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Bills and bailouts: the bankruptcy management of Egypt’s economy

March 21, 2024 at 4:30 pm

Egyptian President Abdel Fattah el-Sisi meets EU Commission President, Ursula von der Leyen in Cairo, Egypt on March 17, 2023. [Egyptian Presidency / Handout – Anadolu Agency]

The recent $8 billion EU aid package and the IMF’s newly expanded $8bn programme raise concerns about the sustainability of Egypt’s external balance. Indeed, despite ongoing capital inflows from international lenders and donors, Egypt faces a persistent challenge of capital outflows. This stems from a long-term weakening trend in its international financial standing, driven primarily by chronic current account deficits. The question thus arises: are these injections merely delaying the inevitable, rather than stemming the internal haemorrhage?

In fact, Egypt’s current account deficit stems largely from a structural imbalance in merchandise trade, marked by stagnant exports and surging imports since 2008. This gap is widened further by repatriated profits and equity dividends from foreign direct investment, along with rising interest payments on foreign portfolio investments. While positive revenue from service exports, particularly tourism, and increased income from worker remittances and personal transfers provide some foreign currency inflow, these sources remain inadequate to cover the deficit fully.

Simply put, money received from Egyptians working abroad and foreign visitors isn’t enough to cover both food and commodity imports, along with payments owed on foreign investments.

READ: Egypt to get $6bn from World Bank over three years

Moreover, the continued depreciation of the Egyptian pound delivers a double blow. First, tradable and non-tradable goods are not necessarily perfect substitutes for Egyptian consumers. As a result, the desired quantity adjustment (reduced imports/increased exports) may not occur. Instead, the exchange rate depreciation has primarily led to price adjustments through inflation. This “exchange rate pass-through” effect further weakens the Egyptian economy by lowering household purchasing power.

Second, depreciation erodes the net wealth of both the private and public sectors by increasing the domestic value of their foreign-currency denominated liabilities. This “balance sheet effect” makes lenders more risk-averse, leading them to charge higher risk premiums on Egyptian external debt. The resulting higher interest payments strain Egypt’s external position further and widen the current account deficit.

The IMF and major donors recognise that large bailouts cannot staunch such haemorrhaging and that the problem lies in policymaking.

They also understand that these bailouts can generate moral hazard by incentivising lax fiscal and monetary policies, ultimately burdening Egyptian taxpayers. And this why the IMF typically conditions its ex-post safety nets on the prior implementation of ex-ante sound economic policies.

However, a potential time-inconsistency emerges in Egypt’s case. Because even if ex-ante economic policies are misguided, a complete ex-post bailout of international creditors and investors might still appear optimal from a purely financial standpoint. This is especially so since the IMF’s archetype solution for small open economies – a floating exchange rate regime as a buffer against external shocks – hasn’t achieved its goal of rebalancing Egypt’s current account, despite the severe depreciation of the pound.

Hence, the IMF, much like a central bank acting towards a commercial bank, continues to fulfil its critical commitment as the international lender of last resort to Egypt. And for the time being, the country is being managed like a bankrupt bank. The ever-growing external debt threatens the Sisi government’s control over its financial and real assets. These assets essentially act as collateral for the public debt, meaning that they could be seized in the event of a default. And the harsh reality is that Egypt’s financial well-being isn’t just about the nation itself; it’s about safeguarding the purely financial interests of its key creditors, international lenders and top Gulf donors.

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The views expressed in this article belong to the author and do not necessarily reflect the editorial policy of Middle East Monitor.