The past eight months have been marked by a sharp and steady decline in global oil prices, a slump not seen since the 2008 financial crisis. While the effect on markets worldwide has been mixed, it’s generally seen as positive for net oil importers like Egypt.
The price per barrel of global benchmark Brent crude fell more than 50 percent from a high of US$115 in June to a low of around US$48 per barrel in January. It recovered slightly in the following weeks before making another sharp downturn in early March, and now stands at just above US$58.
The trend spurred market panic for oil producers and exporters whose economies rely on these revenues, and has led to mixed global growth outlooks — but it comes as a much-needed relief for net oil importers.
Egypt is a case in point. Falling oil prices have helped cushion the blow of domestic inflationary pressures driven by a package of subsidy reforms introduced in July, an attempt to rein in a deficit that the cash-strapped government has struggled to tighten.
For one, the Petroleum Ministry expects to decrease its subsidies bill by LE30 billion this fiscal year if oil prices continue at this level.
“If this persists, Egypt will be able to fix its fiscal accounts, because they were on an unsustainable fiscal path,” says Wael Ziada, head of research at the Cairo-based investment bank EFG Hermes. “They can reduce the huge debt pile on the economy, which is causing structural inflationary problems.”
Just this week, Egypt reported an annual inflation of 10.6 percent for February, an increase from 9.7 percent in January. That month, the Central Bank of Egypt (CBE) had made the unexpected decision to cut key interest rates by 50 basis points, encouraged by the supposed ease in inflationary pressures.
“Upside risks from imported inflation continue to be contained on the back of lower [global] oil prices and the consequent revision in international food price forecasts,” the CBE’s Monetary Policy Committee said in a statement.
There are several key areas where global oil prices will have a mixed impact. Ahead of the Egypt Economic Development Conference (EEDC) opening Friday in Sharm el-Sheikh, it’s vital to note how this trend affects the country’s broader economic and fiscal health. Half of the projects Egypt will present to investors at the EEDC are expected to be in energy, and the government is desperate to maintain renewed investor interest in the sector.
Current account deficit
“Given that Egypt, Morocco and Tunisia are net importers of fuel, they stand to gain from the plunge in oil prices,” says London-based economic research consultancy Capital Economics. “Smaller current account deficits will ease the strains in the balance of payments which have plagued these economies over the past few years.”
Mohamed Farid, CEO of Cairo-based economic and financial consultancy Dcode, explains that “the entire import bill for oil products will decline, so the government will save some money in its oil trade balance.” Crude oil constitutes 22 percent of total petroleum imports and 5 percent of Egypt’s total imports, his firm notes.
In the fiscal year 2014/15, the first six months of which saw relatively high oil prices, Egypt’s net oil trade balance is expected to save “US$1.5 billion on the current account,” says Ziada. If prices remain at this level, Egypt could see even more savings of up to US$2.5-3 billion in the 2015 calendar year.
But since energy prices are still heavily subsidized, “the benefit will largely accrue to the government through a lower subsidy bill,” says Jason Tuvey, the Middle East economist for Capital Economics. “We estimate that the drop in oil prices, if sustained, could reduce the government’s subsidy bill by as much as 3 percent of gross domestic product (GDP).”
Many believe that emerging economies that heavily subsidize energy could take advantage of this dip in oil prices to cut energy spending and redirect those funds elsewhere.
“The fall in oil prices provides an opportunity for many countries to decrease energy subsidies and use the savings toward more targeted transfers,” the International Monetary Fund wrote in December. Energy subsidies cost Egypt 6.5 percent of GDP in 2014, according to the IMF.
But since the government already pushed forward some subsidy cuts and energy price hikes this summer, it may be wary of touching the socially sensitive and highly contentious subsidy system again in the near future, especially when it comes to basic fuel products.
Furthermore, savings on subsidies can’t easily be redirected elsewhere, since they are savings on an existing deficit.
“The impact on current account and fiscal deficit gives [the government] a breather for the medium and long term,” according to Ziada.
It would also mean less pressure on the country’s foreign reserves, which have dwindled due to rising import costs over the years, translating in part into a weaker currency.
A breather may also be afforded to the country’s banking system, which the government has recruited for borrowing in order to support its gaping deficit.
“The government will tap the local fixed income market, the local debt market, less frequently,” says Farid, meaning that “the cost of borrowing money will not be as high, which creates some fiscal space for the government.”
FDI in the oil and gas sector
Ziada doesn’t see fluctuating oil prices directly reversing Egypt’s ongoing energy crisis of the past two years.
What may ease the energy shortage is a revitalization of foreign direct investment (FDI) in the country’s oil and gas sector, which constitutes 50 percent of net FDI inflows, according to Dcode.
Energy investments dried up in the years following the 2011 uprising as the government accumulated arrears to foreign oil companies, which contributed in part to the energy crisis. But this has changed since Egypt began repaying its debts.
