Egypt: crowded, not yet overbought

  • The large front-loaded increase in foreign T-bill inflows puts the onus on reforms as years 2 and 3 of the IMF program are tighter on the external funding side.
  • All eyes are on the FY18 budget as achieving fiscal targets was hampered by the sharp devaluation. IMF could accept a delayed start to further subsidy reforms.

CBE hike suggests close coordination with the IMF

The latest 200bps policy rate hike by the Central Bank of Egypt (CBE) provides comfort on execution of the IMF reform program. The CBE suggested that the hike was predominantly to anchor inflation expectations, as the yoy headline figures remain elevated despite mom deceleration, and the statement was relatively hawkish. We see headline inflation peaking soon, although this will depend on the extent of the transitory shock to food prices due to Ramadan, as well as the timing of the next phase of energy subsidy reforms. Retailers have offered promotions in past months (but no price cuts). Also, authorities have kept the customs USD/EGP exchange rate stable at 16.5 and stronger than spot to support disinflation with no apparent IMF pushback so far.

Foreign positioning in T-bills getting crowded but more room to grow

Foreign inflows to T-bills have surged, encouraged in part by the greater carry following the CBE hike. As of end-May, foreign investors held US$7.5bn in T-bills, compared to US$0.1bn last October prior to the devaluation. The non-resident T-bill holdings represent nearly 20% of the T-bill stock and c25% of the CBE’s Net International Reserves (NIRs). In comparison, at the peak prior to the Revolution, non-resident T-bill holdings reached US$11.4bn (24% of the total T-bill stock and 32% of FX reserves).

IMF reform program on track; fiscal targets compromised by sharp devaluation

Economic authorities are delivering on their commitments as specified by the structural benchmarks and other planned actions included in the Letter of Intent up until June 2017. The latter would not be structural benchmarks, but could be used as a basis for future structural benchmarks (as prior actions, for instance). The IMF may be unlikely to enforce their timely implementation at this stage, but their completion could be an additional sign of the government’s commitment to reforms. The next set of structural benchmarks will likely be published in the IMF’s first review of the program this month.

Currently, the quantitative performance criteria to be observed include a floor on net international reserves, a ceiling on net CBE domestic assets, a ceiling on fuel subsidies, a floor on primary fiscal balance of the budget sector and a ceiling on accumulation of external debt payment arrears. Indicative targets are a ceiling on average reserve money, a floor on tax revenues and a ceiling on accumulation of EGPC arrears.

Authorities are making solid progress toward meeting end-June 2017 performance criteria, which will be examined in the second review, in November or December. CBE NIRs are already meeting the end-June floor quantitative target level. The CBE is still meeting the quantitative performance criteria on net domestic assets (which have declined in April compared to their December level) and the indicative target on average reserve money. There is no sign that the CBE is extending financing to the government. CBE reduced the stock of government overdrafts to below EGP75bn by converting cEGP250bn into securities in November, and gross credit to the government (securities + credit facilities) is fluctuating around the December figure. A total of US$1.2-1.5bn in EGPC external arrears is being repaid by June, in line with the indicative target.

The bulk of the reforms planned for 1H17 were supply-side legislation, mostly laws or strategic reform plans. The investment law and stamp tax on stock exchange transactions were passed by Parliament last month. The cap on USD transfers abroad is likely to be lifted by end-June. The VAT hike by 1ppt to 14% should be automatic as of 1 July 2017, as this has likely been legislated as part of the initial introduction of VAT.

Progress on the fiscal front is lagging, although judgment is hampered by the sharp devaluation beyond the implied 12-14 levels for USD/EGP implicit in the IMF program. Tax revenues appear on course to miss the end-June indicative target. Monthly fiscal data does not allow tracking progress on streamlining energy subsidies accurately, as EGPC-MoF financial flow reconciliation can be bulky. However, the Petroleum Ministry has requested that the MoF appropriate extra funds for fuel subsidies (an extra EGP35bn on top of the existing FY17 budgetary allocation of EGP35bn). If this is realized, the EGP70bn in fuel subsidies would be above the end-June EGP62bn quantitative performance criteria ceiling for fuel subsidies. However, the IMF is unlikely to oppose this, as it did not ask Egypt to undertake compensating fiscal measures (although the letter of intent originally signaled this could be a likely course of action).

All eyes on the FY18 budget as crowded positioning puts onus on reforms

The ongoing parliamentary debates on the FY18 budget may mean that the next phase of energy subsidy reforms could be delayed from July to November when favorable base effects for inflation kick in. The IMF will likely accept this delay, as it suggested that the timing of the subsidy hikes is to be left to the discretion of the government. Also, the IMF signaled that bringing inflation down can take precedence over fiscal reforms. The resumption in March of the US$4.5bn Saudi Aramco annual fuel credit line is positive, as it represents 25-35% of the current account deficit and indicates Saudi is likely to roll over its US$5.5bn debt holdings maturing over the life of the program.

The cabinet approval of an EGP46bn social security package, raise of the minimum tax threshold and bonus payments to state employees (regardless of coverage by the Civil Service Act) is consistent with the FY18 budget proposal, which has been praised by the IMF. The bonus payments are also consistent with the Civil Service Act law as the latter eliminates indexation of public sector employees’ bonuses and allowances and requires growth in bonuses and allowances to remain below inflation.

Focus on delivering reforms and taming inflation is paramount given the significant and front-loaded increase in foreign investor positioning, while years 2 and 3 of the IMF program are tighter on the external funding side. Using as proxy the CBE deposits not included as FX reserves, US$5bn out of the US$7.5bn foreign portfolio stock may have used the FX repatriation mechanism by the CBE to hedge convertibility risk. Still, should the remaining US$2.5bn non-resident stock be unwound, it would exert material pressure on USD/EGP as it represents 10 days of the FX interbank market trading volume. The CBE is unlikely to sell reserves to support EGP. Political support for reforms appears intact, but President Sisi is likely to be in campaign mode from early 2018 to secure a strong mandate in presidential elections in mid-2018.