Egypt between Two Economic Crises

It has been 10 years since the world financial crisis, the gravest financial downturn the world has seen since the Great Depression of the 1930s.

On 15 September 2008 the global economy witnessed what the then International Monetary Fund (IMF) chairwoman called “a moment of truth” with the collapse of the US investment bank Lehman Brothers.

The full-blown international banking crisis that followed negatively affected the Egyptian economy. Ten years later, it seems that Egypt is now on the verge of another crisis, this time of emerging markets.

Egypt’s stock market had felt the crunch of the global financial crisis early on in late 2007. Foreign investors had rushed to liquidate their assets, drawing back their investments on the heels of the crisis in the subprime mortgage market in the US.

The trickle-down effects of the crisis came at about the same time that Egypt was taking decisions arousing the worry of foreign investors.

In May 2008 it had lifted exemptions on some industrial projects in tax-free zones, such as fertilisers, petrochemicals, and iron and steel, and it had increased the natural gas prices charged to these industries.

Development fees were also imposed on minerals used in the cement and ceramics industries.

The main stock market index, the EGX30, dropped by 20 per cent in August 2008. Another 43 per cent drop was recorded later in the year when the economic downturn made itself felt in every corner of the world. In total, the Egyptian stock market had seen a 56 per cent retreat by the end of the year.

Save for the telecommunications and petroleum sectors, every field or industry was hit hard by the financial crisis by mid-2008. All sectors of the economy witnessed much slower growth rates in the second half of 2008-09 compared to the corresponding period the previous year.

Growth in the tourism sector declined from 38.3 per cent to -7.8 per cent. The labour market was negatively affected, and according to figures released by the Central Agency for Public Mobilisation and Statistics (CAPMAS), new employment opportunities in the second quarter of 2008-09 dropped to 128,000 from 181,000 during the second quarter of the previous year.

Unemployment increased from 8.4 to 8.8 per cent. The government downplayed the effects of the crisis by “stimulating domestic demand to ease the repercussions and channelling additional funds for this purpose,” said a statement from the Ministry of Economic Development. It sought to implement investments worth LE15 billion in partnership with the private sector.

The government’s approach was “expansionary”, according to a cabinet report presented to parliament. It included tariff discounts of between LE5.1 and LE7.1 billion on capital and intermediate goods to help local firms to compete in international markets and to encourage investment and operations.

It also exempted investors from sales tax on capital goods for the following 12 months and pumped LE5.1 of public money into the economy. Fast forward 10 years and Egypt is facing the emerging markets crisis, again linked to the US and its decision to increase interest rates. The Egyptian government’s options this time round seem limited because of its $12 billion loan deal with the IMF that curbs its ability to implement measures reducing the repercussions of the new crisis, such as increasing wages to confront inflation and easing austerity measure caused by the partial lifting of subsidies on petroleum products.

The emerging markets crisis, one of the consequences of which has been the depreciation of national currencies, has shaken investors’ confidence in the ability of emerging markets to pay in dollars, said Business Monthly, the monthly bulletin of the American Chamber of Commerce in Egypt. Investors have become more attracted to funds denominated in dollars and not in emerging market currencies.

It is probably for this reason that Egypt has had to cancel four consecutive weeks, with investors asking for higher interest rates ranging between 18.4 and 18.6 per cent.

The lack of interest among investors has led the emerging economies to resort to borrowing from the international markets, thus inflating foreign-debt levels.

In June, Egypt’s foreign debt reached $92.64 billion, up from $43.23 billion in June 2013. The ratio of foreign debt to GDP recorded 37.2 per cent at the end of the 2017-18 fiscal year, said Prime Minister Mustafa Madbouli. According to a report issued last week by UAE investment bank Shuaa Capital, the Central Bank of Egypt (CBE) is suffering difficulties as a result of the emerging markets crisis in pursuing its agenda of lowering short-term interest rates in sync with the rise of interest rates in emerging markets.

The developments follow on the heels of previous expectations, according to Shuaa Capital, of lowering interest rates by two or three per cent in the second half of 2018.

As had been earlier announced, the CBE’s Monetary Policy Committee will convene three times this year on 27 September, 15 November and 27 December.

Shuaa Capital believes the CBE has two options. The first is to abandon the initial plan to lower interest rates, a decision that could prove costly because it would cause an increase in the cost of public debt, which in turn would reflect negatively on the budget deficit.

This option may thus seem unlikely, though it would increase the competitive edge of Egypt’s debt instruments among its peers in the emerging markets.

The other option would be to allow the Egyptian pound to depreciate against the dollar. This might help attract foreign investment to Egyptian treasury bills and bonds, but at the same time it would increase inflation, translating into a rise in the cost of imports in a country already suffering from deficiencies in its trade balance.

It seems the latter option is more likely, however, according to Shuaa Capital. Business Monthly explained that the rising value of the dollar would reflect positively on the economies of the exporting emerging markets and their ability to penetrate foreign markets at more competitive prices.

However, things may be more difficult for Egypt, it continued, since it imports 250 per cent more than it exports. An appreciation of the dollar would only exacerbate the deficiency in Egypt’s trade balance. The trade deficit reached $28 billion in the last three quarters of the last fiscal year from July 2017 to March 2018, according to CBE figures.

Coupled with the depreciation of the pound against the dollar after the floatation of the pound in November 2016, the trade deficit has resulted in an unprecedented rise in inflation.

Amr Al-Alfi, head of research at Shuaa Capital, believes the appreciation of the dollar against the pound on the back of the emerging markets crisis will raise the price of petroleum imports, negatively affecting the budget deficit.

The effect will be exacerbated because it comes at a time of a global rise in petroleum prices that exceeds the estimates on which Egypt’s budget was based by $10 per barrel.

“A $1 increase in the international price of a barrel of oil translates into an increase of LE3 to LE4 billion in Egypt’s budget,” Al-Alfi said. He concurred with the Business Monthly evaluation that the additional costs of importing petroleum will impede the government’s ability to commit to its terms with the IMF of a decrease in the subsidies on petroleum products.