Egypt is at risk as doubts grow over quick IMF deal

People walk at a market amidst a traffic jam in downtown Cairo (file). At the heart of the talks with IMF lay the quest to reduce fuel subsidies. Subsidies, wages and interest payments on debt make up the bulk of the country’s budget.

 Bloomberg/Cairo

Egypt will struggle to secure International Monetary Fund cash before yet-to-be scheduled parliamentary polls, leaving its bonds and currency vulnerable to declines, EFG-Hermes Holding and Bank of America Merrill Lynch said.

Egypt will probably not reach a $4.8bn IMF loan accord before the fourth quarter as it needs to take “unpopular” moves such as cut subsidies, investment bank EFG- Hermes, the country’s biggest, said. The benchmark Eurobonds snapped a two week rally after talks ended without a deal, sending the yield on the $1bn notes due April 2020 22 basis points up last week to 7.22%. That is 71% above the regional average, HSBC/Nasdaq Dubai indexes show.

Attempts to secure IMF assistance over the past two years have faltered as political turmoil following the 2011 uprising prompted successive governments to renege on two initial accords. Egyptian officials, which this month secured $5bn in aid pledges from Qatar and Libya, says an agreement could still be reached in a few weeks and IMF managing director Christine Lagarde vowed “not to give up” on the talks.

“Unless additional external aid materialises, the recent rally will slowly fizzle out as negotiations with the IMF drag on until past elections,” Jean-Michel Saliba, London-based economist at BofA Merrill Lynch, said in an e-mailed response to questions April 22.

Central Bank governor Hisham Ramez said this week an accord isn’t tied to elections, according to the state-run Middle East News Agency. For many investors, though, it is now a “matter of seeing is believing” after “so much back and forth over the last two years,” said Raza Agha, chief Middle East and Africa economist at VTB Capital in London.

The yield on the 5.75% dollar-denominated bonds fell three basis points yesterday to 7.21%, according to data compiled by Bloomberg. The cost of insuring Egypt’s dollar-denominated debt against default for five years last week ended two weeks of declines, rising 14 basis points, or 0.14 percentage point, to 596 on April 19. The average for the Middle East was 264 basis points.

While acknowledging that an agreement “still remains likely,” EFG-Hermes sees a “slim” possibility that a staff- level accord may be signed in late May, analysts Simon Kitchen and Mohamed Abu Basha wrote in a report dated April 21.

At the heart of the talks lay the quest to reduce fuel subsidies, a step that Mubarak balked at tackling during his three-decade rule before his ouster in the revolt. Subsidies, wages and interest payments on debt make up the bulk of the country’s budget.

Egypt has already raised butane gas prices for households and businesses, sparking a public outcry. The IMF said April 15 that the nation has taken “valuable first steps” to tackle subsidies and planned further measures to address its fiscal and balance of payment deficits in a “socially balanced way.” The country’s budget shortfall is the highest in the Middle East as a percentage of economic output.

Further cuts in subsidies before parliamentary elections could cost Egypt’s ruling Islamists votes, Giyas Gokkent, group chief economist at National Bank of Abu Dhabi, said. President Mohamed Mursi said elections may be held in October.

Delays in IMF support, which the government expects to unlock more than $10bn in additional funding, will leave the pound under renewed pressure toward mid-2013, “if not earlier,” EFG-Hermes’s Kitchen and Abu Basha wrote.

The pound has weakened more than 10% to 6.9253 a dollar since the central bank started limiting access to the US currency through foreign-exchange auctions on December 30 to stem the drop in reserves, data compiled by Bloomberg show. The pound’s exchange rate may average at 7.6 a dollar in the fiscal year that ends in June 2014, EFG-Hermes estimates.

Reserves have plunged more than 60% since the uprising to $13.4bn in March. The government’s local-currency borrowing costs for one year rose 104 basis points so far in 2013 to 14.58% last week as it seeks to finance the budget gap, according to data compiled by Bloomberg.

EFG-Hermes forecasts a budget shortfall of 12.1% of gross domestic product this fiscal year, above the government’s forecast of 10.4%. Next year’s budget foresees a deficit of 9.6%, according to the draft sent to lawmakers.

With the government having done “little in implementing meaningful fiscal reforms thus far” next year’s budget also “shows an unrealistic timeline for reforms, where the government expects to take a number of inflation-generating reform initiatives in less than eight months,” EFG-Hermes said.

The Egyptian economy may expand 2% this year, the slowest pace since 1992, according to IMF forecasts. Against this backdrop, “any news that an IMF programme would be delayed beyond May or June could generate further weakness” in Egyptian bonds, Agha of VTB Capital said by e-mail April 22.

“If sustained donor support is not forthcoming, private capital inflows will remain weak, which will keep the Egyptian pound at risk of a disorderly depreciation,” he said.