ShareKUWAIT: We see the Egyptian economy transitioning to a higher growth phase after an exceptionally challenging four years. Inflation has dropped sharply since last year’s peak of nearly 36 percent to just under 13 percent in February, paving the way for monetary policy easing by the central bank potentially starting in April. This easing is critical to lower the cost of doing business, assist in the control of public spending and boost equity and FDI inflows. This in turn will support economic growth that we believe is improving on a recovery in consumption.
External sector dynamics are the key risk to Egypt’s fiscal sustainability and economic growth profile, especially if the currency is not left to float properly. The IMF noted that the exchange rate is still fluctuating within a limited range and that more effort is required for stakeholders to perceive it as truly flexible. The current account deficit has widened on the back of a pick-up in imports, higher energy costs, and a drop in Suez Canal receipts. FX flexibility is crucial to maintain strong levels of reserves and commercial banks’ net foreign assets (NFAs) that have so far been volatile and heavily reliant on FDI into the local currency debt.
The IMF on March 11 completed its fourth review of the Extended Fund Facility Arrangement (EFF), unlocking a further $1.2billionin financing and bringing total withdrawals under the $8 billion EFF to $3.2 billion. The IMF also approved access to $1.3 billion under the Resilience and Sustainability Facility, but re-stressed the need for further structural reforms related to divestment, a more level playing field, governance and transparency.
Signs of improving growth are evident in both hard and soft data. GDP growth in Q1 FY24/25 (Jul-Sep 2024) rose to 3.5 percent y/y, comfortably above the previous quarter’s gain of 2.4 percent. Private consumption was the key growth driver, expanding by 12.8 percent on a strong pick-up in imports (34 percent). Government consumption and gross capital formation contracted by 15 percent on average. We expect growth to accelerate in Q2 towards the 3.5-4.0 percent range and reach 4.0 percent for the full year, a substantial rise on 2.4 percent in FY23/24. Indeed, survey data confirm better momentum continuing into this year, with the PMI activity gauge in expansion territory for two consecutive months in Jan-Feb, a first in more than four years. This was mainly driven by a recovery in local new order books boosted by cooling inflation. Firms also increased their input purchases at the sharpest rate in 3.5 years.
The current account deficit will continue to widen as imports grow and Suez Canal revenues remain subdued. Latest figures show that deficit widened substantially to $6 billion in Q1 FY24/25from $2.8 billion in Q1 FY23/24. This was mainly driven by a large increase in imports (to $23 billion from $16 billion a year ago) on the back of higher oil & gas imports (to $5.4 billion from $2.9 billion) and non-energy imports (+30 percent y/y to $17.7 billion).
On the positive side, non-energy exports increased by 18 percent and remittances almost doubled to $8.3 billion in the same quarter. Meanwhile, in terms of services receipts, Suez Canal revenues plunged to $0.9 billion from $2.4 billion in the previous year as geopolitical tensions continued to discourage Red Sea trade flows.
With no clear sign of a pick-up in Suez Canal revenues, we expect the deficit to remain large at $15-20 billion in FY24/25 and inflated by high energy import costs. The pick-up in economic growth is also likely to spur import increases. We reiterate our view that it is critical to maintain a flexible exchange rate to limit the ballooning of the current account deficit.
Foreign reserve levels at the central bank continued their slow upward trend, rising by $129 million in February to $47.4 billion, a 34 percent y/y increase. Commercial bank NFAs continued to see volatility on the back of outflows and inflows of foreign portfolio investments into the LCY debt market. The negative balance (deficit) of commercial bank NFAs narrowed to $3.3 billion from $6.4 billion due to higher foreign assets ($25.2 billion) and lower foreign liabilities ($28.5 billion), with Egypt’s $2 billion Eurobond issuance and the EU’s dispensing of EUR1 billion from its EUR7.4 billion financing package the major contributors. The slowdown in the global EM debt sell-off also allowed commercial bank NFAs to recover.
