External debt: a tricky, dangerous route towards reform

Hisham Salah
13 Min Read

Egypt’s negotiations for loans from the International Monetary Fund, World Bank, and the African Development Bank would increase the country’s external debt to approximately $70bn. Yet, the government views the loans as a way for reforming poor economic conditions that have plagued the country since 2011, and a tool to attract foreign investment.

 

Essentially, the loans are supposed to tell the world that Egypt’s economy is going to get better.

However, attracting investments based on receiving these loans is not a guarantee towards eventually paying back these loans. The government must implement real, game-changing reforms.

 

With the higher rate of borrowing, repaying the loans remains a serious problem that could create an extensive burden on future generations. Bankruptcy is the worst case scenario.

Experts think that the rate of borrowing will not get any lower, due to the foreign currency shortage. However, the government needs to keep an eye on the debt and how to fix this problem, especially given that foreign exchange reserves at the Central Bank of Egypt recently recorded $19.5bn, which is very low compared to Egypt’s external debt.

 

Government’s thoughts about foreign loans attracting investments are overly optimistic: expert

The government has been keen on obtaining loans from different international institutions, such as a $12bn loan from the International Monetary Fund (IMF), a $3bn loan from the World Bank, and a $1.5bn loan from the African Development Bank (AFDB).

The loans, however, would push Egypt’s total external debt from $53.4bn in August to approximately $70bn, and the nation’s external debt per capita, currently at $549.3, would jump to approximately $762.7 if Egypt succeeds in obtaining approval for all loans currently being negotiated.

Although international intuitions study the ability of countries’ economies to repay its loans, Egypt’s ability of paying the debt back is not guaranteed, said the managing director of Multiples Group, Omar El- Shenety, adding that external debt from the 1990s until the 2000s was not as high as it is now.

El-Shenety said that Egypt is falling into a trap that previously affected the nation in the 1980s, when the country started to borrow from international sources hoping to develop economic conditions; however, Egypt did not attract investment and was saddled with debt. This is happening again, he noted. He said that Egypt was only able to reduce the debt by participating in the First Gulf War.

He believes that the government’s faith in obtaining the loans as a means to allow the country to attract foreign investment is overly optimistic.

A tell-tale sign is that the current investment climate is hardly attracting local investments, which would spell out that even greater problems would exist in attempts to attract foreign investors.

He explained that the current rate of borrowing is extremely high considering the $25bn loan from Russia for building the Al-Dabaa nuclear reactor and the other petrol power plants Siemens is building.

Egypt’s external debt easily would cross $100bn within 2-3 years if the rate of borrowing remains as it is now, El-Shenety said.

It’s also important to note that external debt is going higher due to the expected devaluation of the Egyptian pound, which would increase the rate of external debt from 30% to 40% of the GDP.

Currently, Egypt’s external debt represents 16.9% of the GDP.

El-Shenety believes that the problem with external debt is that Egypt lacks the necessary foreign currency reserves. He explained that Egypt’s reserves are small in comparison to its debt, and this issue is compounded by the stipulations that the loans received must be repaid in foreign currencies. If Egypt is unable to pay it would have to announce bankruptcy, he stated.

The government should understand that counting on the loans to attract investment is not good.

Eman Negm, an economist at Prime Holding, said the current rate of borrowing is unprecedented.

The government’s inability to increase foreign capital and attract direct investment will push it to take out further loans. Solving investors’ problems and implementing rules to attract foreign investment are the only ways to solve the economic problems, according to Negm.

She noted that the current level of debt is still safe; however, she warned that the external debt to GDP ratio would rise from 16% to 20% in just two years if the pace does not change. If this ratio reaches 20%, it would indicate a serious problem.

Negm said that the government’s inability to achieve the required GDP growth rate and the continuing decline in the value of the nation’s currency contributes to the increase of external debt. Despite this, Negm believes it is unlikely that the government will stop borrowing any time soon.

Mohammad Abu Basha, an economist at EFG-Hermes, said that the government’s borrowing trend is growing. “This is not healthy,” he noted.

He explained that the loans obtained by the government in the past were “good” as 85-90% of the loans came from international institutions on facilitated conditions. Hence, the size of debt has not been a problem thus far.

