Egypt's Currency Crisis!
Egypt has had a problem with debt for quite some time. Since the Second World War, the country has typically run a trade deficit – importing more than they export. This has been partially offset by transfers from abroad, such as aid from foreign governments and remittances from Egyptians working in other countries. Tourism has additionally been an important
source of foreign exchange for the country, with millions visiting Egypt each year, mostly from Europe, Asia, and other Arab countries. In 2016, The Egyptian president Sisi sealed a deal with the IMF for a $12 billion loan. This bailout was granted on the condition that Egypt’s currency would float freely. The Egyptian Pound halved in value in a matter of weeks, causing inflation to rocket. Harsh austerity measures were implemented including cuts to energy subsidies– to try and restore government finances. Everything was going reasonably well until the pandemic hit in 2020. This destroyed the tourism industry, an important source of foreign exchange.
The central bank began propping up the Egyptian pound from June 2020 up until March 2022, repeating the same mistakes that had led to the prior devaluation. Once the Central Bank stopped supporting the currency it began its decline. Egypt is the Arab world’s most populous nation with 109 million people and is the world’s biggest importer of wheat. When Russia invaded Ukraine, the shortage of wheat, combined with other soaring commodity prices caused real problems in Egypt. The country reached a 3-billion-dollar loan deal with the IMF last October after again agreeing to let the forces of supply and demand determine the value of the Egyptian pound in the foreign exchange market. Egypt allowed its pound to fall to a new low this
Wednesday. It’s lost nearly 35 per cent of its value since the deal was agreed in October as the central bank slowly withdrew support. Analysts are warning that the pound has even further to fall before stability is reached. This currency weakness is adding to the pain of millions of Egyptians as urban inflation hit 21.3 per cent in December 2022, its highest level in years. Around 60 per cent of Egypt’s population of 100mn people lives at or below the poverty line. Inflation for these people means going without food and other necessities.
Egypt has one of the longest recorded histories of any country, but modern Egypt dates back to 1922, when it gained independence from Great Britain, initially as a monarchy, and after the 1952 revolution, a republic. After the Arab Spring and the overthrow of Mubarak, the country endured an extended period of political unrest. Egypt's current government, which has been in power since 2014 has been described by a number of watchdogs as authoritarian and responsible for the country's poor human rights record.
Today debt is a huge problem in Egypt, more than 40% of the countries revenues are used to fund interest payments on debt. Egypt is the second-biggest debtor to the IMF after Argentina and October’s deal was its fourth loan agreement since the deal in 2016, so the best starting point so that we can understand the current problems is probably with the devaluation that occurred in 2016 Before we get to that, let me tell you about today's video sponsor, Blinkist. Blinkist is an app that helps you understand the most important ideas in over 5500 non-fiction books in around fifteen minutes each. You can either read or play the books on your phone. The creators at Blinkist are great at extracting the most important concepts and ideas from a book and making them digestible. I sometimes find myself buying more books than I have time to read. With Blinkist I can listen to lots
of new titles on my commute and if I find one really interesting then read the full book. I also enjoy using Blinkist to refresh my memory of a book that I have read a while back. Here are some of the books I’m currently listening to. They have a new feature called Blinkist Connect, which allows every Blinkist Premium plan to be shared by two different accounts. It’s
no additional cost to you, and it’s free to the person you invite for as long as you’re sharing it with them. If you are like me and planning on reading more in the New Year, Blinkist might really work for you. Get 25% off Blinkist premium and enjoy 2 memberships for the price of 1. Start your 7-day free trial by clicking the link in the description box or scanning the QR code. OK, so, Prior to 2016 Egypt mostly relied on external benefactors, namely Saudi Arabia, the UAE, and Kuwait, to finance its budgetary shortfalls. Saudi Arabia alone contributed nearly $25 billion to the Egyptian economy between 2013 and 2016. Egypt is quite an important country from a geopolitical perspective,
and it has many powerful and wealthy friends including Saudi Arabia, The UAE, The United States and China. Egypt was in fact the first Arab and African country to establish diplomatic relations with the People's Republic of China back in 1956. The Saudis, the Emiratis and the Americans are much happier with the current regime in place in Egypt rather than the Muslim Brotherhood that they replaced. In mid-2016, a severe foreign exchange shortage began to cripple Egypt’s economy, in particular it’s manufacturing sector, which led to the country formally seeking an IMF agreement. The IMF program, which was struck in November of that year, had a series of objectives: It aimed to facilitate inclusive private sector-led growth, increase labor force participation (especially among women), attract foreign direct investment, and strengthen Egypt’s macroeconomic stability. As a precondition to securing IMF approval, Egypt needed to raise $6 billion in external funds, which it did thanks to financial support from the UAE, China, and the G7. The three-year $12 billion IMF loan to Egypt
was packaged with a reform agenda that focused on monetary, fiscal, and structural reforms. Monetarily, Egypt was to transition to a floating exchange-rate and work to contain inflation. Fiscally, the country was to reduce public debt by cutting fuel subsidies while expanding spending on vulnerable groups like women and children. Structurally, Egypt was to streamline industrial licensing, provide financing to small and medium-sized enterprises, decriminalize insolvency, and simplify bankruptcy laws. The devaluation of the Egyptian Pound that occurred when they switched to a floating exchange rate ended decades of the country wasting billions of dollars to maintain the country’s currency peg and stabilized the exchange rate at a new lower level. The value of the currency halved, but in truth that was just the official exchange rate. The black-market exchange rate started a lot lower so didn’t fall as much.
