Egypt in talks with IMF over possible new loan

Egypt has been in talks with the International Monetary Fund over the past few months to look into the possibility of securing a new loan, according to two government officials, a former government official, a Western diplomat working in Cairo, and a prominent figure in one of Egypt’s financial groups who spoke separately to Mada Masr in the past two weeks on condition of anonymity.

The sources indicate that Egypt's decision to formally apply for such a loan depends on what it would be able to secure from other borrowing sources it has depended on in the last few years, specifically, the bond market, the deposits of Gulf allies, and the sale of assets managed by Egypt’s sovereign wealth fund.

Through this loan, Egypt is aiming for a symbolic approval that would constitute a “certificate of trust” in economic performance from the government’s point of view, as well as the financial incentive of the IMF’s low interest financing relative to the bond market.

The talks for a new loan are playing out against several challenges facing the Egyptian economy. On one hand, the government’s need for funding to guarantee it can fulfill its debt obligations is set to increase, especially in light of the weakness of foreign direct investments and the insufficiency of export returns. On the other hand, there are different challenges awaiting the usual debt sources, some due to global economic changes and others due to complex regional relations.

Egypt has depended mainly on foreign financing in recent years. According to the latest central bank reports, total Egyptian foreign debt stood at US$137.9 billion by the close of June 2021 (an increase of $14.4 billion compared to June 2020). This value does not represent all forms of external debt, because official figures exclude local bonds sold to foreign nationals.

These debts are diverse. Some come in the form of loans from international lending organizations, the most important of which is the IMF.

Egypt received two loans from the IMF in the past six years. The first came in 2016 for US$12 billion through the IMF’s Extended Fund Facility (EFF). The EFF program is designed to assist countries facing “serious medium-term balance of payments problems because of structural weaknesses that require time to address.” The primary benefits of the program for countries in need of financing are the amount of the loan and the length of the repayment period, which can extend out to 10 years, and that it is not bound to certain projects but instead can go into the general budget.

As the world economy faced a severe contraction amid the COVID-19 pandemic, Egypt returned to the IMF again in 2020, borrowing a total of $5.2 billion through the Stand-By Arrangement (SBA). The SBA is designed to be used in times of “economic crisis” when countries “need financing to help them overcome their balance of payments problems.” As such, financing is provided over a shorter period of time than the EFF, and the repayment period is no longer than 5 years.

While sources disagree on the expected value of the loan under discussion with the funding institution, there is consensus on two features.

The first is the type of loan. According to a prominent official at one of the most important financial institutions in Egypt, the IMF refused Egypt’s request that the loan be negotiated under the terms of the EFF program, as the Egyptian economy is not facing a major crisis or an exceptional situation. The same source said that the mechanism currently being discussed is the SBA, as with the 2020 loan.

The second feature is the conditionality of the loan which Egypt will have to abide by. According to the financial group source, the IMF has expressed its frustration with the decrease in private investments and the unresponsiveness of the Egyptian side to the requests of the IMF to amend the competition law.

Some sources have indicated that the IMF might require new austerity measures in the form of further lifting of subsidies. But the financial group source says that Egypt would not need the IMF to push for these measures because Egypt is “more royal than the king when it comes to austerity.” The Egyptian direction to lift subsidies is ongoing in any case.

The most important condition, according to all sources, is that Egypt must stop propping up the price of the pound in the foreign exchange market. Despite liberalizing the exchange rate as part of a 2016 structural adjustment program, the central bank has de facto pegged the pound’s value at LE15.7 to US$1. To achieve this stability, the central bank has enlisted local commercial banks to supply any extra hard currency that the market may need. According to the sources, the expected decrease in the value of the pound against the dollar will not exceed 5 percent.

Decreasing the value of the pound, as political economist Wael Gamal explains, would pose a challenge to the government, which would be trying to allow the pound to reach a value that would satisfy the demands of the IMF without causing major harm to living standards in Egypt, something that the policy of protecting the pound achieves.

In the last loan Egypt received in mid-2020, IMF officials pointed to the number of risks the country could face. The fund based their assessment on local and international economic activity returning to normal by the end of 2020. 

“However, a more severe and/or prolonged shock to economic activity and delayed recovery could further aggravate public finances, resulting in greater financing needs, and higher public debt and risks to debt sustainability,” according to the IMF’s report. “Moreover, a further tightening of global financial conditions could put renewed pressure on capital flows and the government’s borrowing costs.”

“Global financial conditions” mainly refers to the bond market, through which the government offers foreign traders government securities to buy, in exchange for a premium paid out at the maturation date on the bond. The advantage of the bond market for the government is that it comes without conditions on how to spend the inflows or whether it adheres to the economic reform plan. From the bond trader’s perspective, the only thing that matters is the interest they would get at the maturity of the bond and Egypt’s ability to commit to paying its debts and interests on time.

