Egypt and the IMF’s economic dilemma: To review, or not to review, that is the question

In the last week of September, several news outlets, including Youm7, Al-Arabiya and Reuters, published a Finance Ministry statement announcing that an agreement had been reached between the International Monetary Fund and Egypt to conduct the delayed first and second reviews of the smaller-than-anticipated US$3 billion Extended Fund Facility loan simultaneously before the end of the year.

A few hours later, Al-Arabiya removed its report and Youm7 replaced the text with general information on Egypt’s reform program with the IMF.

Under the agreement signed with the financing agency in December, the government’s adherence to the reform program outlined in the document was to be subject to biannual reviews. However, neither the government nor the fund have given an indication as to when the review will start, and government sources and economic analysts have told Mada Masr that they expect it to be postponed until the end of the year. The reason, according to the analysts, is that moving forward with the review would lay bare the government’s poor adherence to the most important terms of the loan agreement and would risk damaging the IMF’s reputation as an international lender of note.

Nonetheless, indefinitely postponing the review also has negative repercussions, and therefore Egypt and the IMF find themselves caught in a bind: conduct the review and expose the agreement’s faltering progress or continue to delay as speculation builds.

Delayed review stalling loan disbursements

At the end of last year, the IMF approved a $3 billion economic reform loan as part of its Extended Fund Facility program to the Egyptian state. The loan was to be distributed in nine tranches over the course of four years and is subject to biannual reviews. Egypt received the first loan installment of just over $347 million in December upon signing the agreement. Installments of the same amount, worth a total of about $700 million, were set for delivery pending biannual reviews set for completion in March and September. However, the fund postponed the March review and Egypt did not receive the agreed-upon loan disbursement. Despite several assurances that the second review would be conducted on schedule in September, the government agreed with the IMF to delay it until the end of the year, according to a source at the Central Bank of Egypt.

Several analysts explained that the decision to postpone the review was difficult given the pressure that Egypt is under, not only to receive an influx of funds from the attendant loan disbursal but also to renew the “certificate of trust” that the government has celebrated whenever a new milestone or agreement is reached with the fund. This rhetoric, both on the part of the government and the fund, is a key part in bolstering confidence in Egypt’s economy, thus allowing another plunge back into the debt market, which can help the state secure necessary foreign investments to complete the review. 

The delayed review was supposed to track the government’s progress on the recommendations through the end of June.

But aside from the various technical conditions, the state has yet to advance the most crucial condition from the fund’s perspective: the adoption of a flexible currency exchange rate.

Since March, the Egyptian pound has seen minor fluctuations but has largely sustained its value on the foreign exchange market after a precipitous drop in January that was orchestrated in concert with an influx of hot money. The central bank has claimed that it will let supply and demand dictate the price of the pound, but, in reality, the downward pressures on the pound’s value in the form of depleting foreign currency reserves and speculation on future devaluations have resulted in a widening gap between the pound’s official price and its price on the parallel market.

Egypt’s perplexing policy 

Ostoul Capital Group Managing Director Ahmed Diab told Mada Masr that the current pressures on the government are too significant to risk holding the review on time, the most challenging of which is the real liberalization of the exchange rate. Exchange rate liberalization has been a key demand from the fund since talks began on a new loan agreement. According to the IMF, a flexible exchange rate would have three main benefits.

According to a recently published research paper by the Institute of International Finance, the first benefit would be the reduction of the chronic imbalances between the official exchange rate and the parallel market. The second, which the IMF has pointed to on several occasions, is that a liberalized exchange rate would help Egypt “adjust more smoothly to external shocks,” as it would appreciate or depreciate in line with global economic conditions.

The third benefit in the fund’s estimation is that there would be less of a need for the central bank to be so heavily involved in fiscal policy management, including taxation and public spending policy, which is usually administered by the government. The central bank, nominally a monetary authority, would then focus on influencing the amount of money and credit in the economy to curb inflation and stabilize prices, including by adjusting interest rates, without concern for whether increased rates could deepen the government's debt or risk of default.

According to the institute, the same opinion is held by the majority of experts, who argued that the fixed exchange rate, hovering around LE31 to US$1, is not sustainable but is, as IMF Director Kristina Georgieva described it, “putting water in a bucket that has holes,” given that the parallel rate is 30 percent higher than the official one at a time when the futures contracts predict further declines in the near term.

The institute also pointed to an “interesting pattern” in the historical fluctuations in Egypt’s official exchange rate, where the government resorts to a one-off substantial devaluation in response to external pressures, momentarily easing the strain on the real exchange rate.

“However, before long, structural issues and flawed policies, which have plagued Egypt for years (bottlenecks in the economy, poor monetary policy transmission, subsidized lending, and expansionary fiscal policies) put upward pressure on inflation and thus any benefits from the original nominal devaluation are lost through ... The real exchange rate then remains overvalued until the authorities are eventually forced to devalue once again, starting the cycle all over,” reads the report.

In simpler terms, macroeconomic analyst Mona Bedeir says that the shortage of foreign liquidity in banks and official channels creates a parallel market with higher prices because of the high demand and low supply, Bedeir notes.

“Upon devaluation, the government attempts to bring the official rate closer to the value in the parallel market, dollar liquidity is unavailable in the official market, or it is procured momentarily, which increases pressures and renews the parallel market all over again because the problem was not addressed at its roots. As this plays out, the official exchange rate increase heightens inflation, driving local producers of goods and services to increase their prices at a higher rate than of the same imported goods. Producers tend to import raw materials instead of local, but more costly ones, which increases the demand for dollars and we find ourselves in a closed circuit of more imports, as well as pressure on the exchange rate.”

