Thursday 28, September 2017 by Nabilah Annuar

Egypt’s recovery is well underway

The IMF Executive Board has recently concluded the first review of its $12 billion three-year Extended Fund Facility (EFF). The assistance has reaped benefits, evident in the country’s international reserves, foreign exchange market and inflation rates.

Earlier in July 2017, following the review, the IMF allowed Egyptian authorities to draw the equivalent of SDR 895.48 million (approximately $1.25 billion), bringing total disbursements to SDR 2,865.53 million about $4 billion.

Based on the IMF’s review, the Egypt’s reform programme is off to a promising start. The authorities have demonstrated strong ownership from the beginning of the programme. They adopted the value-added tax (VAT), floated the exchange rate, and increased fuel prices. The reform programme was strongly welcomed by foreign investors, as was demonstrated by successful Eurobond placements of $4 billion in January 2017 and $3 billion in May 2017, as well as increasing portfolio inflows. International reserves were seen to be growing and the balance of payments is also improving.

The foreign exchange (FX) market normalised after the float. However, the depreciation was larger than expected. According to the IMF, FX shortages and the parallel market have virtually disappeared, and bid/ask spreads have narrowed. The Central Bank of Egypt (CBE) has not intervened in the FX market and only supplied FX to state-owned enterprises (SOEs) for critical imports. At the end of May, after a period of volatility, the exchange rate stabilised at about EGP/$18 compared to EGP/$8.8 before the float. According to the organisation’s numbers, the initial depreciation was larger than anticipated, partly because of excess liquidity and continued uncertainty over FX backlogs, and more persistent because some portfolio investments that were absorbed by the CBE through the repatriation mechanism, did not flow in to the FX market.

The unification of the exchange rate and elimination of FX shortages attracted informal trade into formal channels, said the IMF. As a result, the underlying strengthening of the trade balance because of depreciation and higher import tariffs has been masked by a larger share of imports being captured in the official statistics. Consequently, the current account deficit in 2016/17 is expected to reach 5.8 per cent of GDP, which is 0.6 percentage points of GDP more than in the programme. Portfolio inflows have increased with at least $5 billion registered since the float. Gross reserves rose from $16.4 billion in October to $28 billion in April 2017.

The inflation in Egypt reached 31 per cent in April, but eased to 30 per cent in May, while growth recovery was slightly slower. High inflation was mainly driven by the depreciation of the pound, the new VAT, and the increases in electricity and fuel prices. But the continued strong credit growth, negative real interest rates and, reportedly, growing private sector wages point to demand pressures that need to be addressed. GDP growth was less than expected in July-December 2016 but accelerated in the first quarter of 2017 from 3.6 per cent to 4.3 per cent, led by manufacturing, construction, tourism, and retail trade.

The IMF highlighted that programme performance through December was strong, but two end-June performance criteria (PC) were likely to have been missed. All end-December PCs were met, while the indicative target on tax revenues was missed because of the delay in issuing executive regulations for the VAT, in addition to the impact of the large depreciation of the pound, which increased the price in pounds of imported oil products and food. Nevertheless, the programme objectives remain achievable and the slippages in 2016/17 will be made up in the next two years.

IMF’s updated macroeconomic projections reflect recent developments, including the impact of the larger-than-expected depreciation. The current account deficit is projected to narrow to 4.6 per cent of GDP in 2017/18 and 3.8 per cent of GDP in 2018/19. Improved competitiveness from depreciation and productivity gains from the reforms are expected to support exports and contain imports, while tourism is projected to recover as security conditions improve.

Egypt’s international reserves are expected to reach $30 billion in 2017/18 and $31 billion, or 120 per cent of the ARA metric for floating regimes in 2018/19. Annual inflation for June 2017 was revised from 17 to 33 per cent to account for the larger depreciation than expected. It is expected to return to the programed path by end-2017/18 in view of the recent monetary tightening as the first-round effects of the VAT and energy price increases fade.

The growth projections for 2016/17 and 2017/18 have been reduced slightly to 3.5 and 4.5 per cent respectively because of weaker than expected growth in the second half of 2016. However, because of higher inflation, nominal GDP in 2017/18 is now forecast 11 per cent higher than before. The planned fiscal consolidation, higher nominal GDP and the negative growth-interest differential improved the debt outlook—gross public debt is projected to decline from 98 per cent of GDP in 2016/17 to 88 per cent of GDP in 2017/18 and 78 per cent in 2020/21.

The IMF further highlighted that risks to the EFF programme may arise from a still fragile stability, the difficult reform agenda, and possible deterioration of security conditions. If the situation is entrenched, high and persistent inflation could pose a threat to macroeconomic stability. It may also impede credibility of the new monetary policy framework. Any discretionary attempts to minimise exchange rate volatility, including through moral suasion or non-transparent interventions, could weaken the confidence in the float. Pressures to raise spending, including on wages, could further undermine the programme’s fiscal objective.

Additionally, opposition by vested interests, corruption, and fear of escalating social tensions could derail structural reforms and hurt medium-term growth prospects. Lower growth in trade partners will most likely weaken demand for Egyptian output, but the removal of flight bans would support tourism. Furthermore, the worsening of domestic security may undermine market confidence and the business climate. These risks are mitigated by the strength of the policies under the programme, the flexible exchange rate regime and the programme’s backing at the highest political level.