DUBAI (BLOOMBERG) – An already turbulent year for emerging-market traders is getting another shot of adrenaline as Egypt fights to avert a debt crisis.
The north African nation has become the latest symbol of the distress gripping poorer nations on the back of surging inflation, rising bond yields and a grinding down of global growth. Investors, still smarting from recent defaults by Russia and Sri Lanka, are watching Egypt as a case study to gauge whether – and how quickly – the broader developing world can sidestep a full-blown foreign-currency debt crisis and navigate the coming era of tighter credit conditions.
The turmoil is all too visible in Egypt’s assets. The probability its government will fail to repay debt in the one year has surged to the highest since 2013, and to the region’s worst, based on a Bloomberg model. That sent the Egyptian pound to its the weakest since the 2016 surprise devaluation, and pushed the extra yield investors demand to buy Egyptian bonds rather than Treasuries above 1,200 basis points in July, according to JPMorgan Chase & Co data.
Some signs of stability that emerged this month have helped contain some of the more dramatic moves in the country’s markets. A new central bank chief, alongside ongoing talks with the International Monetary Fund, led the spread of bonds over Treasuries to narrow to 857 basis points on Friday, set for its biggest monthly drop in more than two decades. Still, concerns that the Arab world’s most populous nation will fail to honor its debt will remain front of mind for investors until there’s clarity that Egypt will devalue its currency and an International Monetary Fund (IMF) package will be large enough to close its funding gap.
“To stave off a debt default, Egypt will require additional external support, especially within the context of a bulging current account deficit and weak capital inflows,” said Callee Davis, an economist at Oxford Economics Africa. “If Egypt is unable to secure further external financing, the risk of a debt default will increase substantially.”
It’s been a wild ride for investors, as seen in the cost to insure the country’s bonds. The gauge remains elevated – hitting a record high 1,500 basis points last month, before moderating to around 940 basis points on Monday (Aug 29), still higher than troubled Turkey and Angola.
The pain being felt by heavily-indebted countries – like Egypt, whose ratio of debt to gross domestic product stands at about 94 per cent – cannot be ignored. Egypt has US$83.3 billion (S$116.3 billion) of foreign-currency debt outstanding, including more than US$5 billion of dollar- and euro-denominated securities coming due in the fourth quarter, according to data compiled by Bloomberg.
All of these reasons have investors weighing the risk that Egypt could follow the footsteps of Russia and Sri Lanka. The South Asian nation was the first to stop paying its foreign bondholders this year, burdened by unwieldy food and fuel costs that stoked protests and political chaos. Then Russia followed in June after getting caught in a web of sanctions.
Support from the IMF could be the difference maker – something investors who are sticking it out in the region point to, alongside the nation’s foreign-exchange reserves. While the central bank’s net international reserves fell to US$33.14 billion in July, they’re still enough to fund Egypt’s current-account deficit and external debt in the near term, investors say. Moody’s Investors Service expects the reserves to stabilize and gradually increase on higher non-energy exports and a recovery in foreign inflows.
“Egypt is not Sri Lanka – it has much higher reserve buffers and much better financing options going forward,” said Matthew Vogel, London-based portfolio manager and head of sovereign research at FIM Partners. “Egypt’s problem is manageable with tighter policies and official creditor support.”
A major food importer, Egypt has struggled to cope with a jump in grain prices fueled by Russia’s invasion of Ukraine. Saudi Arabia and Egypt’s other wealthy Gulf Arab allies have together pledged more than US$22 billion in deposits and investments to shore up the economy of a country viewed as a linchpin in the Arab world.
Just days after a leadership shakeup at the central bank, Egypt’s prime minister said on Aug 22 that the country is nearing an agreement with the IMF on a new loan. Veteran financier Hassan Abdalla is now acting chief of the central bank, replacing Tarek Amer, who was seen as supportive of a stable pound.
With the IMF favouring a more flexible exchange rate, chatter about a further currency devaluation pushed the nation’s pound to the lowest since December 2016 in the offshore market last week. Even after it was devalued by about 15 per cent in March, analysts say the currency still needs to fall further to reduce Egypt’s funding gap.
“The IMF isn’t a make or break default scenario,” said Todd Schubert, head of fixed-income research at Bank of Singapore. “Rather, it would be a confidence builder and be a catalyst for another leg up in pricing to the point that when the EM market does open up, they could conceivably tap the offshore dollar bond markets.”