Analysis Rising inflation and falling tourism deals Egypt a ‘double whammy’ By James Gavin May 23, 2022 Reuters Egyptian Prime Minister Moustafa Madbouly has reason for cautious optimism despite the country's challenges Ukraine crisis has hit country hardOutflows from bond market investors began before Russian invasionPlanned privatisation of government assets to ease burden With inflation surging and the government forced to fix the price of bread to head off civil unrest, Egypt has felt the heat from the Ukraine crisis more acutely than most countries in the Middle East and North Africa (MENA) region. Higher commodity prices and the loss of tourism revenues from both Russian and Ukrainian visitors – a mainstay of this critical economic sector – have dealt a double whammy to Egypt, which had survived a relatively “good” pandemic. As IMF managing director Kristalina Georgieva commented in the early phase of the military conflict: “I worry for Egypt.” Egypt relies on Russia and Ukraine for more than 60 percent of its wheat imports, and the country has a history of inflation-fuelled social unrest. Policymakers in Cairo have taken swift action to deal with the fallout. On May 19, in a bid to douse inflation that in April reached 13.1 percent, the Central Bank of Egypt (CBE) raised interest rates by 200 basis points (bp) to 11.25 percent. This followed earlier action to tackle inflation taken on March 21, when the CBE devalued the Egyptian pound by 17 percent against the US dollar and raised interest rates by 100bp. With food price inflation hitting 26 percent in April, additional tightening is on the cards for later this year. The CBE has an official inflation target of 7 percent. A toxic mix The toxic mix of higher interest rates, a weaker pound and lower foreign investor risk appetite for emerging debt will likely hike Egypt’s debt servicing costs, with an estimated $30 billion fiscal deficit expected for the 2022-23 fiscal year. General government debt is close to 90 percent of GDP. Not all of this can be pinned on the Ukraine crisis, however. Outflows from bond market investors started well before Russia’s invasion on February 24. Some $5 billion of net outflows were recorded in the September-December 2021 period. Foreign holdings of Egyptian pound-denominated government debt dropped to $17.5 billion by mid-March, a decline of $11 billion from the end of 2021. According to Fitch Ratings, Egypt’s vulnerability to portfolio outflows of non-resident investment from its local-currency bond market reflects both higher interest rates and investor perceptions about the overvaluation of the Egyptian pound. “Non-resident portfolio investments was a key vulnerability for Egypt even before the Ukraine war, and the large outflows in March reflected concerns about the impact of the Ukraine war combined with pre-existing concerns about the sustainability of Egypt’s external finances and exchange rate,” Krisjanis Krustins, director at Fitch Ratings’ sovereign team told AGBI. “We have not yet seen a significant recovery, which we expect will require a decisive monetary policy decision as well as agreement on an IMF programme.” Debt burden The debt servicing burden will constrain the ability of the government to focus spending on productive areas of the economy. Capital Economics, a London-based consultancy, reckons that one-third of government spending will be devoted to servicing debt interest payments in 2022-23. Not only is this very large at around 9.2 percent of GDP, Egyptian bond yields have risen sharply since the turn of the year. Local currency yields are up by 100-150bp and dollar bond yields by more than 300bp, said the consultancy. While there is no data available on recent visitor numbers, Russian and Ukrainian tourists typically account for nearly 40 percent of annual arrivals to Egypt and the war has delivered another blow to a sector that has never completely recovered from the collapse in visitors after the 2011 revolution and the series of terror attacks that followed. The Egyptian tourism industry was also hard hit by the pandemic, with revenue halving to $4.9 billion in 2020-21 from $9.9 billion a year earlier. The situation on wheat imports remains challenging, but the government is working to source alternative supplies. Reuters reported on May 17 that about 300,000 tonnes of wheat ordered by the General Authority for Supply Commodities and due for delivery in February and March had yet to be shipped from Ukraine, with one cargo stuck in port and four others to be loaded. Egypt’s prime minister said in mid-May that the government had wheat reserves to last four months, although according to traders any wheat that has been purchased is counted within the country’s strategic reserves, even if it has not been delivered. Egypt is now in talks with India, Australia, Kazakhstan and France to secure wheat import deals. “Wheat imports from Russia have continued, and the EU provided Euros 100m assistance to Egypt to deal with the food crisis,” says Krustins. “Our base case is that Egypt will find new supplies, but at higher prices and/or lower quality. “Although Egypt is a large importer of wheat and food commodities, these imports are still relatively small as a share of GDP, so even a sharp increase in the import bill will still be manageable in terms of the overall impact on the trade balance.” There are other reasons for cautious optimism. The IMF has revised upwards its forecast for economic growth for the current 2021-22 financial year to 5.9 percent, a figure that is higher than the government’s own growth outlook. One reason for this is that Egypt’s exports have been buttressed by stronger natural gas prices and manufacturing performances. Friends in times of crisis Cairo also boasts some powerful friends willing to pledge substantial financial support to help it see out the crisis. In March, Saudi Arabia’s Public Investment Fund (PIF) deposited $5 billion at the Central Bank of Egypt. Qatar too agreed to invest $5 billion, and that followed a separate $5 billion deposit from Riyadh and another $3 billion from the UAE. All told, Gulf support to Egypt this year has reached about $20bn. In April, Abu Dhabi’s state holding company ADQ also bought shares worth $1.85 billion in five publicly traded Egyptian companies, including the country’s largest listed bank, to help shore up the economy. The government has also requested a support package, expected to total $2-3 billion, from the IMF, to help it deal with the consequences of the Ukraine crisis. The authorities have other tricks up their sleeve to boost the economy. Red tape is to be slashed and under a new directive from President Abdel-Fattah al-Sisi businesses can now to open in Egypt without a physical headquarters in the country. Setting up a business is also to be made easier and cheaper. Privatisation programme Plans to privatise about $40bn of government and military-owned assets should also help to inject more cash into central coffers, as part of a wider move to reduce the state’s presence in the economy. Prime Minister Moustafa Madbouly wants private investment to rise to 65 percent of the country’s total investments within three years, up from around 30 percent currently. Ten state-owned firms and two army-owned companies will be listed on the stock market later this year. Electric vehicle infrastructure, data centres, oil and gas facilities, communication towers, desalination plants, banking assets and renewable energy projects are also planned to be offered up to private sector investors. Full details are due to be published by the end of this month. The economic shocks arising from the Ukraine war appear to be giving renewed impetus to long overdue reforms to create a more efficient private sector in Egypt, but Cairo still faces sizeable challenges ahead as it grapples with double digit inflation, weaker tourism income and investment outflows.