Reaching a dead end? Where Egypt and the IMF stand on the stalled loan program

At the end of last year, the Egyptian government celebrated inking a new agreement with the International Monetary Fund. The 46-month, US$3 billion loan was a more meager sum than what Egypt had initially set out to obtain, but, after a year of tense negotiations, the government was not ready to accept more robust reforms and needed to secure an influx of cash and a certificate of trust from the financial institution.

Nonetheless, the agreement still came with several benchmark conditions that would unlock the periodic disbursal of installments over the course of the 46-month loan program. The most important conditions set in the loan program were to adopt a flexible exchange rate and reduce the state’s footprint in the economy, which was to be carried out through an offering program of state-owned assets (including those owned by the military), in addition to some reaching macroeconomic targets around inflation and downward public debt.

Since the deal was signed, however, the government has failed to meet these conditions. As a result, the IMF postponed its first review of the program, which was initially scheduled for March, and the second installment of the loan has been held in limbo.

While both the government and officials from the fund have issued reassurances in the press that the review would take place in September, if the international financing institution reviews the government’s progress through June, the reality would be that very little has been achieved.

Experts and analysts who have spoken to Mada Masr in recent weeks note that the lack of progress on the program and the unclear status of the review throw into question Egypt’s ability to climb out of the economic crisis it finds itself in as significant debt payments loom on the horizon. One of the few remaining options, which is being seriously discussed in government corridors, is to voluntarily default on some of its debt and negotiate with creditors about a new payment schedule. However, this option remains difficult in light of the upcoming presidential election.

The biggest obstacle to the review, for House Planning and Budget Committee MP Mohamed Badrawy, is the liberalization of the 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.

In mid-June, President Abdel Fattah al-Sisi stated that Egypt has “flexibility in its exchange rate,” but, in the same breath, he excluded the possibility of another currency devaluation any time soon, which has been anticipated by research centers and banks in their analysis reports on the Egyptian economy in recent months.

“When [a devaluation] can potentially affect the country’s national security and destroy the Egyptian people, then no,” Sisi said. “When the foreign exchange rate can affect the lives of Egyptians and destroy them, we cannot sit still, even if this will contradict the conditions of... you know what I mean.”

A few days later, IMF Managing Director Kristalina Georgieva replied in a statement asserting that propping up the value of the Egyptian pound cannot continue forever, comparing that to “putting water in a bucket that has holes” and stressing that the IMF postponed its first review of the Egyptian economy, initially scheduled for this March, to give the Egyptian government another chance at achieving progress in some of the conditions, such as reducing the government's footprint in the economy and adopting a flexible foreign exchange rate.

But there is no alignment on the idea that another devaluation will be a panacea for Egypt’s economic troubles.

From the Deutsche Bank’s viewpoint, any new devaluation of the local currency will not contribute to solving Egypt’s major challenges. Instead, it could be counterproductive to attracting sustainable inflows.

The three devaluations of the local currency did not yield any success during the last year, according to the bank, therefore it is unreasonable to think that a fourth one will solve the crisis. 

“Another devaluation risks Egypt getting stuck further in this cycle of continuous devaluations. Given the inelasticity of Egypt's imports, an even weaker currency would further contribute to already elevated price pressures. This would have several detrimental consequences: First, higher inflation would then result in additional monetary policy tightening or high rates for longer. Nominal rates are at 18.25 percent, already high, but we have at least 300bps additional hikes penciled in at the moment. High interest rates are then passed on to higher refinancing costs almost immediately given that the maturity profile is skewed towards shorter tenors. Second, higher inflation would also require additional fiscal support to protect the vulnerable share of the population given how high, especially food price inflation, it already is," reads the mid-June report by the bank. 

Badrawy agrees with the bank’s assessment. "There are times when the exchange rate can be left to move naturally, and other times it cannot. This depends on the priorities at the time, such as inflows and outflows, the effect of the exchange rate on inflation and commodity prices, and debt servicing, which increases with a devaluation," the MP said.

“But now, the exchange rate is actually considered suitable, especially if you look at the rate in the parallel market, which is high due to speculation and a fear of the future from both regular people and businessmen. Due to this fear, they have started to hedge against the possibility of a deterioration of the value of the pound, and the black market thus has a heftier dollar supply compared to the official one,” adds Badrawy.

