Egypt continues to move ahead with structural economic reforms. While painful, these measures should help put Egypt on a path of improving fundamentals. Foreign investors have taken notice, with inflows picking up sharply.
President el-Sisi remains firmly in control after winning the 2014 election handily. Parliamentary elections in December 2015 saw the pro-government “For the Love of Egypt” bloc win a big majority. However, turnout was very low as the parliament is widely perceived as a mere rubber stamp. The next presidential election will be held in 2018, and el-Sisi should easily win reelection to another four-year term.
Relations with the US are likely to remain on good terms. Trump and el-Sisi met during the US presidential campaign, which led to an official visit by el-Sisi this April. Egypt is one of the biggest recipients of US aid at around $1.5 bln annually, and that is not about to change.
Regional tensions remain high. Egypt was one of the countries that sided with Saudi Arabia in isolating Qatar. Qatar stands accused of destabilizing the region with its support of terrorist groups, and is thought to have actively supported the Muslim Brotherhood in Egypt. The 2013 coup first brought el-Sisi to power, at the expense of Mohammed Morsi. He and others from the Muslim Brotherhood were jailed or fled Egypt.
The $12 bln IMF program from November appears to be on track. After an initial $2.75 bln disbursement, another $1.25 bln is expected in July. After the first review, the IMF noted that “This agreement is a vote of confidence by the IMF staff in the continued implementation of the Egyptian authorities’ program. It is also testimony to the great efforts the Government and the Central Bank of Egypt (CBE) have been making to reform the economy. The authorities’ economic reform process is off to a good start.”
There are growing concerns that the austerity measures contained in the program will feed into civil unrest. Indeed, the government has raised pensions and approved a cost-of-living bonus for public employees. It also gave some exemptions for low-income taxpayers whilst increasing subsidized food programs.
Other structural reforms are clearly needed. Egypt scores very low in the World Bank’s Ease of Doing Business rankings (122 out of 190). Same goes for Transparency International’s Corruption Perceptions Index (108 out of 176 and tied with Algeria, Cote d’Ivoire, Ethiopia, and Guyana).
The economy should recover next year. Austerity measures under the IMF program will act as a headwind this year. GDP growth is forecast by the IMF to decelerate to 3.5% in 2017 from 4.3% in 2016, before picking up to 4.5% in 2018. Given the fiscal and monetary tightening seen so far, we see downside risks to the growth forecasts.
Price pressures are starting to ease, with CPI decelerating to 29.7% y/y in May from 31.5% in April. However, the government just raised fuel and cooking gas prices significantly as part of the IMF program. Prime Minister Ismail expects inflation to accelerate by an additional 4-5 percentage points as a result of the price hikes.
This supports the case for tighter policy. After a 300 bp hike in conjunction with the EGP float, the central bank remained on hold until it hiked 200 bp more to 16.75% in May. More tightening may be needed in the coming months if inflation remains stubbornly high.
Fiscal policy still needs improvement. Revenues should be underpinned by the VAT passed last year, but expenditures need to be controlled better. Even with this week’s hike in fuel and cooking gas prices, Oil Minister Tarek El-Molla said fuel subsidies will still cost the government about EGP105 bln annually. The budget deficit was an estimated -10% of GDP in FY2016/17, down from -12.1% in FY2015/16. Under the IMF program, the deficit is expected to narrow to -8.3% in FY2017/18 and -5.9% in FY2018/19.
The external accounts bear watching. Exports have picked up recently, while imports have been restrained by falling real incomes. The devaluation should help narrow the gap, but the so-called J-curve could see an initial widening. The current account deficit was an estimated -5.3% of GDP in FY2016/17, and is expected by the IMF to narrow to -3.9% in 2017/18.
Foreign reserves have nearly doubled since mid-2016. They have been boosted by $7 bln of bond issuance so far this year on top of the IMF funds. At $31.1 bln in May, they cover nearly 4 months of import and are almost 3 times larger than the stock of short-term external debt. The first tranche of IMF funds should boost reserves even further.
More importantly, it appears that the central bank is buying USD in order to put a floor under USD/EGP. The exchange rate has basically trade just above 18 since mid-March. Perhaps the stable exchange rate is meant to promote investment inflows, perhaps it is meant to maintain some export competitiveness. Either way, we suspect that the IMF would prefer that Egypt allow the currency to float more freely.
The pound has steadied since the freefall when it was floated in November. In 2016, EGP fell -57% vs. USD and was by far the worst EM performer. Next closest were ARS (-18%), TRY (-17%), and MXN (-16%). So far in 2017, EGP is flat YTD and is ahead of only COP (-1.5%), PHP (-1.6%), BRL (-1.7%), and ARS (-3.6%). Our EM FX model shows the pound to have VERY WEAK fundamentals, so this year’s underperformance is likely to continue.
Egyptian equities are underperforming EM after a terrific 2016. In 2016, MSCI Egypt 110.5% vs. 7% for MSCI EM. So far this year, MSCI Egypt is up 4.5% YTD and compares to 17.6% YTD for MSCI EM. This underperformance should ebb, as our EM Equity model has Egypt at a NEUTRAL position.
Currency controls have been eased, suggesting policymakers no long see a dollar shortage. Good two-way flows have been seen in EGP, which has also helped encourage foreign investment. Finance Ministry reports that foreign holdings of local currency debt jumped from EGP10.1 bln at the end of 2016 to EGP136 bln as of May 30.
Yet Egyptian bonds have underperformed. The yield on 10-year local currency government bonds is up 109 bp YTD. This is the worst in EM and compares to the next worst Czech Republic (+62 bp), China (+54 bp), and Korea (+12 bp). With inflation likely to turn higher again and the central bank forced to tighten further, we think Egyptian bonds will continue underperforming.
Our own sovereign ratings model has Egypt’s implied rating at B/B2/B. Actual ratings are B-/B3/B, which suggests upgrade potential for S&P and Moody’s. If Egypt can stick with the reform plan, the agencies may reward it with upgrades towards year-end.