On May 5th, the Ministry of Finance released the government’s long-awaited debt management strategy. The government plan, which had originally been scheduled for release in March, comes at a crucial period in Egypt’s contemporary economic history. Over the last four years, the government has been engaged in a borrowing spree — reversing a quarter century-long aversion to external loans — and taking on levels of debt not seen since the 1980s.
By the end of June of 2018, government debt amounted to 97 percent of Egypt’s gross domestic product. Egypt’s foreign debt alone accounted for 35.4 percent of GDP last September. A whopping one third of annual government spending goes to servicing debt (including both interests and installments) — a percentage the Ministry of Finance nonetheless insists is safe.
The government’s new strategy aims to find ways to minimize the cost of debt instruments it has incurred over the past several years by restructuring public debt (which includes both domestic and foreign debt). The plan is to reduce short-term debt obligations and secure loans with more preferential terms that can allow the government to service its debts in the medium and long term, instead of paying billions of dollars in interest each year.
Economists who spoke to Mada Masr say the planned government measures are necessary but don’t go far enough to avoid a prolonged debt cycle. They add that the current strategy mirrors a previous 2015 government plan which was eventually abandoned after the devaluation of the pound sent interest rates soaring. Additional measures, such as industrial sector development and import substitution, should be taken to strengthen the country’s debt position, the economists say.
Long-term maturity and decreased debt servicing
In March, the Ministry of Finance released a statement outlining a number of measures it had taken over the preceding months as part of its effort to curb increases in debt servicing and to improve the financial structure of government debt. Those measures included issuing new instruments (such as zero-coupon bonds) and issuing more long-term than short-term bonds, and promoting Egyptian bonds in new foreign markets.
Zero-coupon bonds are debt instruments that do not pay interest, but are bought and sold at a heavy discount and repaid the par value at maturity. Because the trading price is much lower than the bond’s face value, investors make returns when the bond is redeemed.
According to managing director of Multiples Investment Group, Omar al-Shenety, the Ministry of Finance is using zero-coupon bonds to reduce the servicing costs of short-term debt since there are no interest payment obligations throughout the term of zero-coupon bonds until maturity.
The burden of foreign debt on Egypt’s budget is relatively large. According to the Central Bank’s quarterly report on the external position of the Egyptian economy, the government’s financial commitments to foreign creditors for one year — between July 2018 and July 2019 — reached USD$24 billion. Based on the estimates released in June 2018, this figure amouned to 54 percent of Egypt’s foreign reserves at that time. More than half of those liabilities — USD$12.4 billion — service short-term debts.
Egypt’s debt obligations are slated to decline over the coming years as short-term debts are paid out. Foreign debt servicing is expected to decrease to USD$8.8 billion between June and December of 2022 unless the government accumulates more debt, takes out additional short-term loans, or reschedules its debt payments.
The government is currently prioritizing the restructuring of its public debt, especially foreign debt. “The government has become alarmed by the speed of debt accumulation, especially that of foreign debt. Domestic debt will not be exacerbated by inflation, but this does not apply to foreign debt,” Shenety explains. Domestic debt is repaid in Egyptian pounds, and the currency’s value decreases over time due to inflation. Foreign debt, on the other hand, is affected by fluctuating foreign currency exchange rates.
The government also aims to issue new long-term bonds. “There is a need to find new funding. Hence, the government is taking out new loans after paying off older debts. The government expects the economy to recover, just not now. To improve economic indicators, and until emerging markets recover from the current crisis, the government has to issue new long-term bonds, with a maturity of 10 or 30 years,” says Shenety.
In its statement, the ministry says that “it succeeded in issuing long-term bonds in the international market and using them to finance the government’s short-term foreign debt servicing, which include dollar and other foreign currency-denominated treasury bills issued to local banks.” The statement goes on to say that this development has a positive role in “extending maturity length and avoiding the risks of exchange rate fluctuations and the dangers of financing through short-term loans.”
The final measure is to actively promote Egyptian bonds in markets in Asia, such as China, South Korea, Singapore, Japan, and countries in the Gulf. Salma Hussein, an economic researcher at the Egyptian Initiative for Personal Rights, says that the government is trying to enter new bond markets that are not as competitive as Western markets. In other words, Egypt is trying to increase its access to debt, in the hope of securing slightly lower interest rates in Asian markets.
“We have been told that there are big opportunities in Asian markets and many funds in it are willing to invest, so we will go and tell them the Egypt story and about our reform program,” Finance Minister Mohamed Maait said in an interview with Bloomberg last September.
The current debt portfolio, where the majority of public debt is made up of medium and short-term debt, is relatively new. During the second half of Hosni Mubarak’s 30-year rule, long-term debt constituted the vast majority — 90 percent — of Egypt’s public debt, according to Hussein.
Debt management: past warnings and future concerns
In the 1980s, Egypt underwent a severe debt crisis, with the public debt to GDP ratio reaching a staggering 150 percent. But Egypt’s alliance with the United States in the 1991 Gulf War acted as a lifeline, with the American government forgiving half of Egypt’s USD$20.2 billion debt to the U.S. in return.
“Egypt’s foreign debt management had a pre-1990 Mubarak phase and a post-1990 Mubarak phase,” Hussein says. After 1990, the government made a decision to limit its dependency on foreign loans, and the public debt to GDP ratio remained more or less stable.
Sherine al-Shawarby, an economics professor at Cairo University, explains that in the years following the Gulf War, there was strong agreement within the government to put a cap on foreign loans. Annual loans did not exceed USD$1 billion, and investments were directed into productive sectors that could generate enough revenues for the state to be able to service its debts.