While ordinary Egyptians suffered from a sudden and steep loss of wealth as the currency fell in value, international investors were now willing to invest in the country and its exports were much more competitively priced. Holidays in Egypt suddenly became a lot cheaper attracting tourists from all over the world. Additionally, Egyptians living abroad began sending more of their money home in both remittances and investments in the country. Inflation, which had fluctuated within a range of 8-15 percent between 2011 and 2016, rose to 22 percent in December 2016 and remained above 30 percent for much of 2017, “causing deep public concern and hardship. The 2016 devaluation along with the IMF’s reform program brought about discipline in government spending and introduced policies conducive to economic growth. The purpose of the IMF is to provide financial support to countries hit by crisis, creating breathing room as they implement policies that restore economic stability and growth.
There are two types of IMF program, funded and unfunded, funded is when IMF makes a loan and supervises spending and unfunded is when they just adopt that supervisory role while other lenders make the loan. The fact that the IMF is monitoring economic policy within a country gives confidence to big lenders and investors, making them more willing to step in. Especially in situations where the economic data being reported might be unreliable, investors are able to rely on the IMF as they almost act like auditors of the country. They will verify numbers like inflation figures, current account data, reserve data and so on. The first investors to step up to the plate after the 2016 devaluation were mostly emerging market hedge funds who had the experience and knowledge to understand the risks. Other investors who had just been burned by the devaluation were keeping
their distance. The Hedge Funds were attracted by the high interest rates being paid on local currency bonds and were able to negotiate agreements guaranteeing their exchange rate when the bonds matured. This type of agreement is known as a repack. It’s a structured finance technique where banks create tailored investments for customers like hedge funds. The cash flows from the underlying security are channeled through a swap counterparty to create a new cash flow, with characteristics which meet the requirements of the hedge fund investor.
These hedge fund investors were earning returns of around 16% a year on these bonds, with limited foreign exchange risk. There is of course some tail risk – as these were not dollar denominated bonds, where the investors could sue in New York if they went unpaid. They fell under Egyptian law, but this was still a very high return in the near zero interest rate environment of the time. This
was a big trade for emerging market hedge funds in 2017 and 2018 and they will have made a lot of money from it. They were often investing in short term (so 3-month and 6-month bills), and as they expired, the Egyptian Central Bank honored the agreements and paid out dollars as requested. So why was Egypt willing to pay this high return and guarantee an exchange rate upon exit? In particular when they were supposed to be letting their currency float. Obviously guaranteeing an exchange rate for certain investors is outside the spirit of that agreement. Well, it was expensive debt, and the country will have paid out 300-500 million dollars in interest per year on it, but in return, they demonstrated their financial stability to much bigger investors and brought in a huge amount of Foreign Direct Investment from investors like big oil and natural gas companies. Once those companies invested in offshore exploration,
Egypt could export fossil fuels bringing in more foreign exchange which they badly needed. Multinational corporations want to see that a currency is stable and that the central bank has sufficient reserves. Egypt used this fast money – from Hedge Funds to build a track record of stability to attract the long-term investors like Oil and Gas companies who would only invest after seeing a track record of repayment. A very large number of Egyptians work abroad in neighboring countries. Egyptian workers’ remittances began to grow over this period too, reaching $8 billion in the second quarter of 2017, up by 13 percent from a year earlier. Bankers reported at the time that the currency black market had all but disappeared after the devaluation, and banks were enjoying improved dollar liquidity.