Both Credit Suisse, in a May report, and Deutsche Bank do not have the government allowing the exchange rate to balloon up to an excessively high value. Deutsche Bank expects the pound to hold at LE31 to the dollar before gradually falling to LE37 by the end of the year, while Credit Suisse expects that the government’s reform program — namely its exit from the economy and the implementation of the IMF program — will keep the pound’s value between LE33-LE44 during the coming year.

This fixed range makes sense to Badrawy, who says that allowing supply and demand to drive the exchange rate without protecting the local currency will lead to an “unjustifiable” increase in the value of the dollar against the Egyptian pound. “This is not because the pound should fall in price, but because there are no dollars in the country. That’s why the forecasts predict that the exchange rate will balance out on the condition of achieving progress in other reforms,” the MP adds.

After a group of experts from American investment bank Goldman Sachs visited Egypt last month and met with state officials, the bank published a research paper stating that Egypt’s shift to a flexible exchange rate in the coming months is “unlikely.”

The government’s choice to move toward a flexible exchange rate, according to Goldman Sachs, depends on the sufficient availability of foreign currency reserves to manage the risk of a potential overshoot of the pound’s value.

The bank estimated that the government would need around $5 billion in additional reserves to prevent this scenario.

"This amount is beyond what Egypt can generate," a financial analyst at an Egyptian investment bank tells Mada Masr. "Egypt has been trying since the beginning of the year and over the past six months to secure less than half of that amount and has failed. Hence, flotation will remain unlikely."

In February, the government announced its intention to offer 32 state-owned companies across 18 economic sectors for partial privatization through public offerings on the stock exchange and offering stakes to strategic investors within a year of the announcement. Per the program, Egypt is supposed to sell up to $2 billion in assets to foreign investors, specifically from the Gulf, by June. During the fiscal year 2023/24, Egypt is supposed to sell $4.6 billion in assets, followed by assets worth $1.8 billion in 2024/25.

Before this week, the government had made little progress on these aims, having sold minor holdings in only two companies. The first, state-owned paint maker Pachin, was sold to Emirati National Paints for $25 million. The second was Telecom Egypt, in which the government sold 10 percent of its stake to undisclosed local investors for $121 million.

According to the financial analyst, 90 percent of the Telecom Egypt shares were sold to local investors, including the National Authority for Social Insurance, which means the deal was done mostly in local currency and did not bring in foreign currency inflows.

“The aim in selling the state’s stake in Telecom Egypt wasn’t to attract foreign currency, but to assert to the IMF and foreign investors that the government wants to exit the economy. So they brought in an unnamed semi-governmental entity to make the purchase,” the financial analyst says.

A similar sleight of hand was at work when the government announced last week that it had sold a cumulative $1.9 billion as part of the offering program. The announced contracts include a deal to sell minority stakes in three oil and petrochemical sector companies to Abu Dhabi sovereign wealth fund ADQ for $800 million, a deal to raise $700 million by offering capital in a portfolio of hotels, and a deal for a 31 percent stake in Al Ezz Dekheila Steel Company worth $241 million. Of the $1.9 billion, $1.65 billion would be paid in foreign currency, Madbuly said in the press conference.

However, sources told Mada Masr that none of the deals announced have been finalized at this point, indicating that the only money the government has in hand is the $146 million from Pachin and Telecom Egypt.

The mystery shrouding the deals is not surprising, as it has been a defining characteristic since the announcement of the offering program, according to banking expert Hani Aboul Fotouh.

In Aboul Fotouh’s opinion, the "mysterious" offering schedule was faulty from the very beginning. "Selling state-owned assets is a long and complicated process that consists of company valuations, the provision of data to investors, promotional campaigns, and long discussions to reach a fair price for both parties. The government put itself under pressure during a time of global instability. And the result is that, until now, there has been nothing new," says Aboul Fotouh.

And while the global economy has undergone stress due to Russia’s invasion of Ukraine in early 2022 and the rebound from the COVID-19 lockdowns, Egypt has also faced hurdles at a regional level.

“The government does have high-quality and diverse assets: banks, power plants, food companies and fuel stations. Yet, the circle of buyers is very limited, consisting mostly of three Gulf countries: Saudi Arabia, the UAE and Qatar,” the financial analyst says. 

