Egypt faces a “stark choice”: Accelerate economic reforms or face further “painful adjustment” in the form of more currency depreciation and a further drop in imports that could fuel inflation and stymie growth, Goldman Sachs’ Farouk Soussa and Sara Grut write in a new report to clients yesterday.

The problem: The “sharp external adjustment” we’ve seen in the past year hasn’t been enough to alleviate our payments imbalance. The EGP has depreciated by more than 50% since last March, imports are down, inflation and interest rates are up, and growth has slowed — but all that hasn’t been enough to alleviate balance of payments pressures on the economy, Goldman says. That means FX demand is still outstripping supply and the USD-EGP exchange rate in the parallel market is still rising — with potentially detrimental effects on the economy.

The key: Exports. Authorities face a stark choice: “Either carry out reforms aimed at increasing exports and improving the financing mix, or move towards further painful adjustment.”

Why hasn’t the depreciation been enough to right the imbalance so far? Even though the EGP is now “significantly undervalued,” FX scarcity persists and investors have not returned to the country in a significant way, Goldman reports. The bank cites several possible reasons for that: It’s hard to suppress demand for key staples like food which make up a large chunk of our imports; exports and remittances remain weak; the FX demand backlog is yet to be cleared; dollarization persists as people hoard USD; and government spending remains high.

The key danger, according to Goldman: Egypt enters a “vicious circle” of depreciation and inflation. That could impact the country’s capacity to service its external debt, damaging investor confidence. It would also pressure growth as a lack of imports and higher prices trigger demand destruction in the domestic economy.

SO, WHAT DO WE DO? “Addressing Egypt’s external imbalances means tackling the structural trade deficit which, at 10% of GDP, is one of the largest among major emerging markets,” Goldman writes. To do so, the bank thinks the country needs to double down on its move to a more flexible exchange rate, ramp up exports, lower state spending by slowing down the implementation of national mega-projects, and follow through on its program of asset sales in state-owned companies.

We’re not doing well on the export front: Total exports including hydrocarbons came in at just 10% of GDP in the five years up to covid, well below the 37% rate in Goldman’s emerging markets sample. “The trade deficit is due to low exports, not excessive imports,” they write.

Goldman lays out two potential scenarios for our economic future:

#1- The best case: The government doubles down on its ambitious reform agenda, “boosting FDI inflows and gradually bringing down the current account deficit by supporting greater export growth in the medium term.” In its “optimistic scenario for asset sales and market access,” Goldman sees:

  • FDI rising sharply to USD 14 bn annually on average over the next three years (double the historic average);
  • Capital market financing increasing to USD 6 bn annually over the next three years, split between portfolio inflows and sovereign issuances;
  • The current account deficit narrowing to c. 2.6% by FY 2025-2026 from a current 3.5%.

#2- The not-so-great case: If economic reforms are not followed through, Goldman sees:

  • FDI hitting just USD 9 bn annually over the next three years;
  • Capital market financing of USD 3 bn annually over the next three years;
  • A sharp drop in foreign reserves to less than USD 13 bn by FY 2025-2026.

BEHIND THE FORECAST-

Our external financing needs have “more than doubled in recent years” to some USD 20-30 bn annually, the investment bank writes. Egypt’s widening current account deficit and a lack of FDI growth — which has on average brought in less than USD 10 bn annually — has led the country to rely increasingly on external borrowing to fill the gap. External debt stock now stands at some 49% of GDP, according to Goldman estimates, up from 17% in 2016. Taken altogether, this external imbalance has left Egypt “highly exposed to a potential disruption to its ability to borrow from abroad.”

We’re still effectively shut out of the capital markets: Russia’s invasion of Ukraine saw investors flee risky emerging markets including, triggering a “sudden stop” — USD 20 bn in portfolio money left the country, marking the “sharpest and most sustained reversal of capital flows in Egypt’s history.” Since then, the country’s USD bonds have continued to underperform. Wide spreads on Egyptian bonds suggest investors continue to view our debt as risky.

And alternative financing options — think the IMF and the GCC — may not be an option: The lenders who have traditionally jumped to our aid in times of crisis are now putting greater emphasis on the need for economic reform, Goldman notes. The IMF has ponied up relatively little money, and much larger pledges from the GCC have been “slow in materializing.”

News of stalled privatization talks isn’t helping: The reported stalling of negotiations with Gulf investors to sell state-owned assets —including in United Bank and Telecom Egypt — “may have undermined investor confidence somewhat in the prospects of success for Egypt’s asset sale program,” Goldman writes.

ON A RELATED NOTE- Egypt placed just 0.04% of EGP 3 bn worth of local currency bonds on Monday, Bloomberg reports. The government accepted only one offer to buy EGP 1.1 mn worth of the three-year bonds at 21.7% rate, after investors demanded yields of up to 28%. Demand for EGP-denominated debt has been severely impacted as investors wager on further depreciation of the currency, the business newswire reports.

Twelve-month non-deliverable forwards this week have the EGP hitting 41 to the USD for the first time, according to Bloomberg.

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