Its economy hit by Ukraine war, Egypt risks defaulting
The focal point of the mass protests 11 years ago that brought down Egyptian leader Hosni Mubarak, Cairo’s Tahrir Square last month became the scene of another struggle, this time over the economy: In a bid to cut electricity consumption and save precious dollars, officials ordered Tahrir’s lights dimmed.
The move is part of a broader campaign that calls for streetlights to go off after 11 every night and for air conditioning at shopping malls to maintain temperatures at a warmish 25 degrees centigrade (77 Fahrenheit). The aim is to cut electricity usage by 15 percent, which will allow Egypt to direct more of the natural gas it produces to exports and earn it desperately needed foreign currency.
Many emerging-market countries have been hit hard by a combination of rising global interest rates and the fallout of the Russian invasion of Ukraine. But Egypt has been impacted more than most and faces the prospect of defaulting on its $83 billion in foreign debt.
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“Attempts are underway to delay debt repayments to Gulf neighbors. Government reporting is deliberately scant on debt repayment figures this year, pointing to the extent of the crisis. And international institution reports suggest that the country will struggle to meet repayment requirements. Therefore, the risk of defaulting is real,” says Alice Gowers, director of geopolitics and security at Azure Strategy, a London-based consultancy.
James Swanston, Middle East and North Africa economist at Capital Economics in London, says the risk is heightened by the fact that a lot of Egypt’s debt must be repaid in the near term. Egypt has among the shortest average debt maturities among major emerging-market countries, he says, with officials suggesting it is in the range of 1.5 years, he says.
Still, analysts agree that the risk of default is low, if only because Egypt’s Gulf allies have already pledged $22 billion in investment and other financial aid and will probably come through with more. “I would expect Gulf neighbors to weigh in again before that, as it is not in the regional interest for Egypt to suffer instability,” says Gowers.
Egypt’s struggle
Egypt has been struggling economically for some time. The tourism industry – whose foreign currency earnings are vital for a country so reliant on imports – was dealt a body blow by the crash of a Russian airliner in 2015. Moscow blamed terrorists and banned charter flights to Egypt, which effectively slashed tourist arrivals by one third. The coronavirus travel bans that began in 2020 deprived the country of the other two thirds. To help cover its import bills, Egypt took on more and more foreign debt.
The gradual waning of the pandemic and Moscow’s lifting of the travel ban in July 2021 aroused hopes in Cairo that the worst was over. The war in Ukraine dashed them. Not only did the war bring a halt to Russian tourism, but global food and energy prices – already rising due to supply-chain problems and the post-COVID world economic recovery – surged higher.
Egypt was especially vulnerable to these setbacks. Its foreign debt was already at a steep 94 percent of gross domestic product, and rising global interest rates were making the cost of repaying the debt more onerous. The war caused Egypt’s import bills to rise sharply. The world’s biggest importer of wheat, Egypt had been sourcing 86 percent of it from Russia and Ukraine before the invasion.
Although the government has managed to keep bread on the shelves by scrambling for supplies at home and abroad, it has come at a huge cost. Bread subsidies – a major state expenditure that Egyptian leaders have long feared to touch out of concern it would set off political unrest – have soared, as has the cost of imports.
Meanwhile, concerns over the war’s impact on the economy caused foreign investors to pull their money out of Egypt to the tune of $35 billion in the first half of the year, while its current account deficit drained another $5.8 billion in that period. By March, the central bank had no choice but to devalue the Egyptian pound by 15 percent against the dollar. It has since drifted lower another 4 percent to its weakest ever.
The depreciation has fueled the inflation that had already begun rising due to higher global commodities prices, with prices up 13.6 percent year on year in July.
In some respects, the worst of the war’s impact has receded. Not only did Russia agree in July to allow some Ukrainian grain to be shipped through the Black Sea, but world food and energy prices have dropped back in dollar terms – although that offers Egypt only partial relief because the pound today buys fewer dollars than it did before the war.
In any event, Egypt is not out of the woods yet, and all the paths that would take it there involve difficult trade-offs and risks.
Austerity, like the power cuts, as well as suspension of many infrastructure projects and ceilings on public sector hiring ordered by the government, could undercut economic growth. They are also politically risky at a time when ordinary Egyptians are already feeling the pinch of soaring consumer prices.
Swanston, of Capital Economics, says the government is keeping to its policies of fiscal restraint in the current budget, but in order to keep a lid on social unrest it has also allocated extra money for cash transfers to the poor and put paid to earlier talk of subsidy cuts.
But the big decision facing Egyptian policy makers is whether to further devalue the pound and/or accept a loan from the International Monetary Fund, both of which entail risks for the regime.
Capital Economics believes that in order to reduce Egypt’s yawning current account deficit, the pound needs to weaken from its level of just over 19 to the dollar today to 24 by the end of 2023, and to 25 by the end of 2024. A devaluation would make the Egyptian currency more competitive, but the cost of Egypt’s dollar-denominated debt will grow, notes Swanston.
“Depreciation of the currency will lead to higher inflation, and that will certainly erode household income. There will be government measures to offset that. If there is an IMF deal, there will be more leeway on that,” he says, but adds: “I think there will be benefits over the longer run – businesses benefiting from import substitution, households buying more domestic goods over imports, and that will help employment prospects.”
Three weeks ago, Tarek Amer, the central bank governor who steered Egypt through the Russian-tourism and COVID crises and reportedly opposed a weaker pound, resigned. His interim successor, Hassan Abdalla, seems more inclined to let the currency depreciate, albeit gradually.
Talks with the IMF have been underway since March, but are proceeding slowly, in part because Egypt’s Gulf allies have come through with financial aid. The IMF is not only expected to require a depreciation of the pound, but structural reforms designed to make the economy more competitive.
Controversial reforms
Among the most controversial of those reforms, say analysts, is an extensive privatization drive, which would almost certainly involve selling companies belonging to the Egyptian military’s sprawling business empire. Since coming to power, President Abdel-Fattah al-Sissi has encouraged the growth of the army’s role in the economy; he can’t easily afford to alienate the generals with a complete about-face.
Swanston says he believes that al-Sissi, who in April pledged to sell off $40 billion in state assets over the next four years, will find a way to accommodate both the IMF and the army. ”I think it will be strategically done, so that the Egyptian government and military continue to hold on to their prize assets and sell those assets that won’t lose them influence,” he predicts.
However, the question remains whether al-Sissi can pull off the same balancing act with the public. On that account, most analysts contend that the harsh security controls and a lack of appetite on the part of ordinary Egyptians to take to the streets as they did in 2011 raise the bar to unrest.
“Dissatisfaction among the public is present and widespread, but right now the extent of the military’s control – into state organs, particularly key areas such as the judiciary – will likely keep a lid on any uprising attempts,” says Gowers. “What would make Egypt sit up and notice is a stronger stance on this issue from international actors. But this is not likely to happen given Egypt’s pivotal role in global geopolitics.”