Can Egypt fix its finances?

International investors are waiting for details to emerge of the new programme the IMF has agreed with Egypt. The fund was expected to lend the North African state up to $15bn in return for certain fiscal and investment environment reforms, including reductions in subsidies for basic commodities and energy, and the privatisation of state enterprises. Its intervention was expected to bolster investor confidence that Egypt would be able to meet its international and domestic debt obligations.

However, investors are puzzled by the size of the financial support package the IMF has actually offered – around $3bn – especially given the new problems that Egypt faces. These include, notably, the explosion in global food and fertiliser prices resulting from the Russia-Ukraine war that is severely straining its external finances.

There is also confusion over why Egypt has not received from its wealthy friends in the Gulf any direct grants to help shore up its finances.

Qatar recently became the latest member of the GCC to deposit a large sum in Egypt’s central bank. Such deposits by the Arab Gulf states, alongside commitments to invest in projects in the economy, provide a backstop for Egyptian finances and reassure international investors that their money is safe. But deposits have to be paid back eventually, unlike grants, which reduce or obviate the need to borrow from other sources. And, given that foreign funders demand that recipients of financial support open up their economy in return, many observers are questioning whether Egypt’s government will be able to make sufficient concessions to secure the funds it needs to restore stability to its economy.

Spending on big-ticket infrastructure projects deepens debt crisis

Egypt’s financial constraints have been a constant problem reaching back to the presidency of Anwar Sadat. The Arab Spring and the ensuing political chaos and instability were the latest in a series of crises to cause severe economic damage. Moreover, falling natural gas reserves and the need to feed more gas to the domestic market led to the curtailment of Egypt’s LNG export programme and the total loss of export revenues from that source. Lower oil prices after 2014 also caused a temporary decline in remittances, one of biggest income flows into the economy, although ENI’s discovery of a major gas field in 2015 somewhat helped to repair the country’s external finances.

Since Abdel Fattah Al Sisi came to power in 2013, a key pillar of the government’s economic strategy has been to roll out major infrastructure construction projects –the Suez Canal expansion, a new capital city, highways and housing – funded by government borrowing overseas, notably from multilateral institutions like the World Bank and the European Bank for Reconstruction and Development. Bilateral trade financing and occasional international bond and sukuk issuance also played a role.

But the amount secured from these sources was not enough. The government also offered foreign investors local currency bonds that carried a high interest rate – an attractive opportunity in the era of exceptionally low interest rates in Europe and the US. As an extra incentive, the central bank maintained a stable currency, which in turn required sufficient foreign currency reserves to maintain investor confidence. The GCC played an important role in this effort by providing the bank with hard currency deposits to bolster its reserves.

However, the bond programme had a fundamental problem in that it led to an overvalued exchange rate and high domestic borrowing costs. The former dampened export growth while the latter discouraged private sector investment so Egypt was unable to attract foreign direct investment despite the improvements to its infrastructure. Consequently, it had to take on more debt in order to meet its external financing obligations. The government had access to external debt markets as long as the global environment was amenable, with international investors looking for high yields in emerging markets. But when the US Federal Reserve started to raise interest rates to fight domestic inflation last summer, foreign capital returned to developed markets and borrowing costs started to rise rapidly for Egypt, as they did for other emerging market countries.

On top of the higher funding costs, the massive increase in Egypt’s import bill following Russia’s invasion of Ukraine severely strained the North African state’s public and private finances.

Sisi’s political aims clash with needs of economy

But one particular feature of Al Sisi’s economic strategy has come under scrutiny by foreign investors, bilateral aid donors and the IMF, namely his allocation of a large share of the economy to Egyptian military companies.

While the involvement of the armed forces in the domestic economy is nothing new – the military-industrial complex benefitted under former President Mubarak as well – their access to the economy had previously been limited. However, Al Sisi has put the military in control of multiple sectors. He has done so for reasons of urgency and efficiency, and as a means of securing the support of the senior military cadre.

The largesse of Al Sisi’s government has turned out to be unsustainable as the economy sinks under the burden of debt. Foreign investors and lenders are now demanding that the military cedes some of the economic space to the private sector in return for more funding. But the international financial press – as well as the big Gulf donors who are interested in gaining access to the Egyptian market – have voiced doubts over whether Al Sisi will be able to reconcile his political objectives with the economic and financial strains facing the economy.

At best, Egypt can be expected to muddle through this challenging period, enacting partial reforms but also returning to regional backers for more support. As in the past, nothing will fundamentally change; the cycle – and the crisis – will be repeated down the line.