Egypt is “one of the most compelling economic stories” in the MENA, Africa and Eastern European regions but continues to face “significant risks” and many structural obstacles, HSBC said in a note last week. Reforms over the past four years have put the economy in a strong position to rebound from the covid shock and weather future economic turbulence, yet the country’s large debt pile, precarious sources of hard currency and weak investment will pose serious challenges for policymakers, Simon Williams, HSBC’s chief economist for Central and Eastern Europe, the Middle East and Africa (Ceemea), wrote in the note.

Growth to pick up in 2H2021: HSBC is optimistic that the economic recovery will remain on track, and is forecasting the economy to grow at a 2.5% clip during FY2020-21 and near 5% in FY2021-22. Economic activity will pick up steam during the latter half of the calendar year, underpinned by strong domestic consumption and fuelled in part by remittances, which surged to a record high in 3Q2020. The bank is also confident that the country’s tourism sector will begin to attract more visitors as we near 2022, while an unexpectedly strong economic rebound in Europe — one of Egypt’s largest trading partners — will help to support exports and add fuel to the recovery.

Look beyond consumption and things start to look more uncertain: “Outside of consumption, signs of a broader rebound in activity are difficult to see,” Williams writes, noting the private sector business activity contracted in January and February this year.

Here’s why:

#1 Productive FDI continues to remain low, with levels among the weakest in the Ceemea region, and existing investments are dominated by the public sector, Williams says. That is in stark contrast to the strong foreign appetite for the EGP carry trade, as well as to strong consumer spending. “Although consumption is a powerful driver of short-term growth, it is investment that lifts long-term potential,” Williams writes. The combined 400 bps interest rate cut by the CBE last year created momentum for capex, but according to Williams, this “may start to fade” as the central bank tapers off its cheap lending programs for sectors vulnerable to the covid fallout.

#2 Trade supported economic growth during the pandemic because imports fell faster than exports — not due to more exports. The HSBC economist links this to the wider story of Egypt’s current account weakness, with merchandise exports being traditionally lower than imports and leading to an enduring — and widening — trade deficit. This is usually compensated by a strong services balance, this time around the slowdown in tourism and weaker remittance inflows takes away this advantage.

#3 The commodities boom could undermine CBE’s room to ease: Should the recovery take longer, pressure is likely to build up for further monetary easing. The CBE has room to drive rates lower, but this would prove challenging if booming global food and energy prices continue to trend higher. Rate cuts could also make EGP debt less attractive for foreigners, which won’t help if it happens before other key sources of FX (tourism and remittances) recover, Williams said.

Finances are on a firmer footing: Tax reforms and spending cuts put public finances in a much better position to handle the economic shock caused by the pandemic, and gave the government room for fiscal support while limiting the impact on the budget deficit. Revenues have been unexpectedly strong, supported by the Finance Ministry’s efforts to expand the tax base and covid-era measures to bring informal businesses into the fold such as conditioning state support to SMEs on registering into the formal sector, Williams notes.

And debt sustainability has improved: The Finance Ministry succeeded in lengthening the average maturity of government debt to a little over three years in FY2019-2020 from closer to 1 year in FY2012-2013, alleviating short-term debt servicing costs. Foreign investors are also now playing a bigger role in the country’s financing mix. The proportion of foreign debt ownership is still low by global standards though, and at 20% of total debt, still has room to grow. That said, foreign portfolio investment is now at a record high of USD 29 bn, having staged a full recovery from the emerging-market sell-off caused by the pandemic last year.

But high debt levels and a large fiscal deficit continue to pose problems: While the budget deficit has been narrowing, a “fiscal overhang” remains unresolved and it isn’t just cyclical. It stems from “heavy debt servicing costs that amount to some 10% of GDP, … [absorbing] the equivalent of 60% of all revenues and nearly 90% of taxes.” With the state coffers being increasingly subject to a growing need for external funding, the economy needs to sustain a real growth rate of 5.5% (and nominal growth of nearly 14%) to drive the debt stock sustainably lower, “leaving little room for error,” Williams notes.

And there is “much policy work still to be done”: Low levels of national savings, heavy state involvement in the economy, weak capital formation, a “still-low” business environment ranking, and high levels of poverty. Egypt’s GDP structure also suffers from a “marked structural imbalance” owed to a low level of goods exports and weak real wages.

Authorities are increasingly recognizing those structural shortfalls, and have since 2017 introduced “a raft of reforms designed to overhaul the investment climate and prioritise export sectors,” he writes.

You can read a summary of the report here (pdf).