The Covid-19 pandemic has inflicted detrimental effects on the global economy, causing production shutdowns, the closure of economies, escalated spending on public health policies, and the implementation of economic stimulus packages by numerous countries to mitigate the pandemic’s economic repercussions. Consequently, the external debt rates of most countries have markedly surged in the past three years. However, comprehending the precise implications of these debts necessitates a nuanced understanding of their intricacies, including their ratio to the gross domestic product (GDP), secure ratios, and multi-year payments.
Financing Growth
Debt serves as a crucial means for countries to finance their state budget deficits and sustain their operations while also driving economic growth. For instance, if a country’s economy is valued at $1,000 and the state aims to achieve an economic growth rate of 10 percent, it has two principal options: either attract foreign direct investment worth $100 to infuse investments into the economy and finance growth, or acquire external debt to augment the size of the economy by the requisite amount. Consequently, debt is an essential component for economic growth and development. No country can achieve substantial economic growth without engaging in debt, which elucidates the inclination of developed countries to acquire debt through bond issuance before developing countries. Even nations with budget surpluses are keen on obtaining debt to accelerate the pace of growth in their economies.
Nonetheless, apprehension regarding debt increases considerably when it is denominated in a foreign currency, particularly due to the fluctuations in a country’s capacity to generate cash flows in foreign currencies, which may be relied upon to meet the cost of debt and installments in light of internal and external economic conditions. Additionally, concerns arise when a nation’s debt levels surpass its ability to meet them, hence the discourse surrounding the safe ratio of debt in the economy. This is a contentious matter; while some argue for a limit of 40 percent, the issue is more intricate than a mere numerical threshold. Several other factors must be considered, including the availability of foreign exchange reserves in the country, the rate of improvement in the current and capital account balance, the strength of public finances, the enhancement of deficit ratios, and the economy’s ability to grow and thus enhance its capacity to manage the expenses of borrowing.
What is the current state of the Egyptian economy?
The impacts of global economic conditions can be as grave as those of world wars and may even surpass them. The Covid-19 crisis caused significant disruptions in global supply chains, while the Russo-Ukrainian War led to a notable surge in global food prices. Consequently, the global economic environment transformed into a high-interest rate environment, significantly impacting the capital balance of most countries, particularly emerging and developing economies, in terms of their ability to borrow or attract investments in hot money.
Egypt faced a significant challenge in providing foreign currency liquidity due to the withdrawal of a substantial portion of non-resident investments in domestic hot money, amounting to approximately $20 billion. These economic conditions prompted an increase in Egypt’s external debt at a compound annual growth rate of 11.5 percent between 2019 and 2022, according to World Bank data. The pandemic year was a significant contributor to this rise, with debt increasing by 14.3 percent year-on-year in 2020, followed by a 10.6 percent rise in 2021.
The surge in debt can be attributed to the financing of the state budget deficit with the objective of spending on healthcare during the pandemic period that lasted for nearly two and a half years, from 2019 until the first half of 2022. Most of these loans were obtained due to the pandemic; Egypt secured loans worth $2.8 billion under the Rapid Financing Instrument (RFI) in May 2020 to support the balance of payments amid the pandemic. Additionally, Egypt received $3.6 billion from the International Monetary Fund (IMF) in 2020 out of $5.2 billion of standby credit over one year. As for the remaining debt, Egypt acquired financing by selling bonds in the international market, amounting to $5 billion.
Figure 1. Source: macrotrends
Accordingly, the ratio of Egyptian external debt to GDP (in Egyptian pounds EGP) according to the current exchange rate stands at 38 percent, which is close to the average of the previous 5 years of the Egyptian debt-to-GDP ratio of 37.8 percent. Compared to Turkey, a country characterized by demographic and geographical characteristics and an industry structure similar to Egypt, the Egyptian current situation is better in terms of external debt to GDP ratio.
However, as previously mentioned, relying on a single indicator to measure whether debt is at a safe level or not is incorrect. Donors and maturity dates directly affect our assessment of the countries’ level of debt. Concerning Egypt and according to the World Bank’s International Debt Report 2022, the ratio of IMF debt according to 2021 data represents 16.5 percent ($23.6 billion of a total debt of about $143.2 billion), while in Turkey it is only 1.8 percent. It is worth noting that debt from international institutions is a good thing, especially since the cost of debt is usually less than the cost that can be incurred in the event of resorting to the international market through the issuance of bonds. The cost of borrowing from IMF ranges from 1.7 percent to 3 percent according to the size of the state’s debt, which is calculated based on the state’s share in the Fund.
On the other hand, approximately 10 percent of Egypt’s external debt is due in 2023 and 2024 ($7.7 billion from May to December 2023, and $8.5 billion in 2024), which puts great pressure on the Egyptian government’s ability to meet these debts during the current 2 years, especially since the high-cost global economic environment causes a decrease in the ability to reschedule these debts with new debts (rolling the debts). This pushes the demand for insurance contracts on Egyptian debt instruments in foreign currencies to rise significantly. The cost of insurance contracts on foreign debt instruments with a year maturity is about 19.82 percent, and reaches 20.18 percent in contracts with a maturity of 2 years. Yet, it declines again in future maturities to reach about 12.47 percent in contracts with a maturity of 10 years.
Figure 2. Source: Blomberg Database, 1 May 2023
Nonetheless, the cost of insuring Egyptian debt instruments was not at those levels before the Russo-Ukrainian war in December 2021. The cost of insuring Egyptian bonds with a 2-year maturity was 3.81 percent and it was normal yield curve (upward sloping). This means that the current situation of the high cost of insurance on Egyptian debt is an exceptional situation and is mainly related to the economic consequences caused by the Russo-Ukrainian war on global financial markets, which negatively affected the country’s capital balance.
Throughout its history, the Egyptian government has never defaulted on paying any debt or its returns, as confirmed by the Prime Minister’s statements on 29 April 2023. For instance, one of Egypt’s debt instruments, namely treasury bills, with a value of $1 billion issued on 2 May 2022, was due on 2 May 2023, and the Egyptian state ensured timely payment of the dues. The Central Bank encountered no difficulty in selling treasury bills worth $1 billion on 1 May 2023, to settle the outstanding bills. Therefore, despite the high rates of Credit Default Swap returns, it is unlikely that the Egyptian government will default on paying any of its debt or returns on time. The Egyptian state regards its commitment to creditors as a top priority as it directly impacts Egypt’s reputation in the international market.
Figure 3. Source: Reuters Database, 1 May 2023
Despite the significant challenges that the Egyptian state is currently encountering in providing foreign currency to meet its requirements for importing essential commodities or settling the costs of debt service and installments on time, several positive developments suggest that the current pressures on Egypt are exceptional and temporary. These include the improvement in the Egyptian trade balance, the Egyptian state’s strict commitment to paying debt costs and installments on time, and the Prime Minister’s assurance that the history of the Egyptian state does not involve any default in paying debts, and that the state can fulfill its obligations promptly. Additionally, the Egyptian state is working on a plan to strengthen the private sector and attract dollar resources of approximately $2 billion during the first six months of the program’s announcement, which is a positive indicator.
These factors support the view that the current pressures facing Egypt are transitory and that their effects will diminish as the global economy shifts away from deflationary policies with high interest rates. Until then, the Egyptian state is making extensive efforts to secure dollar resources from multiple sources to satisfy its obligations and needs from the outside world.
