Positive Sentiment Awaiting Validation
February 2nd, 2017 – Improving clarity on FX supply and demand dynamics should steadily encourage foreign investors to leverage lucrative interest differential – Slower private consumption and investment growth in the short term to be largely offset by an improved net import position – Budget deficit likely to remain stretched on higher USD-based expenses and elevated debt service costs.
Post-floatation signs are positive, but some hurdles remain: Over the past 3 months, HC has seen some positive signs from Egypt’s external position. Based on the monthly reported figure of net international reserves, and their estimated net borrowings by the government, the Central Bank of Egypt (CBE), and commercial banks, HC calculates a sizable improvement in the country’s current account balance, with the deficit running at an annualized USD14.2bn in November and December, down from USD18.7bn in FY15/16. Moreover, the parallel market and official exchange rates have largely converged, and the EGP has relatively stabilized against the USD. Although HC estimates debt and equity markets have attracted some USD0.9bn in portfolio inflows over the same period, the figure is dwarfed by a very lucrative risk-adjusted interest rate differential. In their view, there could be a number of reasons holding back inflows at the moment, including upside risks to foreign currency demand from profit repatriation and corporates overcoming short-term funding hurdles, the lack of an accurate estimate of Egypt’s unmet funding gap as it is not clear which of the secured funds would go into rebuilding reserves, and to a lesser extent, the few capital controls that remain in place. We believe some, if not all, of these factors will be dealt with over the coming few months, paving the way for sizable portfolio inflows, which should help put the economic recovery on fast track.
Soaring inflation a short-term growth impediment: HC expects annual headline inflation to average c21% in FY16/17e on the back of recent economic reform measures. This, coupled with unemployment hovering around the 13% mark, should pressure private consumption growth to come in at 2.5% versus 4.6% in the previous year. HC also expects gross fixed capital formation growth to fall short of the government’s initial target of 28.1%, negatively impacted by the unhealthy business environment in the months preceding the floatation as well as the more recent potential cash squeeze and FX volatility. On a more positive note, HC expects this to be partially offset by an improvement in Egypt’s net import position, suggesting a real GDP growth of 3.5% this fiscal year, down from 4.3% in FY15/16. Going into FY17/18e, they expect growth to rebound to 4.0% as inflation eases to an average c16%, interest rates drop, investments picks up, and private consumption growth starts to accelerate. Despite a continued improvement in Egypt’s current account deficit, external balance vulnerabilities remain on some USD11.5bn of debt repayments in 2018e, of which USD8.7bn are GCC-related deposits with the CBE. On the other hand, higher tourism receipts and lower hydrocarbon imports pose sizable upside risks.
Budget deficit to remain stretched, but no crowding out on external funding: HC expects the government’s budget to be hit hard by the floatation of the EGP along with higher debt service cost, for the deficit to come in at 13.1% of GDP in FY16/17e and 11.5% of GDP in FY17/18e. The subsidy bill, which makes up c25% of expenses, is highly sensitive to international prices, the EGP/USD rate, and the pace of reform, with the latter expected to be finalized in March. Although the International Monetary Fund (IMF) has imposed a restriction on the CBE funding of the deficit, which stood at c50% over the past 3 years, they do not see any sizable pressure on banks’ ability to fund growth thanks to considerable external funding. The government’s secured loans from the IMF, World Bank, the African Development Bank, as well as the Eurobond sale, should all go into financing the deficit. This comes over and above strong local currency deposit growth, some EGP358bn of excess liquidity with the CBE as of December, and expected foreign portfolio inflows.