When the Central Bank of Egypt posted monthly macroeconomic figures for the month of December last week, there was a surprise: Egypt’s foreign currency reserves had dropped for the first time since the government and the International Monetary Fund (IMF) agreed to a US$12 billion loan.
According to CBE data, foreign reserves increased from $16.687 billion in 2013/2014 to $44.259 billion in 2017/2018, before dropping by $2 billion to $42.550 billion by the end of December 2018. Over the same period, external debt rose from 15.1 percent of the GDP to 37 percent.
The initial reasons circulated for the dip in reserves pointed to the IMF’s decision to delay the delivery of the fifth tranche of the loan agreed to in the November 2016 deal. According to press reports, the delay by the IMF was due to Egypt’s delays in implementing an automatic price indexation mechanism on fuel, which would allow the government to lift fuel subsidies in Egypt and reflect international gas prices, as per Egypt’s agreement with the IMF.
But according to analysts and industry insiders that spoke to Mada Masr, the drop is also a sign that the methods Egypt has used to prop up its foreign currency reserves are unsustainable, given mounting external debt and the impact of foreign investors in treasury bills exiting the Egyptian debt market in recent months.
“The crisis is mainly due to the fact that foreign currency inflows to Egypt are unsustainable,” explains Omar al-Shenety, chief executive of private equity and investments firm Multiples Group.
“Government funding of the gap in foreign currency reserves left by the exit of foreign investors from the Egyptian debt market is a major reason behind the decline in reserves, while inflows from sustainable sources — such as foreign direct investment, for example — have not reached a level that would protect foreign reserves from a decline in unsustainable sources,” Shenety adds.
In 2018, interest rates in developed economies rose, pushing investors to turn away from investments in debt instruments in emerging markets, including Egypt. Egypt responded by raising interest rates in an attempt to restore and retain those investments. This did not prevent the eventual decline of foreign investments in Egyptian treasury bills, which amounted to investments worth $6.5 billion in the 2017/2018 fiscal year, compared to $10 billion the previous year, according to CBE data.
Esraa Ahmed, a senior economist at SHUAA Capital, suggests that the decline in foreign reserves was triggered by relatively high external debt obligations (the repayment of instalments with interest) in addition to the payment of government debt obligations (which includes debt owed to foreign oil companies), all of which coincided with the delay of fifth tranche of the IMF loan.
“The delivery of the fifth tranche that was supposed to happen in December would have covered the payment of these obligations, and this would have prevented a decline in foreign currency reserves,” Ahmed adds.
For the SHUAA economist, however, the decline in reserves could not have been caused by the exit of foreign investors from the Egyptian debt market.
“Most treasury bill payments aren’t funded by foreign currency reserves to begin with, but from a special account that was set up specifically to hold funds to pay investors in the event that they choose to exit the market, knowing that some foreign currency entering Egypt is not sustainable, especially treasury bill purchases,” Ahmed says.
However, Ramy Abul Naga, deputy governor of the Central Bank, said in a press statement on January 7 that the foreign currency reserves have declined in order to settle obligations, including those related to bonds and securities.
Shenety explains that it was most likely that the CBE did not deposit all foreign currency inflows from foreign investments as debt instruments into the specialized accounts intended for this purpose. Rather, he posits that they deposited part of the investments in the foreign currency reserve instead. As a result, part of the government’s obligations to exiting investors was paid for from the reserve.
Enterprise, an online publication sponsored by investment bank Pharos Holding, quoted in December a report by Capital Economics showing that Egypt’s state-owned banks were suffering from a sharp drop in foreign assets due to the CBE’s dependence on them “to mobilize their [foreign exchange] liquidity and thereby avoid agitating the IMF by directly intervening.”
“At the current rate of depletion, banks would exhaust their [foreign exchange] assets in eight months,” Enterprise also reported, citing Capital Economics. “Banks’ foreign assets have fallen to 4 percent of total assets and they could drop to 2.5 percent of total assets, the level prior to the 2016 devaluation, by early 2019.”
“Based on an informal agreement with the CBE, state banks have increasingly funded the exit of foreign investments from the Egyptian debt market, to the extent that their foreign currency obligations exceeded their foreign currency assets to the the tune of approximately US$7 billion,” says one macroeconomic analyst at an investment bank, who spoke to Mada Masr on condition of anonymity.
“The actual condition of the foreign currency reserve can only be gleaned through a reading of the condition of the net foreign liabilities of banks, because the CBE, in the end, has to intervene to finance their inability to pay their obligations,” the source adds.
The Central Bank announced in late November 2018 that a mechanism for the transfer of foreign investors’ funds — which had been announced during the crisis in foreign currency reserves before the decision to liberalize the Egyptian pound in November 2016 — had been halted, a decision that went into effect on December 4.
The mechanism allowed the CBE to finance foreigners’ exit by itself in an attempt to dispel investors’ doubts about their ability to recover their money in foreign currency, and to encourage investment in the debt market.
The Central Bank justified its decision to halt the mechanism by asserting that foreign currency inflows after the devaluation allowed for the sustained availability of foreign currency in the market. “As a result, confidence in the exchange market has increased, which was reflected in increased interbank transactions of foreign currency.” As such, the CBE no longer needed to finance the exit of foreigners from the debt market. However, the bank pledged to continue transferring foreign investors’ money to investors who entered the Egyptian market through the mechanism before December 4.
Ayman Hadhoud, an expert on financial and monetary markets and policy adviser at the Center for International Private Enterprise, believes that the central bank is attempting to protect the Egyptian pound by pressuring government banks to provide foreign currency to finance the exit of foreigners, beyond their capacity.
“The major cause of the crisis,” he says, “is a dependence, which has been present since the beginning [of the 2016 currency devaluation] on the abundance of dollars coming in from hot money [foreign investments in the Egyptian debt market], which can disappear as quickly as it flows in.”