Egypt Avoided An Economic Meltdown. What Next?

The rapid change of fortune began with a $35 billion tourism development deal with the United Arab Emirates, the largest inward investment in Egypt’s history. This brought an infusion of dollars that paved the way for a record interest rate hike and an expanded International Monetary Fund loan. Whether the government is able to fix the economic problems that precipitated the meltdown isn’t clear. Egypt has a track record of announcing market-friendly reforms, then dragging its feet.

Egypt gets much of its hard currency from energy exports, tourism, fees from ships plying the Suez Canal and money sent home by expatriates. Domestic industries are hobbled by under-investment, and private companies complain of unfair competition from entities linked to the country’s powerful military. This limits foreign direct investment outside the oil and gas industry, leaving Egypt’s finances more susceptible to the volatile flows of “hot money” invested over shorter periods by international funds. A sharp devaluation in the Egyptian pound that began in 2022 aggravated inflation, creating a potential political powder keg in a country where many households depend on state subsidies to afford essential goods. Capital flight and a dearth of hard currency brought the supply of dollars to dangerously low levels in 2023. The pound began changing hands on the black market at twice its official rate, raising costs for businesses and importers. Attacks on shipping in the Red Sea by Yemen’s Houthi militants dented Suez Canal fees. Remittances ebbed as Egyptians abroad held back transfers in the expectation of another devaluation.

The deal with the UAE to transform Ras El-Hekma, a pristine stretch of Mediterranean coastline, into a tourism haven brought an immediate confidence boost that pulled the country back from the brink. Authorities followed it up with an interest-rate hike of 6 percentage points that helped to reverse capital flight by giving rate-arbitrage investors the opportunity to make annual returns of more than 20%. In a widely-anticipated move, the central bank said it would allow the currency to float, triggering an almost 40% plunge in the pound’s value against the dollar in a single day. The IMF had been calling for a flexible currency regime for many months, and the multilateral lender rewarded Egypt’s government by almost tripling the size of a loan program first approved in 2022 to $8 billion. This was a catalyst for a further influx of around $14 billion in financial support from the European Union and the World Bank.

There was a stampede into Egypt’s local-currency bonds. For now, investors have targeted tactical trades and are waiting for more evidence that the country has turned a corner before locking up their money in more strategic, longer-term investments. For that reason, most of the money has flowed into short-term opportunities like carry trades rather than Egypt’s dollar bonds. In fact, the country’s international debt has lost some of its allure in the dash to local-currency debt offering higher returns.

Egypt has suffered periodic economic crises since the Arab Spring uprising of 2011 and the government has struggled to cover huge bills for wheat imports, subsidies and public sector salaries. President Abdel-Fattah El-Sisi, who came to power in 2013 after the military under his leadership ousted Islamist President Mohamed Mursi, tried to kick-start the economy by launching vast public works projects, including widening the Suez Canal and building a new administrative capital in the desert. Returns on those investments have been patchy, and many of them were funded through borrowing. By late 2023, almost half of state revenue was being spent on debt interest. That was only sustainable because of high interest rates and a managed currency that propped up foreign demand for local debt. The jump in global interest rates following the pandemic and Russia’s invasion of Ukraine led investors to pull some $20 billion out of Egypt, precipitating a crisis that many saw as long in the making.

The government has said it will fulfil a pledge made to the IMF to curb state spending and boost competition by giving the private sector a bigger role in the economy. It’s made similar promises in the past, only for those efforts to largely fizzle. One concern among investors is that the authorities will reverse course on the latest devaluation at the earliest opportunity — as they did in 2016 and again in 2022 — in order to tamp down galloping price increases that are threatening social stability and forcing the government to pay out more in subsidies.

There’s a lot of skepticism about that, including from Bloomberg Emerging Markets Economist Ziad Daoud, who says that the currency’s movement is “too smooth” for a true free float. The central bank has stressed a commitment to continue a transition to flexible inflation targeting.

Egypt’s role as a regional power broker, which developed under President Gamal Abdel-Nasser in the 1960s, has been slowly eclipsed as Gulf monarchies used their oil wealth to extend their influence across the Middle East and Africa. More recently, the Israel-Hamas war has reaffirmed Egypt’s pivotal role in the region’s politics. The first Arab nation to make peace with Israel, it controls the only non-Israeli border points into besieged Gaza and will have a say in the outcome of the conflict. The idea that Egypt is too important to be allowed to fail helped it to secure past bailouts. The latest cash infusions come with more strings attached. The EU’s €7.4 billion funding package hinges partly on Egypt helping to limit illegal migration to the bloc. And more than ever, the Gulf nations want a decent return on projects like Ras El-Hekma so have an interest in good stewardship of the economies where those investments are made.