Hong Kong/London: Securing an IMF funding deal would be credit positive for Egypt, but implementation risks are high and the country will continue to face several economic challenges, Fitch Ratings says.
Egypt has requested financial support, and an IMF visit to Cairo started on 30 July. The finance minister has said that Egypt is seeking USD12bn over three years. If negotiations are finalised during the two-week visit, an agreement could be in place by September.
With additional multinational assistance, for example from the World Bank and African Development Bank, plus international sovereign bond issuance, the government is aiming to raise a total of USD21bn over the next three years. In our opinion, this could still fall short of Egypt’s total financing needs, which we estimate could be closer to USD10bn annually, but a package would also likely stimulate some return of portfolio investment inflows.
By supporting Egypt’s external finances, a deal would pave the way for further necessary currency devaluation. A deal would also speed up fiscal reform and boost confidence in the economy, currently struggling with a budget deficit of close to 12% of GDP, mediocre economic growth and double-digit inflation.
The 2015 current account deficit widened to close to 5% of GDP, constraining the Central Bank of Egypt’s (CBE) foreign currency reserves, which were USD17.5bn at end-June 2016, compared with USD37bn at end-2010 before the Arab uprisings. The CBE reacted by devaluing the Egyptian pound by 14% in March 2016, but expectations of further downward adjustment have continued with widening differentials between the official auction currency rate and the parallel market.
Multilateral assistance would be disbursed in predictable tranches, provided conditions are met. This is important because, by contrast, financial support from Gulf states is less regular and transparent. Furthermore, the level of financial support Egypt can hope for from the Gulf in the near term is lower than in recent years and lower than Egypt stands to gain under an IMF deal.
Egypt has held stop-start negotiations with the IMF since 2011, but financial support has never materialised largely due to a combination of political constraints and shortfalls regarding fiscal reforms. Prospects for reaching agreement may be better this time round: Egypt has formally completed its political transition and a new parliament is in place; the authorities have undertaken a number of fiscal reforms and have a programme outlining further measures; and the CBE has shown greater acceptance of the need for exchange rate adjustments.
But seeking IMF support is politically contentious in Egypt and we expect some opposition to a deal. To counter this, the government will argue that it is pursuing its own economic programme and the IMF agreement would be in support of this, rather than imposing policies. Considerable implementation risks remain. An IMF programme is likely to include provisions to move to a more flexible exchange rate, wide-ranging fiscal measures including implementation of VAT and further subsidy reductions, and ongoing civil service reform.
In our opinion, the IMF is likely to be accommodating to Egyptian concerns over too sharp a fiscal retrenchment, given political risks and the need for economic growth. But the Egyptian authorities could shy away from reforms at some stage during a three-year programme if faced with popular opposition. Even if implementation proceeds on plan, Egypt faces a testing period of fiscal, monetary and structural reform.
