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.
An International Monetary Fund delegation is back to Cairo today amid efforts to advance a stalled $4.8 billion loan agreement.
But tensions are running high. IMF officials arrived within hours of opponents and backers of the president Mohammed Morsi clashing near the Muslim Brotherhood’s Cairo headquarters.
In what we hope to be the first of a series of podcasts on Rebel Economy, the blog’s editor Farah Halime spoke with two business journalists, Nadine Marroushi, a business and finance reporter and Amira Ahmed, deputy editor at Egypt Independent about the impasse between Egypt and the IMF.
While Nadine says she’s pessimistic the government will get past this stumbling block under Mr Morsi considering the lack of trust from the people, Amira calls on all political parties to bolster their efforts to offer viable reform alternatives that address Egyptians’ concerns.
Special thanks to Cairo-based radio journalist Kimberly Adams, who produced this podcast.
The International Monetary Fund, after signalling that it does not believe Egypt’s proposed economic reform programme is strong enough, has offered Cairo a temporary loan to help the nation weather its currency and budget crisis while it negotiates a more complex $4.8 billion loan.
In Washington, the International Monetary Fund said Egypt needed bold and ambitious action to tackle its economic problems urgently and it could get temporary IMF funding while it negotiated a long-delayed full loan programme.
An IMF spokeswoman Wafa Amr said the Rapid Financing Instrument was designed to provide rapid, but limited, assistance to member countries facing urgent balance of payments needs.
Reuters, March 11
The stop-gap measure could amount to about $750 million, according to Reuters, a sum which pales in comparison to the budget deficit targeted at $28 billion this financial year, or 10.9% of annual economic output.
The Fund is quietly acknowledging that in the absence of the reforms president Mohammed Morsi has been reluctant to enforce, the country needs immediate help as it fast runs out of cash for fuel and wheat imports.
Providing immediate help at a smaller and more grass-roots scale, and ensuring this is not hinged on an IMF final accord is something other international investors should consider in Egypt, as Rebel Economy has argued before.
Especially as Gulf money, which has acted as a stop-gap in the past, is not forthcoming. (Qatari finance minister Youssef Kamal dashed any hopes that more funds were on their way soon this week. “We already announced $5 billion,” he told Reuters. Asked whether Doha expected to provide more, he replied: “Not yet.”)
But there is a problem in the IMF’s approach.
While the IMF is working hard to represent a voice of compromise at a time when the government’s credibility is being tested and the mandate to follow through on important reforms narrows, it should not help Egypt plug an unsustainable budget through these temporary measures because it artificially props up the government.
Egypt should not accept the bridging finance. Instead, what the government should do is begin a campaign to make the budget transparent and the economic situation clear. It needs to do that to get political buy-in for austerity measures.
The president and his supporters are buying time because they want to win parliamentary elections before imposing a more difficult economic reform plan. Accepting the bridging finance only furthers the government’s interests.
It’s almost like Mr Morsi is holding the country hostage with the help of the IMF.
If anything the IMF should not offer bridging finance and force the president to be clear about a reform plan.
Billions of dollars of financing earmarked for Egypt is mounting up behind an IMF dam.
Until Egypt agrees a final deal with the International Monetary Fund for a $4.8 billion loan package, none of the estimated $14.5 billion in additional financial support and aid will be released.
The effect of the delay on signing the loan are far-reaching, and are now affecting Egypt’s ability to finance a faltering energy subsidy system.
US banking giants, JP Morgan and Morgan Stanley, are holding off on as much as $1.7 billion to $2 billion of financing for Egypt’s state-run oil company the Egyptian General Petroleum Authority until the IMF loan is set in stone, Egypt’s Al Mal newspaper has reported (Arabic).
The financing, which was first announced in December, was partly to help EGPC cover dues to foreign oil partners and sustain imports of petroleum products. EGPC is in billions of dollars of debt partly because it has kept up an inefficient subsidy system that imports fuel at international prices but distributes to the public at very discounted prices.
Other loans that are contingent on the IMF loan include: $6.3 billion in EU aid, $500 million from the African Development Bank, $1 billion from the US. The remainder is coming from the World Bank and other smaller lenders.
The reality is that without the IMF loan, investors and financiers will have little confidence in Egypt.
With the nation’s credit rating also now on par with Greece, investors are unlikely to make bold moves into Egypt without some reassurance that the country is recovering.
These are the five best stories on the repercussions of Egypt’s delay of a $4.8 billion loan from the International Monetary Fund:
1. The Wall Street Journal’s report uncovers rifts and miscommunication between the presidency and the prime minister’s team. An interview with Abdallah Shehatta, a former IMF fiscal policy analyst and the chairman of the economic committee in the Brotherhood’s Freedom and Justice Party revealed that confusion over the tax decree which was subsequently postponed “stemmed from cracks in the delegation of executive power”.
Mr. Morsi’s prime minister announced the decision without consulting the presidency, he said, forcing Mr. Morsi to reverse the decision hours later.
2. Bloomberg’s summary of events illustrates Morsi as a man focused on defusing a resurgent protest movement rather than the economy. Most importantly, the inability to implement vital reforms including additional taxes shows a weakness in the Egyptian government, analysts told Bloomberg reporters:
Even if an IMF deal does go through, Mursi’s U-turn on taxes suggests it will be hard for his government to stay on the program, said Raza Agha, chief regional economist for VTB Capital Plc in London. IMF loans typically set conditions for the disbursement of each tranche of cash.
Achieving “targets and reform measures in the current political environment will be extremely difficult,” Agha said. “This could well threaten the program itself.”
3. The IMF loan is inherently linked to other loans to Egypt. The African Development Bank has been the first to say its $500 million loan is contingent on the country’s negotiations with the IMF, Bloomberg reported. This situation also applies to other loans from the European Union.
