Like an ambivalent marriage, The International Monetary Fund’s on-off relationship with Egypt (which dates back to the 1980s) is back on track.
There is $12 billion on the cards for Egypt, subject to final approval from the IMF’s executive committee. A green-light on the three-year loan package is expected to be followed by a flood of cash from the Gulf, the World Bank and African Development Bank.
Yet for the billions of dollars Egypt has received in the last five years – over $25 billion alone from Gulf States – there is one issue that has the country tied down in a vicious cycle: the banking system, nearly half government-owned, is inextricably indebted to the Egypt’s finances, allowing it to rollover maturing local currency government debt, which is a whopping 30% of GDP, while also providing new financing. Banks are also obligated to invest enormous amounts in Treasury Bills, the hard currency short term debt that the country taps into regularly.
But much of this money has gone to financing deficits and propping up a hugely overvalued currency.
What does this mean for the economy? The government is allowing its banks to superficially support its finances, allowing it to inch along, plug gaps as they appear, without acknowledging deep rooted social and economic reform that is mostly grounded in infrastructural changes. It’s reached a point that the government’s dependance on banks is the “only reason why a full blown economic crisis has not taken place, despite extremely weak economic indicators,” according to Raza Agha, the chief economist of MENA at VTB Capital:
I do not think lending these amounts is healthy – it crowds out generally more productive private sector needs. Plus, lending such amounts also creates enormous risks for banks balance sheets/financial sector in general.
So what does this kind of support look like on paper? First of all, look at what happens when credit to government overtakes the private sector (note: this happened right around the beginning of the Arab Spring, when the red line overtook the blue line):
The chart shows that net credit to the government and public sector businesses is over 1000% of bank capital and reserves, a huge burden to place on the banking sector. Then look what happens when banks go crazy on Treasury Bills, again to support the government:
Banks’ investment in Treasury Bills is 1200% of their capital base. Twelve hundred percent. Agha explains why banks do this:
There are regulatory reasons; there could also be “encouragement” by the government to invest in upcoming auctions of government bills (it’s easy to be convinced when the public sector ownership dominates the banking system); there may also be risk-reward considerations – if banks can earn double digit returns by lending to the government, which technically cannot default in local currency, why engage in riskier private sector lending at a time when growth dynamics are weak?
The banking sector has little choice. Why invest in a potentially more lucrative private sector when the safety and reward is with government lending, and they’re telling you there’s no risk of default?
But it’s a risky game. For instance, this system is predicated on the fact the country’s credit worthiness (which gives investors a window into the level of risk associated with investing in Egypt including political risks) remains fairly steady. If it was to sharply drop, then the banks would be lumped with very risky debt. Agha puts it into context again:
[Egypt’s] credit worthiness is already amongst the weakest I have seen across single B rated countries [see here for definitions of credit ratings]– this is clear in their debt levels, debt servicing pressures and the extent of external financing needs.
In a country ruled by the government of Abdel-Fattah el-Sisi, a former army general who seized power from an elected Islamist government three years ago, there are of course other doubts over the success of the IMF loan. Will it tend to rising inflation and the 13% jobless rate? Will it narrow the huge budget and current-account deficits—almost 12% and 7% of GDP, respectively? As Bloomberg’s editorial board puts it in this great op-ed:
IMF officials practically admitted that the new package is mostly cosmetic. The fund and Sisi’s friends in the Gulf need to insist on real reform. Egypt should invest in simple infrastructure such as roads, schools and water-supply systems; make it easier for small and medium-sized business to get bank loans; and break up the military-industrial monopolies in everything from washing machines to olive oil.
The IMF loan is only a window to recovery. Egypt must find a way to balance the social cost of reform with the economic cost of no reform. So far, Sisi seems to have focused much of his economic reform rhetoric on a $45 billion mega-city, which was quietly shelved.