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Return of hot money foreshadows even more debt for Egypt
Al-Monitor Pro Members
Marc Español
Journalist covering Egypt and Sudan
March 3, 2023
On the back of a sharp devaluation of the Egyptian pound on Jan. 11 and the highest interest rates in over five years, Egypt has witnessed a large inflow of short-term debt in recent weeks. But the return of large amounts of hot money raises doubts about Cairo’s ability to wean itself off these inflows anytime soon as other sources of more sustainable revenues, such as foreign direct investments (FDI) and exports, take time to materialize.
- From 2016 until shortly before Russia’s invasion of Ukraine, Egypt had become heavily dependent on portfolio investments to shore up its financial account, offset its current account deficit, and ultimately keep its external position afloat.
- Until the end of 2021, portfolio inflows — mainly hot money — flowed in large quantities thanks to one of the world’s highest interest rates, a stable currency, robust foreign reserves, and the relatively good performance of other dollar sources such as remittances, tourism, energy exports and the Suez Canal.
- The first year of the Covid-19 pandemic, however, showed that Egypt’s external position was highly vulnerable to shifts in emerging market sentiment, and over $7 billion flowed out of the country in 2020, according to the Central Bank of Egypt (CBE).
- Capital flight was much higher with the outbreak of the Ukraine war and the first interest rate hikes in the US. In 2021/2022 financial year (FY), $21 billion flowed out of Egypt, $14.8 billion of which left between January and March 2022, according to the CBE.
- In 2022 several members of the Egyptian government stated that the country would try to wean itself off its dependence on this hot money by developing three alternative sources of more sustainable capital inflows: foreign direct investment, especially from Gulf countries, boosting exports and expanding the private sector.
- As part of its efforts to diversify its sources of financing, Cairo also reached an agreement with the IMF in October for a $3 billion loan. The credit line was approved by the executive board on Dec. 16, and should help the country unlock a further $6 billion from other lenders and serve as a certificate of confidence to investors.
- In parallel, Egypt has moved to adopt a more flexible exchange rate regime as part of the reform program attached to the IMF loan. Since March 2022, the Egyptian pound has devalued by about 50% against the dollar.
- But the development of the previous alternative sources of financial revenue, which for now revolve mainly around the sale of state-owned assets and enterprises, will take time to materialize and rebound Egypt’s external position.
- Meanwhile, Egypt’s financing needs are more immediate. The IMF estimates that Egypt will have a financing gap of about $17 billion over the next 46 months, provided the structural reforms outlined in the economic program are implemented.
- The IMF also projects that Egypt’s current account deficit will reach $12.6 billion in the current fiscal year, which ends in June, even if the country has tried to narrow this gap by imposing tight import restrictions.
- Egypt’s short-term debt obligations, which tend to be easy but costly to rollover, exceeded $30 billion in FY2022/2023, excluding Gulf deposits, according to the CBE.
- The IMF projects Egypt’s total external debt servicing for the next FY2023/2024 at $51 billion, more than half of which corresponds to short-term debt. Six years earlier, in FY2017/2018, total external debt servicing stood at $20.9 billion.
- As of last December, the value of outstanding Treasury bills (T-Bills) due over the course of a year amounted to 1.7 trillion Egyptian pounds, according to a finance ministry report.
- Against this backdrop, Egypt has again resorted to more debt. On Feb. 22, Cairo closed its first issuance of sukuk bonds worth $1.5 billion at an interest rate of close to 11%. It was the first offering in international markets since March 2022.
- But hot money is also playing an important role in closing the immediate funding gap. The IMF projects that Egypt will attract some $6.1 billion of portfolio investment from global and local markets during the current fiscal year to close this gap. The figure is set to rise to $7.3 billion for the next fiscal year, and to $8 billion in FY2024/2025.
- In three consecutive auctions held between late December and early January, the CBE failed to attract this type of hot money. But momentum has revived following the latest major depreciation of the pound on Jan. 11 and the rise in yields for T-Bills above 20%, the highest rate in five years, data from the bank shows.
- In T-Bills auctions on Dec. 27, Jan. 3 and Jan. 10, the CBE only accepted between 5 to 21 billion Egyptian pounds, while on Jan. 17 it took 180 billion Egyptian pounds. To do so, in addition to devaluing the currency, yields had to be raised from 18.08% to 20.52%
- Since then, the amount of money accepted by the CBE through these 91, 182, 273 or 364-day T-Bills has remained high. In each of the four auctions held in February, the CBE took in a similar amount, above 80 billion Egyptian pounds, which is above the average of the last half year with the exception of September, CBE data shows.
Scenario 1: Egypt becomes too exposed again to hot money to close its financial gap
The recipe by which the IMF expects Egypt to close its financial gap and shore up its external position in the short to medium term is bullish and carries a risk of falling short. In FY 2022/2023, the IMF sees FDI reaching $9.7 billion, compared to $8.6 billion in the previous year, and it expects the figure to rise to $12.1 billion in FY 2023/2024, which starts in July.
Similarly, it forecasts exports to increase from $70.8 billion in FY 2021/2022 to $76.4 billion in FY 2022/2023, and up to $79.8 billion in FY 2023/2024. According to their projections, remittances should also increase from $31.7 billion in FY 2021/2022 to $34 billion this FY 2022/2023 and to $35.9 billion in 2023/2024. In parallel, the IMF sees the current account deficit contracting in FY 2023/2024 to over $11 billion, down from $12.6 billion in FY 2022/2023
A failure to meet these targets would leave Egypt little choice but to rely on debt again, including hot money, to close its financing gap. Such a U-turn could also risk diminishing the current urgency felt by the authorities to implement ambitious structural reforms.
Scenario 2: Egypt keeps hot money at low levels while developing alternative inflows
The Egyptian government intends to attract some $40 billion in FDI over the next four years. In December it approved a strategic program that includes the economic sectors the state plans to exit in coming years, as part of its efforts to increase the private sector’s contribution to economic investment by 25-30%.
In February, the government also unveiled the 32 state-owned companies of which it plans to sell shares for the first time within a year through direct sales to strategic investors and listings on the Egyptian Exchange (EGX). The cabinet also intends to sell stakes it holds in already listed and privatized companies.
A successful implementation of these measures could provide the state with a significant injection of non-debt funds, and allow it to maintain local short-term debt instruments, especially in foreign hands, just as a complementary source for its budget as it develops more sustainable sources of financing, such as exports, that require more time.
In the short term, Egyptian authorities will have little choice but to resort heavily to debt again, particularly short-term, to bridge its financial gap, shore up its precarious external position and restore some macroeconomic stability. The high interests it will have to pay will represent a significant burden. Still, in the medium term, the country is unlikely to fall back into the strong dependence it had developed on hot money before the Ukraine war. Its critical position and the growing unease and pressure from its traditional allies, including the IMF and GCC countries, make a bid to develop alternative and sustainable sources of revenue, particularly FDI, more realistic than in the past. But to reach this goal, authorities will need to adopt — not just draft and announce — far-reaching reforms.
Marc Español has been reporting on Egypt since 2017, with a focus on the economy and the human rights situation in the country. He has been a contributor to Al-Monitor since 2018 and his work has appeared in other publications such as El País and the think tanks Fundación Alternativas and the European Institute of the Mediterranean (IEMed).
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