Egypt’s economy is bouncing back – for now

Reuters/Amr Abdallah Dalsh

Fitch Ratings raised Egypt’s credit rating by one notch to ‘B’ earlier this month, citing a series of positive economic developments. 

Critical factors included boosted foreign exchange reserves following Abu Dhabi’s investment in the Ras El Hekma project on Egypt’s north coast, a successful currency devaluation earlier this year, and a steady decline in inflation. 

Fitch predicts inflation will drop to 12.5 percent by mid-2025, a significant improvement from the 26 percent rate recorded in September.

Fitch’s action was taken before the International Monetary Fund managing director Kristalina Georgieva’s visit to Cairo, which seemed to have passed off well. 

Although we do not know what was said behind closed doors – presumably the routine IMF line urging that the Egyptian authorities make greater efforts with the agreed economic reforms – publicly, there was no sign that the IMF will delay its next disbursement under the current $8bn Extended Fund Facility. 

Nor does Egypt appear to be seeking to renegotiate the Facility to enable it to delay the partial lifting of government subsidies, and to continue dragging its feet on privatisation. 

But Fitch’s positive view has not been shared by the other two big agencies, S&P and Moody’s. On October 18 – after Georgieva’s visit – S&P affirmed its B- rating, albeit while also maintaining its positive outlook. At the beginning of the month, Moody’s also affirmed its rating of Caa1 and retained the positive outlook. 

Fitch’s focus on foreign exchange reserves seems a little odd. The Ras El Hekma investment was announced in March, and Abu Dhabi began depositing foreign currency within days of the agreement being signed.

It’s true that Egypt’s foreign exchange balance of $47 billion at the end of October was the highest it has been for more than 10 years. 

But even before the Abu Dhabi injection, Cairo had been maintaining reserves of $30-40 billion, double the levels seen during the economic turmoil following the Arab Spring in 2011.

In contrast, the drop in the rate of inflation is significant, since it will enable a reduction in interest rates, and therefore a reduction in payments due on domestic debt. Interest payments on all types of debt – domestic and overseas – have been accounting for more than half government expenditure in recent months and domestic debt accounts for the lion’s share.

With one fifth of the population living in extreme or moderate poverty, subsidies will be a significant burden

All three rating agencies agree on the significance of the decision, in March, to float the Egyptian pound. The parallel market in foreign exchange has been squeezed out, and the authorities have avoided the temptation to re-enter the market and resume meddling with the exchange rate. 

That said, the exchange rate has not been under pressure so there has been little cause to intervene. Since releasing the currency and allowing it to depreciate by 38 percent, Egypt has benefitted from substantial inflows of foreign exchange, from the IMF, as well as from the Ras El Hekma investment. 

On the liabilities side, in August, Saudi Arabia converted $10 billion that it had deposited with the Central Bank into investment funds.

So, the question to be asked is whether the authorities will be able to maintain their hands-off approach whenever the next foreign exchange crisis occurs, as it most surely will.

The pattern over decades has been for the central bank to allow a significant depreciation when pressure on the Egyptian pound becomes too great, but then to try to hold that new rate for as long as possible, in the face of long-term loss of competitiveness and purchasing power. 

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Will this time be different? I can’t think of any reasons why it should be, given that economic policy is being run by the same people, or at least people with the same outlook, as have been in charge for many years, and given that the fundamental fiscal challenges faced by the government remain.

Egypt is of course taking important steps to reform its economy. Subsidies are being reduced, Value Added Tax is being increased, tax collection is being streamlined (again), and a few state-owned companies are being put up for privatisation – the Central Bank is trying to offload a 30 percent stake in United Bank, mainly to institutional investors, by early December.

All of these are steps towards a more sustainable fiscal position and a more vibrant economy. But the vulnerabilities remain. 

Current regional tension has cut revenues from the Suez Canal by more than half – and those revenues are in foreign currency. Tourism revenues – again, primarily in foreign currency – have also been reduced by regional events. 

The cost of subsidising fuel and basic goods has been reduced, but with one fifth of the population living in extreme or moderate poverty, subsidies will be a significant burden on the state budget for decades to come. 

There is also the huge burden of state salaries. These eat up between a fifth and a quarter of government revenues but social and political conditions in Egypt preclude reducing the role of the government as the country’s largest employer. 

So, should we be feeling more positive about the Egyptian economy? Over the short term, yes, we should. Despite the economic effects of the regional war, Egypt has strong foreign currency reserves and good relations with those, such as the IMF and Gulf investors, who can provide more foreign exchange in the months ahead. 

But let us not delude ourselves that we are seeing any fundamental change in the underlying structure of the Egyptian economy. 

Andrew Cunningham writes and consults on risk and governance in Middle East and sharia-compliant banking systems