This small circle and its political stance toward Egypt has posed major obstacles to the offering program. “The government was pushing to sell certain companies at different times, trying to pit the various companies against each other to reach a higher sale price. But it did not only fail in achieving this, since the Gulf countries communicate with each other, but it also created political tension between Egypt and the three countries,” the analyst says.

As the attempts to play the various buyers off each other to get the highest payout made the negotiations drag on, Egypt’s bargaining position weakened due to the downward pressure on the pound. 

“The power is always in the hands of the buyer. They are the ones with cash looking to invest. In the beginning, the offers were tempting, but the Egyptian side’s greed wasted a lot of time and led to the buyers’ accruing more power,” the analyst adds. “The buyers are of course in search of the best investment opportunity, which would come only with the devaluation of the pound.”

This back and forth in the negotiations caused delays in the implementation of the IMF program. And while, in Badrawy’s opinion, the government doesn’t seem to be in a hurry for the next installment of the IMF loan, a delay comes with many risks.

For Oxford Economics economist Callee Davis, postponing the first review relays the message to foreign investors that Egypt is not doing enough with regard to its commitments to economic reform from the IMF’s viewpoint, which implies significant risks for the country’s reputation and would thus undermine its ability to attract new foreign investments despite the IMF’s efforts to stress in the media that Egypt has in fact been able to achieve progress.

The uncertainty has not just affected foreign confidence. Egyptians in the country have also lost trust in the economy, hastening to buy dollars from banks or convert their Egyptian pounds into gold to maintain their value. Similarly, the Egyptian diaspora opted to keep their dollars out of the banking system and convert their foreign currency on the black market. Hence, the formal economy saw the exit of around a quarter of these exchange transactions in just a few months, according to Badrawy. 

During the first half of the past fiscal year, remittances from Egyptians abroad dropped by 23 percent compared to the same period in FY21/22, coming in at $12 billion, compared to $15.6 billion. In a new report, the World Bank attributed the decline to an increasing trend toward selling foreign currency in the black market or holding onto it in anticipation of a potential devaluation of the pound.

“This percentage is very worrying, because it is $3.5 billion in six months, which is $7 billion on average per year,” says Badrawy, emphasizing that this money could have been an easy and free source of foreign currency. 

In addition to that, the pressure on imports naturally means pressure on raw materials and inputs for manufactured exports, which will lead to a drop in the Egyptian exports during the next period, Badrawy says. 

Data from the Central Agency for Public Mobilization and Statistics has indeed shown a 23.8 percent increase in the trade deficit during April, which came in at $2.33 billion. The value of Egyptian exports decreased by 44.9 percent in April alone, falling to $3.03 billion compared to around $5.50 billion during the same period of last year. The value of Egypt’s imports also saw a steep decline, falling by 27.4 percent to $5.36 billion.

And while foreign exchange management and the government’s exit from the economy require long-term planning, the government has also failed to take any explicit action to meet its pledges. 

For example, the government promised to demand that all state-owned companies (including ones owned by the military) produce and submit biannual financial accounts to the Finance Ministry, which, in turn, should have made this information available to the public. 

It pledged to provide information on the benefits afforded to state-owned companies, including tax cuts and exemptions, before the end of April and publish all public procurement contracts that exceed LE20 million, as well as the Central Auditing Organization’s three latest annual audit reports, before the end of January. The government also vowed to develop the governance and management of state-owned companies by outsourcing management to specialists hired on performance-based contracts and publishing guidelines for the selection of the companies’ boards and the bonuses they are entitled to as board members.

But none of these measures were implemented. 

While some analysts see that Egypt might suspend the IMF program, Davis says that even though it is lagging behind in meeting benchmark targets, the state has not yet abandoned the program.

In her estimation, the IMF will postpone the first review until the government agrees to take steps toward a more flexible system for the exchange rate — meaning another devaluation of the pound — which could happen around mid-September. “When it comes to cutting back on the state’s role in the economy, we believe that the IMF will be more lenient. But with regard to the benchmark targets, the IMF can extend the deadline like it has in the past,” says Davis.