Despite heightened regional geopolitical tensions, yields on Egyptian sovereign debt have remained compressed and largely unchanged since last July, with 5-yr Eurobonds at 8.6 percent and 5-yr CDS spreads (a measure of default risk) at 578 bps. Moreover, the government’s successful $2 billion Eurobond sale, the first issuance in almost two years, was well-priced at 8.62 percent for the 5-yr notes and 9.45 percent for the 8-year note given the stresses the sovereign has been under over the last two years. Also a sign of confidence was the fact that the issuance was around 5 times oversubscribed ($10 billion). We expect the proceeds to be mostly used to plug part of the external financing gap which we estimate at $10bn over the next two years starting March 2025.
Inflation falls
Inflation, largely as expected, dropped sharply in February to 12.8 percent y/y from 24 percent in January, on the back of a favorable base effect. On a monthly basis, inflation slowed to 1.4 percent m/m from 1.5 percent m/m in January. Looking ahead to the rest of the year and beyond, our inflation expectations take into account the resumption of subsidy cuts to fuel (possibly including natural gas) and electricity. For 2025 and 2026, we think inflation will average 15 percent and 12 percent, respectively. The current inflation target set by the central bank is 7 percent (+/- 2 percent) for Q4 2026, which in our opinion could be achieved based on current trends.
Monetary easing cycle
The Central Bank of Egypt (CBE) kept policy rates unchanged at 27.75 percent (discount rate) during the first eight months of FY24/25. However, with inflation having plunged, we believe that the CBE is more comfortable about pulling the trigger on interest rate cuts, likely as soon as its next meeting in April. We think cuts of 2-3 percent are likely at the meeting followed by 3-5 percent in the second half of the calendar year. With the fall in inflation, real policy interest rates currently stand at 15 percent and will remain significantly high even after the CBE embarks on the easing cycle, possibly ending the year at around 8-9 percent.
Bank credit to private businesses expanded by 32 percent y/y on average for the Nov-Jan period (31 percent in the previous 3 months). Household credit growth was relatively unchanged at 23 percent versus 24 percent for the same period. In inflation-adjusted terms, corporate credit was up 8 percent y/y (4.6 percent for Aug-Oct). As for household credit, it also improved to -1 percent from -2.8 percent for the previous period. The increase in real credit comes in tandem with the pick-up in economic activity and better PMI levels. With inflation expected to cool further, credit activity will be mostly driven by genuine economic activity rather than reflecting firms’ catching up with price adjustments.
We expect credit to grow by 25 percent in FY24/25 (year-end) in nominal terms, which, while lower than the 32 percent recorded in FY23/24,will at least be9-10 percent in real terms, compared to the previous -2 percent.
Strong fiscal discipline
The government has so far released fiscal accounts for the period July – Nov FY24/25. The figures continue to show the adoption of tighter fiscal discipline, with the fiscal deficit narrowing to 3.3 percent of GDP from 4.7 percent for the same period of the previous year. The reading for the primary fiscal balance (excluding interest payments) was +1.0 percent of GDP, improving on the previous year’s more modest surplus of 0.4 percent of GDP.
In terms of expenditures, at EGP1.38 trillion, annual increases were contained to about 10 percent y/y, which compares favorably to growth of 18 percent y/y in the previous year’s outlay of EGP1.26 trillion. Wage, interest payments, and subsidies – representing 85 percent of total spending – were up by 20 percent y/y, 2.4 percent, and 35 percent, respectively. Total revenues rose by 36 percent y/y to EGP828 billion, mainly driven by large increases in tax revenues (+38 percent), which comprise about 87 percent of total government revenues.
We expect the government to resume cutting fiscal subsidies, after a six-month pause, especially fuels. Based on our calculations, the Fuel Automatic Pricing Committee could increase prices by 15-20 percent at its April meeting and follow this up with another round of price increases in the 3rd quarter of a similar magnitude to bring the cost recovery ratio to around 100 percent by end-2025.
For the full FY24/25, we expect the fiscal deficit to widen significantly to 7.9 percent of GDP from 3.6 percent of GDP in FY23/24 (the latter inflated by one-off revenues linked to the Ras El Hekma deal). A positive upside to this outlook would be the possibility of having another revenue-boosting mega deal this year, a lower interest rate environment that would mainly affect the last quarter of the year, and a recovery in Suez Canal revenues.