Dollars: The root of the issue and the way out of it

House Planning and Budget Committee member Mohamed Badrawy tells Mada Masr that the IMF is pressuring for a full and hasty devaluation of the pound. However, the lack of necessary inflows is the main obstacle.

“The issue is not the pound-to-dollar value. The price can be LE30, LE40 or even LE50 to the dollar, but the question is always about the availability of reserves to stabilize the price at the new rate, or are we going to devalue and come back to where we started?” says Badrawy. 

The key to solving the root of the problem is securing dollars. 

“Everything from the IMF review to curbing inflation and the exchange rate are but symptoms of the foreign currency scarcity and can only be resolved with dollars,” says Bedeir.

However, the government is currently unable to secure greater inflows. Even its revamped privatization program has been faltering in recent months, despite the numerous incentives and pledges it provided to investors. 

In the midst of these circumstances, the government’s decision was to, again, delay the review.

“The fund understands Egypt's current circumstances, which forces it to put off floating the exchange rate until it sells off some of its stakes in state-owned assets or it obtains dollar inflows that allow the government to bear the cost of a devaluation, which is taking longer than expected,” adds Diab. 

What is the cost of delaying the review? 

But the decision to stall comes with its own perils.

“It’s understandable that pressures on the government are forcing it to hold up the review. However, this delay comes at a high cost for the economy,” says Bedeir.

Postponing the devaluation further burdens the economy, according to a recent report by London-based think tank Capital Economics. Additional delays in the adoption of a real flexible exchange rate would make it harder for Egypt to lift itself out of the current economic crisis and increases the risk of sovereign debt defaults, the report said.

The report also pointed to “increasing rumors” that Egyptian authorities are likely not to execute any devaluation until after the presidential elections, a move the think tank called “dangerous game.”

Badrawy says that talk of linking the review with the presidential elections schedule is “true, but its weight in the bigger equation is being exaggerated,” adding that the exchange rate has been fixed for many months now. 

“The central bank has certainly not kept the exchange rate fixed for months now only for the sake of the presidential elections scheduled for the end of the year,” says Badrawy.

For Diab, the consecutive delays lower Egypt’s chances of accessing global debt markets and reducing its borrowing costs. He adds that although the postponement of the reviews furthers investors’ lack of trust but will not be viewed as a new negative indicator “because the world is aware of Egypt’s economic challenges.  

Therefore Diab expects that investors will continue to monitor the situation, waiting for improved conditions and seizing good investment opportunities when available. But Diab doesn’t think that they will stop investing entirely as if they thought the situation was likely to worsen. 

But Bedeir has a more pessimistic outlook, arguing that the postponement of both IMF reviews sends the wrong message.

“Even if the impact is investor uncertainty, this in itself furthers a negative perception of the Egyptian economy among investors, as well as credit rating agencies, which are waiting for the IMF review to decide whether they will downgrade Egypt’s credit rating again. A delay puts them in a position of having to downgrade further, which is not in Egypt’s benefit,” Bedeir says. 

In May, Moody’s began reviewing Egypt’s ability to meet long-term obligations in foreign and local currencies, with the possibility of downgrading the country’s credit rating from B3, basing their assessment on the lack of foreign liquidity. For the same reasons, credit rating agency Fitch downgraded its outlook for Egypt from stable to negative, dropping its rating from B+ to B. 

This week, US investment bank Morgan Stanley moved its rating on Egypt’s sovereign credit from “neutral” to a “dislike stance” as a result of increased financing needs, pointing to heightened risks for investors in the Egyptian market. 

According to Bedeir, these downgrades mean that Egypt will have to pay heftier borrowing costs, given the heightened risks investors will be taking on, compared to the presence of favorable returns in other countries with almost no risk, such as the United States. 

Bedeir believes that the real solution for Egypt’s economic crisis relies on two factors: a stable global economy and lower global interest rates, which would allow Egypt to issue less costly debt. But this also comes with a caveat. 

“If the global economy stabilizes but there is no confidence in the government, the cost of insurance against the risk of default will increase and the overall cost of borrowing will remain high for Egypt despite stability in similar countries,” says Bedeir.

This depends on whether the government has a plan to deal with changes at the global and national scale. 

The central bank source indicated that the IMF review is contingent upon the government’s ability to collect $5 billion for its reserves before liberalizing the exchange rate, which will then guarantee its intervention to fix the rate when needed and avoid the pound’s collapse. 

In Badrawy’s opinion, this amount will depend primarily on state asset sales, which he says did not go through as planned.

The government’s scheme was predicated on the idea that the state would conclude the offerings faster than the schedule it agreed to with the IMF, he says.

“The main issue was one of planning,” Badrawy adds. “The government did not have an alternative plan. In previous plans, the rationale was that we had large installments due between 2023 and 2026, but there was a belief, which was later proved wrong, that hot money and dollar inflows supporting the economy would persist. But come COVID-19, then the war [Russia’s invasion of Ukraine], and the exact opposite happened. Inflows turned into direct investments in the state’s assets, and hot money went and found more suitable places, while Egypt found itself with a large dollar deficit between its expenses and obligations. An alternative plan, that should have been available, was unfortunately nonexistent.”