4. Egypt’s finance minister Mumtaz al Saeed told Reuters:
“Of course the delay will have some economic impact, but we are discussing necessary measures [to address that] during the coming period,” he said. “I am optimistic … everything will be well, God willing.”
Doesn’t fill you with confidence.
5. Finally, the Financial Times’ report offers a glimpse of what could happen in the next round of negotiations:
Analysts say that when Egypt goes back to the Fund it will have to renegotiate the terms of the deal because its macroeconomic outlook will have changed.
“The agreement was based on particular targets to be met before going to the IMF board and plans for meeting other targets in the future,” said Alia Moubayed, senior economist at Barclays. “Given the worsening economic and investment climate, achieving these targets is not any more feasible, so they will have to set new ones.”
The loan, which is likely to be delayed by (at least) a month, is a catalyst for economic reform in Egypt and a vote of confidence for foreign investors.
Egypt’s decision to delay on its best chance of recovering from a balance of payments crisis is also likely to be putting pressure on Morsi’s most loyal supporters.
The president’s backing of some high-ranking Muslim Brotherhood officials is not necessarily contingent on his reaction to protests, or even getting a new constitution, but on setting down the economic pillars of recovery such as the IMF loan.
These Brotherhood advisors and businessmen are the main channel of communication to the secular and business community in Egypt and abroad. But as Morsi turns his back on loan negotiations, the loyalists may be questioning his motives and simultaneously attempting to smooth over ties with foreign investors and diplomats keen to see Egypt back to business. That could be straining the relationship between Morsi and his advisors, as he focuses on political motivations ahead of the referendum on Saturday, when Egyptians vote on the draft constitution.
It is, after all, very rare for a nation to postpone a deal with the IMF so soon after it has made a public announcement.
That begs the question of whether the delay was really the Egypt government’s decision or whether the IMF was actually unwilling to lend at such time of political crisis.
Egypt’s talks with the International Monetary Fund for a $4.8 billion loan should be frozen because the negotiations are secretive and lack popular support, Bloomberg has reported citing a letter released by 17 political parties, civil organizations and labour groups.
The letter is addressed from the Popular Campaign to Drop Egypt’s Debt, an umbrella group which has lobbied hard against the loan since negotiations started last year, the report says.
Among the signatories are three political parties affiliated with former presidential candidates, and a party set up by the Muslim Brotherhood’s youth wing, Bloomberg reports. The April 6th Movement, which took a leading role during last year’s revolution, has signed the letter, as well as unions active in Egypt’s labor movement.
The letter addressed to the prime minister Hisham Qandil and the IMF managing director Christine Lagarde says:
Loan negotiations process has “lacked transparency” from the government and IMF, talks continue in the absence of a parliament and public consultations have been “inaccessible”.
“With little transparency and no clear economic program, the potential loan agreement continues to lack the ‘critical mass’ of support that the IMF requires as a necessary condition for financial assistance.”
Though an open debate about the loan is healthy, especially considering the rich history (Rebel Economy has produced a timeline covering three decades of Egypt-IMF talks) there are several flaws to this broader lobby movement, which will hinder any action against the loan.
Here are some issues that should be noted:
◊ The lobbyists, including the Popular Campaign to Drop Egypt’s Debt, see the IMF loan as one of the main causes of Egypt’s economic downfall today. However, history shows that every IMF loan programme is followed by a period of economic liberalisation and boom. But then incessant corruption and bad economic decisions took force. In fact the IMF told Egypt in the 1970s that subsidies should go, now widely considered to be extremely bad for the economy. However the 1977 bread riots in Egypt led leaders to renege on that decision.
◊ Those opposing the loan misdirect their suspicion at the problem of rising external debt. That’s not the real elephant in the room here. The real issue is spiralling domestic debt caused by a terribly indebted oil sector and mismanaged budget. External debt stands at about $33 billion. Domestic debt is about $200 billion. That is mostly caused by energy subsidies, which use up to a quarter of the government’s spending (more than health and education combined, and then some). If you want to talk about external debt, how about the billions of dollars not on the government’s balance sheet owed to oil companies for energy exploration?
◊ The alternatives offered by lobbyists include solutions inherently linked to the IMF. The most popular option is debt relief. That solution has been popular with the IMF and Egypt in the past and probably will be in the future. For example in the late 90s, the IMF facilitated a framework for obtaining the cancellation of 50% of Egypt’s official debt from countries that are members of the Paris Club.
◊ Finally, as Nadine Marroushi, the reporter behind the story above points out:
The problem is lobbyists don’t seem to have a unified and articulated front on what economic policies need to be implemented. The fact that energy subsidies need to be reformed hasn’t taken root on a grassroots level. People are so focused on being against the loan for all sorts of reasons, many very justified (such as inflation), some just plain ignorant (such as chants that go: “we’re against the IMF’s conditions, we’re against the CIA), but there isn’t enough public discussion and pressure about what the economic problems are and how they need to be tackled.
If these groups want any chance in delaying a loan, there must of course be some kind of unity in why the loan is opposed. The reactionary approach to anything linked with the IMF must stop if a coherent conversation can begin.
But of course the government are mostly at fault. They have failed to open up a transparent dialogue on this negotiation process, leading to further suspicion and fury. And, attempting to pass off the loan as Sharia-compliant is really not helping.
We know that fuel prices need to rise, and we know that Egypt needs international help (the US has in the past offered debt relief that has saved Egypt from bankruptcy). The government needs to address the nation clearly and firmly describing what needs to happen and why. We know big changes are going to happen because they must.
But the government’s weakness breeds suspicion and until Mohammed Morsi and his government can be strong, lobby groups and other political parties will hold them to account making the economic transition difficult.