On March 6, British Petroleum signed the final agreements for its West Nile Delta project to develop 5 trillion cubic feet of gas resources and 55 million barrels of condensates, according to a company statement — an investment of around US$12 billion.
“The Egyptian government has made good progress in tackling the issues that have held back investment in the country’s oil and gas sector in recent years. As such, there are signs that foreign energy companies are taking a greater interest in Egypt, undeterred by the fall in oil prices,” says Tuvey.
Farid says that since market dynamics have created a backlog of exploration opportunities for the past three years, coupled with the fact that “oil prices are still higher than the average cost of exploration per barrel,” there will be no direct negative impact on FDI in the oil sector.
It may seem that investments from Gulf countries are at risk, as the oil producers face the pressure of plummeting oil prices and are expecting a budget deficit in place of the surplus recorded in recent years. However, it is unlikely that their investments in, and support of, the Egyptian economy will waver, since this support has largely been political in nature since the removal of deposed President Mohamed Morsi from power.
“As long as Egypt’s security and economy is viewed as pivotal for the security of the entire region, the allocation of aid to Egypt is going to be second to, if not on equal footing as, the allocation they [Gulf countries] have for military spending,” Ziada contends. While he does expect aid to be reduced, it will be driven less by oil price fluctuations and more by the fact that the level of Gulf aid over the past year has been excessive.
The global deflationary effects of tumbling oil prices and their impact on currencies has forced the central banks of some European countries to foray into the negative interest rates territory. Most global economic outlooks foresee a continued trend of monetary policy loosening.
In Egypt, the CBE cut interest rates in its first meeting of the year on the back of easing inflationary pressures, bringing the overnight deposit rate to 8.75 percent and the overnight lending rate to 9.75 percent. In its last meeting in February, it kept rates unchanged, citing risks to inflation and economic growth.
While negative interest rates are a far-fetched possibility for Egypt, experts point to the fact that real interest rates — that is, nominal interest rates as announced by the CBE, subtracted by the domestic rate of inflation — are, in fact, already in the negative, and have been for some time.
“If you’re talking about negative real interest rates, in the past three to four years we’ve seen more negative than positive rates,” explains Ziada. “Negative nominal interest rates, however, are not foreseen in Egypt because of the fiscal accounts structure.”
Farid adds that “in the case of Egypt, where most individuals are dealing with the banking sector, you will find that rates are a little bit lower than inflation regarding deposits, hence the negative real rate of return when it comes to individual depositors.
“When it comes to financial institutions dealing with the government and investment certificates, we still have a little bit of a positive interest rate. Average inflation has been around 10 percent, while rates for T-bonds have been a bit higher.”
Still, for bank clients with significant sums of money in Egypt’s overly liquid banking sector, even a slight drop in nominal interest rates will be felt in their wallets.
Domestic inflation and prices
While lower oil prices are generally positive for Egypt, in that it helps to reduce the deficit, the fact is that the deficit will still persist because the subsidy system still provides oil at below market prices, Ziada says. For the same reason, domestic prices of goods are not likely to come down.
If there were no subsidy bill, then sliding oil prices would result in a direct decline in domestic prices of goods and services. But since this is not the case, “impact on the consumer is muted,” Ziada explains.
Energy subsidies will also keep the cost of transportation from decreasing, Farid says — another reason that the price of goods and services will likely remain steady. He also points out that emerging markets typically witness downward price rigidity, “as in, it’s always easier for prices to increase than vice versa.”
Globally, however, “with the decline in crude oil prices comes a decline in the derivatives of this crude oil, which implies that bunker crude [marine vessel fuel] will decline, so the cost of cargo shipments will fall,” says Farid. Still, he adds, “the cost of transporting imported cargo is not that significant in the total cost of imports.”
Essentially, while this translates into lower imported inflation and lower import costs for Egypt, the domestic market and its price dynamics will largely be shielded from the effects of dropping oil prices.
What the government can do is avail more energy products to the market, since their prices will fall on the back of cheaper crude oil, says Farid.
Tourism and remittances
Egypt may see less tourism from Russia — one of the country’s main markets — due to the negative impact on the latter’s economy, which is heavily reliant on oil and gas prices, says Farid. This along with the decline in the Russian ruble led Egypt to strike a deal allowing Russian tourists to pay for package holidays in their home currency instead of in US dollars.
There may also be fewer remittances coming in from Egyptians living in the Gulf States, but not to a significantly crippling level.
“Low oil prices will impact the size of the [Gulf] consumer market, and this is what directly impacts people living abroad,” says Ziada. “Remittances will be coming down because they had increased dramatically in the last period to compensate for the shortfall in the Egyptian economy, which left families dependent on relatives living abroad.”
He concludes that “as the economy picks up in the country, you will see less of this anyway.”