Egypt reduced public sector expenditures under the IMF agreement and curtailed overall spending on subsidies. To increase revenue, the government introduced new fees and a value-added tax. They brought in more money by selling telecom licenses and land. The introduction of value added tax was particularly hard on the poor, who were already suffering due to inflation. There was one major aspect of Egypt’s economy that the IMF program didn’t address – the well-armed elephant in the room: the Egyptian military. For decades, the Egyptian military had been allowed to engage in economic activities as a way of reducing the official defense budget. This was also a way of compensating senior officers for their low pay by giving them a way of earning additional money. It started with the military working on land reclamation,
the army then got involved in reconstructing infrastructure along the Suez Canal that was damaged during the war with Israel. This military involvement in the economy, while small to begin with expanded greatly when Sisi, a former army chief, took power in a 2013 coup. As a former military man, he increasingly relied on the military to take major management roles in the civilian economy. The military today has a large and privileged role in the Egyptian economy. In 2015, the president issued a decree “permitting the
military to form companies or partnerships with local or foreign investors and gave the Armed Forces a share of the revenue when these companies were sold. He additionally enabled them to retain ownership of the land. Another law that was passed exempted military businesses from certain taxes. Military-run businesses get subsidized loans through state-owned banks, distorting market forces. As the military was put in charge of hundreds of projects across multiple sectors, it has been blamed for crowding out the private sector and discouraging foreign direct investment which is needed to bring in sustainable sources of foreign currency. Military-owned companies in Egypt benefit from free labor provided by the mandatory military draft and preferential tax treatment. Analysts say
that they are run with the same efficiency as the Egyptian Military, which I’m told locals describe as “organized buffoonery.” Without these benefits these military owned companies wouldn’t even be profitable. It was a mistake for the IMF to allow this to continue. After the 2016 devaluation, Egypt’s economic growth accelerated from 2017 through 2019 but slowed when the Covid Pandemic hit in 2020. The entire economy was impacted but the tourism
industry was hit particularly hard. In response, the Central Bank began propping up the Egyptian pound, repeating the same mistakes that led to the 2016 devaluation and borrowing billions of dollars to maintain the illusion of stability. To make matters worse, analysts started to notice that the Egyptian pound was not moving at all as many other currencies were at the time. Investors became skeptical about the nation’s financial position and started to pull their money out. $5 billion of capital fled Egypt between September and December of 2021. In 2022 Russia's invasion of Ukraine unsettled global investors and led them to pull even more out of the country. Wealthy Egyptians took advantage of the unnaturally strong currency
and moved their money abroad too. Russia and Ukraine were Egypt’s two main source of wheat, as well its top two sources of tourism dollars. The war in Ukraine would have a huge impact on the Egyptian economy. Bread is an important food staple in Egypt and is heavily subsidized by the government. The price of a basic loaf has been kept at a fraction of a cent in Egypt through subsidies since the 1980s. This cost the government around $5.5bil per year before the prices skyrocketed with the Russian Invasion of Ukraine.
The war sent wheat prices spiraling, heavily impacting Egypt, one of the world's largest grain importers, and piling pressure on its foreign currency reserves. The problem wasn’t just the price of wheat, it was sourcing wheat. Egypt had to buy wheat from Australia and the United States, suffering higher shipping costs on top of the higher grain prices. In a country where 60% of the population (which is 60 million people) live at or below the poverty line – the price of food staples rising could cause riots and the overthrow of the government. Short of dollars, the Central Bank began adding restrictions on importers. Under new rules,
for an importer to get a bank letter of credit, they would have to deposit the full cost of the import transaction in advance with their bank, plus interest, in the required foreign currency. Only then could they apply to the Central Bank for approval for the transaction. Applying, by no means meant that the request would be approved. Importers became suspicious that the central bank was suffering from a foreign currency shortage. Their suspicions were confirmed when the central bank allowed the Egyptian Pound to fall in March 2022, but this time the devaluation did not lead to dollar availability like it had in 2016. People quickly realized that this was
because the government was still pegging the exchange rate but at a new lower rate (which was still too high). This would go on cost Egypt billions of dollars it couldn’t afford to waste, while denying the private sector the dollars they needed for imported goods. That same week, Egypt submitted an official request for another $15 billion IMF loan and announced securing around $22 billion in funding from the Gulf countries. This time
none of them were grants or favorable loans. In August, Egypt’s central bank governor stepped down and was appointed as a presidential advisor. the IMF approved a $3 billion loan to Egypt in October, a lot less than the $15 billion that Egypt had originally asked for. The
IMF said the reform program it agreed with Egypt was aimed at “pushing forward deep structural and governance reforms to promote private sector-led growth and job creation”. Egypt is the IMF’s second-largest debtor after Argentina and has become increasingly dependent on support from Saudi Arabia, the UAE and Qatar. China’s appetite for lending to Egypt is very limited as they have many bad debts to deal both domestically and abroad. Chinese banks financing
the new administrative capital have shown concerns over Egypt’s ability to repay its debt. Economists are saying that Egypt been living beyond its means and overspending on big infrastructure projects like an $8.5 billion dollar Suez Canal widening, expensive military weapons systems, a nuclear reactor, and, of course, Egypt’s $60 billion-dollar “New Administrative Capital”. The IMF announced earlier this week that Cairo had agreed to structural reforms to reduce the role of state entities, including military-owned companies, in the economy. It said that Egypt needed “a permanent shift to a flexible exchange rate regime to increase resilience against external shocks and to rebuild external buffers”.
The fund also warned that rising living costs could cause political and social pushback. “The durability of the shift to a flexible exchange rate remains to be proven and the [central bank] may face political and social pressure to reverse course,” the IMF said. “The proposed structural reforms will take time to implement and deliver the intended results, while reforms aimed at reducing the role of the state may face resistance from vested interests in the country.” There is a long list of difficult improvements needed to get Egypt’s economy back in shape. The state needs to improve the environment for business, reduce corruption and eliminate competition from the military to allow space for the private sector to thrive. If you enjoyed this video, you should watch my video on China's Belt & Road Initiave next. Don’t forget to check out Blinkist, our video
sponsor using the link in the description below. Have a great day and talk to you again soon. Bye.