But there are new risks threatening the appeal of Egyptian bonds this year. The first is the expectation for developed economies, in particular the US, to raise interest rates in an attempt to put a halt to rising inflation. With an increase in US interest rates, debt instruments there may become more appealing. As the US is the benchmark for the global monetary system, the risks that traders take in global debt instruments is much lower than the risks of the same investment in Egypt. This could drive debt traders to pull their investments out of Egypt and move to safer markets. While there is a belief that Egypt can weather the storm, it was marked as one of the four emerging countries most vulnerable to these risks, according to Bloomberg.

The risks differ based on the type of bonds. Egypt uses two main types. The first is issued in Egyptian pounds, and the second in foreign currencies (most importantly the US dollar). For both types, foreign bond traders receive their payouts at the bond’s maturation date in foreign currency. And in both cases, Egypt has to provide high-interest rates to attract traders.

Locally denominated bonds are important for the local market. The trader that is seeking to buy them must obtain Egyptian pounds to buy the bonds with. This creates a global demand for the Egyptian pound, which contributes to maintaining its value, especially if other methods fail (such as foreign direct investment or exports).

As a result, Egypt agrees to offer high interest rates on these bonds. This year, returns on Egyptian pound bonds are expected to reach 17 percent (up from 13 percent last year), the largest in the world, as forecast by Bloomberg.

The situation for dollar-denominated bonds is different. The interest rate largely has to track the monetary policy decisions of the US Federal Reserve, as the leading central bank in the world and the shaper of global monetary policy. And like the first type, Egypt has had to set interest higher than the global average to attract bond traders.

But, because of global economic changes, the interest Egypt has set for these types of bonds is no longer enough. According to the Bloomberg report, trades on the dollar-denominated bond market in Egypt lost 8 percent in yields last year in Egypt. This means, as Gamal points out, that Egypt will have to consider increasing the interest rate to maintain an appetite for their dollar bond offerings.

The other main source of debt comes from the Gulf, especially Saudi Arabia and the UAE, which Egypt received in the form of deposits to the central bank after 2013. Total Gulf deposits stood at about $15 billion (about 11 percent of Egypt’s total external debt) at the end of the last fiscal year, with $5.3 billion coming from Saudi Arabia and $5.7 billion from the UAE, according to the central bank report.

But it is not as easy as it once was. Months ago, Egypt asked the UAE and Saudi Arabia for new deposits, according to a government source, who said that Abu Dhabi refused to offer a new deposit and was content with the old one.

As for Saudi Arabia, Noaman Khaled, economic analyst at Arqaam Capital, explains that Riyadh had asked Egypt to pay back $3 billion of its deposit, after which Saudi Arabia would return it to Egypt in the form of a new deposit. Egypt complied and last October, Saudi Arabia approved the new deposit and renewed the remaining $2.3 billion as part of the old deposit.

According to the government source, President Abdel Fattah al-Sisi embarked on a visit to the UAE today that will be the first of several visits to a number of Gulf capitals in the coming weeks to try to secure direct financial cooperation agreements. However, so far, there are no clear features of these agreements.

Until these features become clear, the current situation remains unchanged, with total Gulf deposits having decreased by $2.2 billion at the end of the last fiscal year, compared to the year before.

In return, the government constantly needs US dollar liquidity to cover imports, some of which concern providing staple food items such as rice and oil, and ensuring the stability of the safe stock of main food items whose prices have gone up in global markets for various reasons, including supply lines problems due to the pandemic and crop vulnerability due to climate change.

Gamal points out that the interest due to be paid on short-term and long-term debt exceeds $36 billion during the fiscal year which ends in June 2022, according to central bank data. This represents around a quarter of Egypt’s total external debt and is almost at 90 percent of the total foreign currency reserves of Egypt as of June of 2021.

Because of these complications, resorting to the IMF a third time in six years has become an option.

On one hand, Egypt would receive a sum of money with an interest rate of 1.5–2 percent, much lower than what it pays in the bond market. But the new loan outweighs its monetary value, because it opens the door to other lending tools that Egypt needs. Researcher Salma Hussein notes in her report on the status of Egyptian external debt that the IMF ties Egypt’s ability to repay its debts to its ability to borrow from global financial markets. Therefore, the Egyptian government considers that receiving a loan is akin to a “new certificate of trust” in the Egyptian government which would encourage “foreign investment in Egypt and investment in the bills and bonds of the Egyptian treasury,” according to a former government source who is connected to IMF circles in Washington DC.

In all cases, the increase of Egypt’s external debt in general, regardless of type, poses an ongoing risk in the event of any global crises which could affect the flow of debt or Egypt’s ability to repay.