said.
That resulted in Egypt skipping the IMF’s first and second reviews to release the second and third tranches of the $3 billion facility. In June 2023, Egypt’s President Abdel Fattah el-Sisi poured cold water on plans to devalue the pound, saying an official devaluation would “hurt Egypt’s national security.” At press time, the black market rate was over twice the official one, indicating that “Egypt had fallen off the program,” Cowan said.
In January, an IMF delegation came to Egypt to discuss the outstanding funding facility agreement. After the visit ended in February, IMF’s Managing Director Kristalina Georgieva said the fund is “seriously considering” boosting its loans to Egypt to counter the economic fallout from Gaza if the country could pass the postponed first and second reviews.
Policy shift?
Cowan estimates the “lack of adjustment in the Egyptian pound since 2023 against the backdrop of high inflation rates [means the] pound was overvalued by around 15% to 20%” by the end of last year.'”
However, devaluation of the pound’s official rate won’t be enough. Cowan explained the government must first show unwavering commitment to actively offering more dollars via commercial banks to private-sector companies to import what they need to sustain domestic operations.
The second step before an official devaluation is for the government to clear a significant portion, if not all, of the backlog of goods stuck in customs. It has been increasing for almost a year because local importers don’t have enough dollars to clear them.
Those two steps should build “confidence among companies that, whatever the exchange rate is, they can get dollars when they need them via official channels,” Cowan said. “Businesses want predictability [that guarantees dollar supply] over stability. Businesses will adapt and adjust their pricing structure accordingly.”
Such a commitment could prove a tall order for the government. “We don’t have confirmed figures, but Egypt’s backlog is particularly large,” Cowan said. He added that Citi Group estimates it at between $8 billion and $12 billion, making it the highest in Africa.
That foreign currency crunch has not slowed down government-led investments, which the state admitted to local and international media have a “foreign currency component.” There have been no official announcements about halting the building of roads and bridges and the two new rail systems (monorail and high-speed train). Meanwhile, Khaled Abbas, chairman of the Administrative Capital for Urban Development, the company building the New Capital, told the media in November 2023 that planning for phase two of the capital had started, worth between EGP 250 and EGP 300 billion.
What next?
Cowan believes there are too many scenarios with unpredictable outcomes at play in Egypt. Complicating that situation is that “there doesn’t seem to be an off-the-shelf policy answer.”
The first uncertainty relates to the GCC’s stance toward Egypt. The geopolitical instabilities to their north in Gaza and south in Yemen could make Gulf countries more open to helping Egypt if its problem is solely about more dollars. “Saudi Arabia and the UAE have problems around them,” Cowan said. “That could make the idea of having problems in Egypt less palpable.”
The other uncertainty is whether getting another massive IMF loan would help Egypt out of its current economic problems. “If the program goes as planned, Egypt’s debt to GDP ratio will [drop by 0.7%] to 88%,” Cowan said. “The real problem most don’t consider is that interest equals 8% of Egypt’s GDP. That is crippling for any government. Morocco pays 2.5% of GDP, while South Africa pays 4%.”
Despite such worrisome figures, Cowan stressed, “From an economist perspective, Egypt is not going to default on its loans in the coming year or two.” He added the IMF’s incoming extended fund facility will see to that.
However, he emphasized the government needs to take a step back, given that “the issue of default has not gone away, as Egypt still has high debt levels that will only increase.”
Local banks with no ties to foreign parent banks will likely be the first affected if the government’s finances fail to improve in the coming few years. “If banks take a hit on their future revenue projections, that is a problem,” Cowan said. “The government would need to recapitalize them, especially if they are the larger state-owned banks.”
Cowan said the silver lining of that scenario is that “GCC banks might be interested in buying those distressed banks.”
Nevertheless, he worries about what would happen if the state devalues the pound to its fair value against the dollar and completely clears the import backlog. “Would the government be enticed to hold that rate steady for a few years, as it did in 2016?” he said.
That would be a significant mistake as Cowan predicts that “in the coming three to four years, dollar inflows will always be less than demand, so the government will need to borrow more to meet that demand.”
Cowan stressed the long-term sustainable solution to Egypt’s foreign currency exposure risk is for FDI growth rates to be higher than the interest rates of outstanding foreign currency debts. “Those proceeds must flow to the Central Bank,” Cowan said. “The next step would be to put mechanisms in place … [to manage] those proceeds between reducing government debt and stimulating revenue-generating economic activity.”