The IMF regulations allow its board of directors to overlook a country’s failure to fulfill “some” of the agreed upon terms in the economic support programs, on the condition of providing clear justifications. However, in 2017, the IMF decided to terminate its 2014 loan agreement with Ukraine after the country was unable to meet its commitments, despite the fact that the IMF had already disbursed half of the loan worth $17.5 billion. The IMF agreed again to a new loan with a new Ukrainian government in 2018, only for the loan disbursement to cease again following the Russian invasion last year. And once again, the current government is now receiving loans to support its economy. 

Egypt needs long-term solutions. The financial analyst indicates that selling state-owned assets to repay loans is only a temporary solution to a permanent structural problem in the Egyptian economy, which might defer the crisis but still leaves it with no definitive solution.

Recent data provided by the Planning Ministry shows that Egypt’s external debt increased by $2.43 billion during the last three months (first quarter) of the current year, reaching $165.4 billion, thus raising the external debt by $7.56 billion in just one year, between March 2022 and March 2023. 

The Planning Ministry’s data did not include updates on the external debt’s composition, with regard to the ratio of short-term debts to the total external debt and the ratio of short-term debt to foreign exchange reserves, which represents the most prominent standards for measuring the risks associated with external debt.

Yet, according to central bank data, a large portion of Egypt’s external debt of $162 billion last December consists of short-term debt. Even though the largest portion of these debts (around $132 billion) were long-term debts, Egypt obtained them years ago. Therefore, they are debts that are due in a year or less, increasing the short-term debt figure from December from $30.2 billion to $47 billion, which is 135 percent of the foreign exchange reserves as of May. About 86 percent of these reserves consist of deposits from Arab countries that provided Egypt with nearly $30 billion dollars as short and long-term deposits.

For that reason, the future looks grim, not only in the eyes of citizens but also from the viewpoint of international institutions. This prompted American credit rating agency Fitch Ratings to downgrade Egypt’s long-term sovereign rating from B+ to B while changing the outlook from stable to negative. This came about only two weeks after S&P Global Ratings also changed its outlook on Egyptian sovereign debt from stable to negative due to the significant risks that come with external financing. 

One of the alternative scenarios, in Davis' opinion, is for the IMF to complete its first review before another devaluation takes place and to cite necessary delays in implementation to protect social stability. In this scenario, another devaluation of the currency within the next 12 months would be inevitable. “And even then, we have doubts about this scenario, since the IMF has held firmly to flexibility of exchange rate in the past, and signing off on the first review without Egypt meeting  several of its major requirements is a slippery slope.”

There is another scenario as well. If the IMF refuses to greenlight the first review until some of the benchmark targets are achieved and the Egyptian government delays carrying out these requirements, the loan program could hang in limbo until one of the parties announces its death. 

Davis sees that the success of the IMF program is key to attracting more external financing, thus it is unlikely that the government will give up on the program. Equally for the IMF, the failure of its program or Egypt’s bankruptcy would be a dent in its reputation. 

In these unconventional circumstances, some out-of-the box solutions come to mind.

According to Badrawy, one of the solutions that has begun to catch the state’s attention is voluntarily falling behind on paying some debts and negotiating the possibility of rescheduling, which would entail a further fall in Egypt’s credit rating.

The same possibility was noted in the Deutsche Bank report, which asserted that the only solution to Egypt’s economic crisis is negotiating to extend debt maturity dates. Davis believes that it is in both parties’ interests to sit at the negotiating table to discuss a possible restructuring of debts if external pressures become unbearable.

“[Restructuring debt payment schedules] is not such a big problem for the sake of easing the burden on the market. This can bring in new investments that could improve the situation in the market and consequently in the balance of payments, leading credit rating agencies to raise their ratings for Egypt once again. Thus, the negative effects will only last for a short while,” says Badrawy. “Unfortunately, this will be the government’s decision to make. This is a political decision that should come from the head of state, which still sees that paying debts on time is more important than burdening the market.”

For Columbia University political researcher Karen Yang, the issue comes down to the approaching presidential elections and the political ambiguity dominating Egyptian politics.

“No one knows what will happen in the future, but Sisi’s government might be forced to devalue the currency once more eventually,” says Yang. “And at that time, Sisi will certainly blame external pressures.”