As a result, the government used to reject loan applications from ministers, according to Shawarby. Putting a cap on foreign loans was part of an unofficial, yet consistent, fiscal policy, which Shawarby says stands in contrast to the current situation, where fiscal policy decisions change from year to year.
After Mubarak’s ouster, both the Supreme Council of Armed Forces and former president Mohammed Morsi both maintained relatively conservative fiscal policies, according to Hussein. But — under President Abdel Fattah al-Sisi — the policies abruptly changed in 2015, which Hussein describes as the worst year for Egypt’s public debt.
“Global creditors such as the IMF and the World Bank repeatedly pressured Egypt to borrow because interest on foreign loans was low and Egypt needed funding for development — especially after the calls for social justice that were raised during the Arab Spring,” Hussein says. “But when the Egyptian regime took the decision to borrow in 2015, it ironically happened at the same time when the global market started to shift. The US raised its interest rates to make its bonds more attractive, thus strengthening the dollar at the expense of many other currencies, including the Egyptian pound. It was the completely wrong moment to take out loans. The Egyptian pound depreciated and interest rates in the local market soared to make Egyptian bonds look more attractive and avoid further depreciation of the pound.”
Shawarby says one of the biggest dangers of foreign debt is exchange rate volatility, where any depreciation of the local currency can exacerbate foreign debt servicing to a critical level.
Hussein says there is sustained pressure on the Egyptian pound’s exchange rate, as evidenced in Egypt’s balance of payments. The balance of payments constitutes a record of all transactions made between entities in one country and the rest of the world. Although Egypt’s balance of payments generally fluctuates from moderate surplus to moderate deficit, the relative equilibrium is maintained through loans.
In the fiscal year 2017/18, Egypt’s balance of payments showed a significant surplus of USD$12.8 billion. Yet net loans totalled USD$10.3 billion, and net portfolio investments, which are a type of short-term debt security, amounted to USD$5.3 billion. Therefore, without the loans, the surplus in the balance of payments would have been a deficit. Foreign currency inflows from Suez Canal revenues, tourism, and remittances from Egyptian expatriates alone are not sufficient to cover the deficit.
Indeed, the balance of payments for the first half of FY 2018/19, which was released by the Central Bank in early April, showed a deficit of LE1.8 billion. During the same period of the last fiscal year, there was a surplus of LE5.6 billion. The deficit was primarily caused by investors exiting the Egyptian bond market in light of the emerging markets crisis.
Economists who spoke to Mada Masr say as long as Egypt’s public debt-to-GDP ratio remains low, the country will not face a debt crisis. The Ministry of Finance has also stressed in public statements that the debt situation has improved and will continue to do so.
Shenety, the investment firm head, believes the government’s debt management strategy is reasonable. Egypt is trying to lower its debts and extend maturity dates. If macroeconomic indicators continue to gradually improve, the government will be able to pay off its debts in the long term. Shenety says an increase in revenues through the sustainable development of the industrial and agricultural sectors will undoubtedly help the government forgo new high-interest loans. And due to their export capacity, those two sectors can provide sustainable inflows of hard currency, which is exactly what the economy needs, Shenety adds.
On the other hand, Hussein, the economic researcher, believes that the development of the industrial sector will help ease the volatile cycle of debt, especially since foreign trade is currently stagnant. She says the government’s focus should be redirected from export promotion to import substitution so that the need for foreign currency, which is primarily spent on imports, decreases.
Shawarby says that aside from public debt, the central question economists focus on is strategies for economic growth. “Is our growth strategy diversified enough? Is it targeting sectors that have high growth rates and can create sustainable employment?” Shawarby asks. “There is plenty of construction happening now. Alright, then what? Construction ends when the project ends. Notwithstanding the importance of the construction sector, does it come at the expense of other sectors? These are important questions and we are still waiting to see what the government will do in this regard.”
Two similar strategies
The government is optimistic about reducing public debt through its new strategy. One of its primary benchmarks is to reduce the public debt-to-GDP ratio from 97 percent, where it currently stands, to 79.5 percent by FY 2021/22. However, the new strategy is noticeably similar to the government’s debt management strategy of 2015 — the very year when the debt situation was compounded.
The 2015 plan is strikingly similar to the 2019 plan to the degree that much of the wording is simply recycled. Both aim to “gradually [issue] larger volumes of longer‐dated treasury bonds by means of constant issuance and re-openings in order to lengthen the average life of the debt stock, to consolidate the government securities yield curve, and to reduce refinancing risk.” They both say “the strategy encompasses a focuses on diversifying the sources of financing through the issuance of new instruments such as ‘sukuk’” in order to “to finance development and infrastructure projects as well as enlarging the investor base by attracting retail investors and incorporating additional non-banking financial institutions. These strategies will decrease the cost of issuance of the government’s debt securities.”
Shenety does not view the similarities between both strategies as unusual. He says the new strategy is indeed similar to that of 2015, but points out that the economic conditions created by floating the Egyptian pound — such as the marked increase in interest rates — pushed the ministry to abandon its plans in order to attract financing through short-term bonds. The same applies today. Any sudden change in exchange rates or interest rates could lead the government to abandon its strategy once again.
Hussein agrees that the currency devaluation forced the government to abandon its 2015 strategy, but she points out that circumstances are slightly different this time. Even though the most recent IMF assessment warned against a potential interest rate shock and a depreciation of the local currency, she says most economic analyses conclude that any potential shocks would be far less drastic than the currency float and might not necessarily lead to the government abandoning its 2019 strategy.