ShareKUWAIT: It did not take long for the Egyptian authorities to capitalize on the economic reforms that took place in March, with the appointment in July of a new Cabinet welcomed locally and regionally and injecting fresh optimism for the first time in years. We see in particular scope for greater coherence on economic policy with three key economy-focused ministries (Finance, Investment and the newly-merged Planning, Economic Development & International Cooperation) headed by a young generation (aged 50 on average) of officials with backgrounds in international institutions such as the IMF and World Bank helping to drive policy forward, albeit based on a medium-term plan that we are yet to see.
Meanwhile, the economy has started to show early signs of recovery with inflation cooling, growth indicators ticking up, the currency stable and the external finances correcting sharply. Likely subsidy cuts over coming months should not disrupt the trend of lower inflation, providing space for interest rates to fall from September. Major economic challenges still lie ahead.
Egypt is now emerging from its crisis stage thanks to critical one-off policy moves and deals including the currency devaluation and mega-investment from the UAE in Ras El Hekma that helped secure large capital inflows. Markets, investors and rating agencies will now be looking at what comes next – and in particular for the government to embark on the second stage of the reform process relating to enhancing the business environment and strong communication of the new agenda.
Growth may have bottomed out in Jan-March
Latest data show economic growth continuing its downward path, slowing for the fifth consecutive quarter to 2.2 percent y/y in Q3 FY23/24 (Jan-Mar 2024) from 2.3 percent in the previous quarter. We expect Q4 growth to come in close to 2.5 percent with the full year at 2.4 percent versus 3.5 percent the previous year.
Supporting this view, the PMI activity gauge picked up in April-June to 48.5 versus 47.6 the previous quarter and ended the year at 49.6, close to the 50 neutral level which we expect to be surpassed in the coming months. This was the highest level for the PMI since September 2021. Several sub-indicators already exceeded the 50 mark including the employment, future output, and new export orders indices. In our opinion, this reflects the improvement in overall macro stability including lower inflation, the stable exchange rate, and better availability of foreign currency. We expect further improvement in the coming period as inflation falls further and interest rates start to fall. We forecast growth accelerating in the coming year (FY 24/25) to 3.5-4.0 percent.
CA deficit widens
The current account deficit widened in 9M FY 23/24 (July to March) to $17.1 billion from $5.3 billion in the same period in FY 22/23 mainly on the back of a significant drop in Egypt’s natural gas production, which pushed the oil trade balance into a $5.1 billion deficit. On the other hand, the non-oil trade deficit improved by $1.5 billion to $23.7 billion mainly on the back of a 3 percent drop in imports due to import restrictions. Remittances from Egyptians living abroad also slowed to $14.5 billion (-17 percent y/y). On a positive note, tourism revenues remained strong, growing by 5.3 percent y/y even amid all the regional tensions.
The situation was positive on the capital account front as the EGP devaluation in March allowed for the release of the $15 billion first tranche of the Ras El Hekma deal along with significant inflows from carry trade investments. This was reflected in FDI reaching $23.7 billion (from $7.9 billion) and a net inflow of $14.6 billion in portfolio investments (versus a net outflow of $3.4 billion). The overall balance of payments saw a surplus of $4.1 billion (from a $0.3 billion deficit).
We expect the current account deficit to shrink in the final quarter of FY23/24 (April-June) to around $1-2 billion (from $8.2 billion in Q3) on the back of a rise in tourism receipts and recovery in remittances. On a full-year basis, the deficit could be $19-21 billion, the largest deficit in Egypt’s history, but should correct once again in FY 24/25 to $10 billion as a 10-15 percent import recovery is offset by a higher remittances, continued strong tourism receipts, and the maintenance of a more flexible exchange rate that keeps the pound in line with its fair value. We see limited scope for a natural gas production recovery over the coming two years.
The authorities received the final tranche of the Ras El Hekma investment deal from the UAE in May worth $14 billion (and $11 billion in the form of UAE deposits to be converted into EGP) pushing FX reserves to an all-time high of $46.3 billion as of June 2024. Net foreign assets at banks (both central and commercial banks) has turned into a positive position of $14 billion as of May, from a negative position of -$3.7 billion in April. The authorities clearly delivered on their promise to utilize majority of the Ras El Hekma proceeds to rebuild FX buffers, however we think that that improvement is now mostly behind us. Our outlook of BoP dynamics shows that it will be difficult to sustain ongoing rises in foreign reserves due to a net cumulative financing gap of $10 billion over the coming 2 years until the end of FY 25/26. Additionally, we see no official urge for even higher foreign reserves as they are already more than satisfactory covering close to 7 months of imports.
