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Monday, 6 September 2021

Can Egypt weather a taper tantrum 2.0?

Egypt’s world-beating real interest rate will help it weather an uptick in global rates, but the country faces some risk from capital outflows unless it acts to reduce its debt costs, S&P Global Ratings said in a report yesterday. Despite enjoying the highest real interest rate in the world, a rise in rates in the developed world could leave Egypt vulnerable to outflows if markets seen offering relatively lower risk start hiking rates.

Taper tantrum 2.0: We could be at risk of outflows if the Federal Reserve starts to unwind its bond-buying programme sooner than expected. Statements by Fed head Jerome Powell last month signalled that the central bank could begin rolling back its program as early as this year, which would be followed by an uptick in interest rates, potentially putting some pressure on the EGP carry trade. But a poor US jobs report out at the end of last week has pundits saying the Fed could wait a while longer.

Our high interest rates will help stem the tide: “Compared with some other emerging markets, we think Egypt may fare somewhat better in the event of US interest rate hikes, mainly due to high real interest rate,” Gupta wrote, citing the high returns, foreign reserve accumulation and the USD exchange rate, which has seen slight gains for the EGP. Egypt also has stronger policy credibility than other EMs and it’s positive growth outlook also counts in its favor.

Egypt has a sizable foreign reserves stockpile, which should help it avoid serious capital outflows. We have managed to recoup more than half of the almost USD 10 bn deployed in response to the initial wave of the pandemic last year, last month reaching nearly USD 40.6 bn. Reserves eased close to USD 35 bn during the peak of the covid-19-induced global pullback from emerging markets.

S&P is concerned about the possible impact of a sustained pullback in tourism: “We could see elevated balance-of-payment risks for Egypt if there were a sharp withdrawal of funds while current account receipts remained weak owing to pandemic-related damage to tourism and export receipts,” Gupta wrote. “This could result in a substantial decline in foreign exchange reserves and reduce Egypt’s ability to service its debt.”

Egypt’s high real rates are both a blessing… One of the key policy goals of the Central Bank of Egypt has been to maintain high real interest rates, which has enabled it to attract bns of USD in portfolio inflows and stockpile foreign reserves. Portfolio investment has been an important source of hard currency for Egypt since the onset of the pandemic, which caused tourism receipts to tank and heavily disrupted export and Suez Canal revenues.

…and a challenge: Egypt’s rates means that it currently has one of the highest debt service burdens among countries with B+ ratings and lower, while its interest payments as a proportion of GDP are among the highest in the world.

The government is working to lower its debt costs, embarking on a debt reduction strategy that includes decreasing reliance on short-term debt in favour of longer-term debt, and diversifying its funding sources to include eurobonds, sovereign sukuk and green bonds. The addition of passive flows via the inclusion in the new FTSE Russell bond index, and the possible addition of the JPMorgan index later this year will lower volatility.

Egypt could help bring down yields by increasing confidence in the economy: Investors will likely reduce the interest they demand on sovereign debt should the government deliver strong economic performance and policy credibility, Gupta wrote. This would allow the government to reduce its debt servicing costs without jeopardizing capital inflows.

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