Abu Basha said that the government continues to seek loans to provide its need for foreign currency due to the current state of the Egyptian economy, which has curbed the ability of Egypt’s foreign exchange resources to generate hard cash from sectors such as tourism and foreign direct investment.

The government’s borrowing, however, gave a big boost to investors. “Loans are a certificate proving the Egyptian economy is on track to improvement,” he said.

He urged the government to halt borrowing in the coming period and to focus more on attracting foreign capital to help improve the economic conditions and reduce unemployment.

He also praised President Abdel Fattah Al-Sisi’s decision to borrow only after intensive studies and proof of the projects’ viability to generate funds to repay loans.

Government borrows from international institutions due to high interest rates of local loans: experts

Currently, the government is trying to control the expenditure on the public sector employees’ salaries and subsidies, and is drafting a number of laws for that aim—though it doesn’t seem to care about controlling the increase of government debt.

As opposed to previous years, the government’s debt became the largest burden on the budget, preceding subsidies and salaries of the public sector’s employees.

The interest on the government’s debt for the current fiscal year is about EGP 300bn, which is the highest spending item in the state’s general budget, representing approximately 9% of the gross domestic product (GDP). The subsidies bill has shrunken to 6% of the GDP and the increase in government salaries was controlled through adopting a new law limiting the increase to only 7% annually.

With the current rate of borrowing—which isn’t getting any lower due to the shortage in foreign currency—the government has had to ask for help from the International Monetary Fund (IMF) to escape from the high cost of borrowing in local currency and to provide a source of foreign currency for the next three years.

Head of research at Pharos Holding for Financial Investments, Radwa El-Swaify, said that in the coming period, the government will head towards foreign borrowing because of the increased rates of domestic debt.

El-Swaify expected foreign debt rates to exceed 20% of the GDP, as a result of the current borrowing operations.

She noted that the government will move towards this policy in two to three years, which is the time-frame of the economic reform programme. Therefore, there will be a direction to annually offer US dollar bonds abroad—if the next offering succeeds in reducing the financing gap.

She added that borrowing from the IMF, the International Bank for Reconstruction and Development, and the African Development Bank proves that the government is taking this new direction, in addition to the government’s intention to offer US dollar bonds in the international markets in the next months, and the deposits coming from the Gulf countries.

She also said that domestic debt is increasing compared to international norms, while foreign debt is within safe limits, noting that the stability in exchange rates contributes to decreasing the return on instruments of domestic debt, as compared to foreign debt.

The government is now trying to remove itself from that critical situation through moving towards increasing borrowing from abroad, she said, adding that the economic programme that has been agreed on with the IMF includes raising the least expensive foreign financing and limiting reliance on the local financial regime.

It is worth noting that total public debt, according to the most recent statistics from the Central Bank of Egypt, amounted to EGP 2.4tn, representing 80% of net debt to GDP.

Domestic debt is divided into EGP 2.2tn in treasury bonds and bills, of which EGP 1.5tn are treasury bonds, and EGP 697.6bn are treasury bills.

The aggravation of public debt is putting pressure on the state’s general budget deficit as a result of the high interest rates. The value of the government’s borrowing from the bills and bonds amounted to EGP 1.1tn during the previous fiscal year, while the high cost of debt is putting pressure on the budget deficit that is already high and has been expected to register 11.5% of the GDP by the end of the fiscal year that came to an end in June.

The government’s borrowing trend is growing, according to Mohammad Abou Basha, economist at EFG Hermes. “This is not healthy,” he noted.

He explained that the 85-90% of the loans obtained by Egypt came from international institutions on facilitated conditions. Hence, the size of debt has not been a problem thus far.

Abou Basha said that the government continues to seek loans as it needs foreign currency due to the poor conditions of Egypt’s economy, which have curbed the ability of Egypt’s foreign exchange resources to generate hard cash from sectors such as tourism and foreign direct investment.

The government’s borrowing, however, gave a big boost to investors. “Loans are a certificate proving that Egypt’s economy is moving towards improvement,” he said.

He urged the government to halt borrowing in the coming period and to focus more on attracting foreign capital to help improve the situation and reduce unemployment.

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