Yields on Egypt’s 5 yr-Eurobond has maintained their compression from the past months standing at 9.5 percent as of mid-July from 15 percent pre-devaluation in February, while 5-yr CDS levels (a measure of default risk) have narrowed to around 570bps from 1100 bps and above. The risk compression could be followed soon by upgrades to Egypt’s credit rating from the current B-/Caa1 by at least two notches to B+/B2 by S&P and Moody’s. Key factors needed to earn this upgrade have been ticked, including sustaining a more flexible EGP exchange rate, strong external support, and a significant improvement in the NFA position.
Inflation has continued its clear downward trend over the past quarter, averaging 29.4 percent y/y in Q2 (CY) down from 34.0 percent in Q1 as the EGP devaluation impact fades and smoother FX availability allows for improved supply of goods. Average monthly price rises have slowed sharply to 0.7 percent m/m for Q2 from 4.7 percent for Q1. In early June, the government cut bread subsidies resulting in a 300 percent increase in the price of a loaf from EGP0.05 to EGP0.20. This added around 1.2 percent to June’s CPI which rose 1.6 percent overall as subsidized bread represents less than 0.5 percent of the CPI basket. Next in line could be changes in fixed/subsidized electricity and fuel prices, though we expect the inflation impact to be limited (fuel and electricity represent around 4 percent of the CPI basket and a 20 percent increase adds about 0.8 percent to the CPI).
We expect inflation to average 25 percent in H2 (July to December) of 2024 down from 31 percent in the first half with a strong possibility that inflation ends the year below 24 percent. We forecast inflation to average 19 percent for FY24/25 (much lower than previously on the back of softer than expected inflation post-March devaluation) down from 34 percent in FY23/24. We continue to wait for the CBE to amend the inflation target timeline to Q4 25 (from Q4 24); a target of around 10 percent would be met based on current dynamics, in our view.
CBE to cut rates in H2
The central bank kept rates unchanged throughout Q2 (April to June) at 27.75 percent on the discount rate, while average 1-year treasury bills have dropped by 2 percent since March to 26 percent, which implies that markets are looking at 1-2 percent in rate cuts in the coming period. As inflation has decelerated over the past months (27.5 percent as of June), real interest rates have turned positive for the first time since January 2022. As inflation falls further through 2024, we expect the CBE to commence the monetary easing cycle in the coming period starting potentially in September, with cuts of a cumulative 400 bps rate cuts by year-end.
Household credit growth remained in strong growth territory but unlike business credit there was no strong adjustment to the devaluation with growth at 24 percent y/yin the 3 months to May versus 23 percent for the previous 3 months. On a real-terms basis, credit to private firms recorded -2 percent y/y, improving hugely from -14 percent for the period Dec 23 – Feb 24. As for households, it stood at -7.2 percent, improving from -10.3 percent.
The improvement in real credit growth in both the private and household segments are early signs of economic recovery and proof of the heavy burden on economic activity well before the official devaluation took place in March. As inflation cools in the coming period so will credit growth in EGP terms but possible interest rate cuts in FY24/25 should encourage firms to take on longer-term loans targeted towards CAPEX, not only OPEX spending. We expect credit to grow by 25 percent in FY24/25 down from 31.5 percent in FY23/24, but it will grow on a real basis by +6 percent from -2 percent.
The government utilized 50 percent of the Ras El Hekma deal proceeds ($12 billion once UAE bank deposits – which was not ‘fresh’ money – are excluded/EGP580 billion) to reduce the fiscal deficit evident in the July-May FY23/24 deficit which came in at 3.6 percent of GDP (versus 7.7 percent without the Ras El Hekma proceeds) and a ballooning primary balance of 5.9 percent (1.7 percent ex Ras El Hekma). We expect a deficit of 4 percent of GDP and a primary balance of 6.2 percent of GDP for the full year.
In FY 24/25, we expect a normalized deficit close to 8.0 percent (7.3 percent for the government target), mainly on the absence of another big one-off revenue boost in FY 24/25 (at least for now). The government is allocating EGP 154 billion for the energy subsidy which entails a 20 percent price hike (gasoline, diesel, and butane cylinders) in each quarter in FY 24/25. However, we think the government might opt to go for a lower price hike (10-15 percent) which means the final subsidy could be in the range of EGP 210 billion, adding EGP 60 billion (0.6 percent) to the fiscal deficit.
