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The foreign currency crunch featured high in the Egyptian economic news beat. Analysts across the board tracked its origin to the external debt. At the same time, privatization of state-owned companies, limits on foreign currency denominated purchases, deferral of import payments and even a new military service scheme were framed as policies to address the issue.
However, little effort has gone into explaining why and when is the relationship between external debt and foreign currency important. To begin unraveling the link, one must start with a simple idea: external debt is denominated in foreign currency and failure to repay debt carries consequences. This is one of the reasons for countries to accumulate foreign currency and foreign lenders to loan funds.
The failure to repay debt is commonly referred to as default. If the reader is unfamiliar with the consequences of default, the 2001 Argentina and 2019 Lebanon economic crises may serve as enlightening examples. From a financial perspective, defaulting countries are excluded the international system.
Analysts have rightly pointed out the current relationship between the external debt and foreign currency crunch. However, they fell short from explaining why and when the relationship is important. Indeed, the reasoning was cut short to: debt obligations exceed foreign currency reserves.
The problem with such a reasoning is that it omits addressing the caveats of external debt. Thus, the following paragraphs will attempt to fill the gap by addressing three simple questions: What is external debt? And most importantly, when and why is it important?
What is external debt?
External debt is the money borrowed by any country from a foreign lender. Also, it is denominated in foreign currency and accounted as an integral part of the sovereign debt (total debt). Moreover, the amount of external debt is a key indicator for economic performance and prospects.
Today, Egypt’s external debt stands at around $165 billion (40% of GDP) including national governments (KSA, Kuwait, UAE, Qatar, Germany, Japan, France, UK, USA and China) and international financial institutions (AfDB, AFREXIMBANK, Arab Fund for Economic and Social Development, EIB, IBRD, and IMF) among the top lenders.
Moreover, loan agreements with a foreign lenders come in different forms depending on conditions attached and repayment schedule. For example, Egypt agreed to take an IMF loan worth 46-months $3 billion tied to a structural adjustment program. The funds are to be deposited in successive installments and pending IMF review missions on the progress of reform.
The only bad debt is that it cannot be paid. It is then when the foreign currency crunch joins the conversation. Currently, Egypt faces the maturity of short-term liabilities worth $29 billion in 2024, or close to 80% of current foreign currency reserves ($35 billion as of October 2023).
The story does not end there. Egypt confronts the maturity of debt worth $19.43 billion and $22.94 billion in 2025 and 2026, respectively. To put it bluntly, Egypt must accrue an additional $15 billion in 2024 and another $23 billion in 2025. The size of the task at hand is underlined by current twin deficits.
Lastly, the perspective on Egypt’s external debt changes considerably when taking into account that some $18 billion are deposits by foreign countries. In other words, a sizable share of current foreign reserves is debt. It is money owned by Egypt to Saudi Arabia, UAE, Kuwait and Qatar. The good news is that Kuwait renewed its deposit.
Thus, the external debt can reasonably be argued as the main reason behind the current foreign currency crunch. But, when and why does external become relevant?
When is external debt important?
As mentioned above, external debt is a KPI used by analysts to benchmark economic performance and prospects. It informs economic growth and exports prospects. The last item is most relevant for Egypt, because exports are the single most important source of foreign currency for countries in the Global South.
Alice Y. Ouyang and Ramkishen S. Rajan located the tipping point for external debt in the range of 70-75% external debt-to-GDP ratio (Egypt stands at 40%). Also, they found the relationship between growing debt and growth of exports to be negative, and determining a red line for the amount of external debt any country may take.
However, the ‘tipping point’ should not be taken as a fixed limit. It is more of a reference for analysts. In fact, it is to be used for reference purposes only. Ouyang and Ramkishen argued in that sense in their concluding remarks.
In their words, “countries with flexible currencies, greater reserve holdings, no previous financial crisis, well-developed bond market but a highly concentrated banking system are more likely to have accumulated larger levels of external debt (as a share of GDP) without negative impact on export growth.”
When shifting the focus to Egypt, the resulting record is mixed. The Egyptian banking system is strongly regulated, but growing state intervention in the currency market, low foreign currency reserves as a percentage of GDP (below 10%), and a financial record dashed by recurrent crises all leave little room for caveats. At the same time, the country’s external debt-to-GDP remains well below the tipping point range.
Why is external debt important?
Beyond informing economic prospects, external debt determines a country’s financial solvency and credit worthiness. It is a factor in the complex equation that aids lenders assess the risk involved in lending to any country. This is usually reflected in ratings provided by credit agencies, for example, Fitch Ratings, Moody’s and Standard & Poor’s, among others.
In early October, Moody’s downgraded ratings for Egypt’s sovereign credit rating pointing to the “country’s worsening debt affordability.” Fitch Ratings followed the trend in November and downgraded Egypt’s long-term foreign currency issuer default rating to reflect “increased risks to Egypt’s external financing, macroeconomic stability and the trajectory of already-high government debt.”
Banks were targeted by credit rating agencies too. Moody’s announced the downgrading of five Egyptian banks to reflect “the operating environment and the sovereign’s weakened creditworthiness.” Fitch followed suit three days later citing similar reasons while targeting the same five banks.
Nevertheless, both agencies agreed on the prospects for the Egyptian economy: a stable outlook based on “expectation that reforms – including privatisation, slowdown of megaprojects, and exchange rate adjustment – will accelerate after presidential elections in December.” Egypt entered the post electoral stage with announcements of new privatizations while the floating of the currency remains a rumor.
The downgrade of Egyptian-issued bonds and banks point in one direction: raise foreign currency reserves and implement reforms to improve credit solvency and worthiness. In other words, the meeting of debt obligations will be a strong and positive sign to foreign lenders and rating agencies is only half of the equation.
The external debt, currency crunch and private sector
The battery of economic policies deployed by the Egyptian government is focused on raising foreign currency and improving the macroeconomic environment. So far, the government raised $5.6 billion from the sale of shares in 14 state-owned companies.
Moreover, the purchases recorded several acquisitions by Egyptian companies. Nevertheless, the chunk of the sales were purchased by Emirati and Saudi companies taking home the biggest slices. At the same time, the cap on currency denominated purchases is bound to affect the manufacturing sector dependent on imports.
The good news is that IMF Managing Director Kristalina Georgieva recently applauded Egyptian economic policy and added “Egypt will continue to enjoy strong support from the IMF.” Additionally, Egyptian-issued bonds entered new markets, regional allies renewed deposits in the CBE, and foreign capital found opportunities in state-owned assets. Like it or not, the conflict in Gaza returned Egypt to the center of international politics, lowering the costs of a politically stable and economically prosperous Egypt.
Three things have been made clear about Egypt’s current external debt and foreign currency reserves. First, the debt remains below the risk range. Second, the foreign currency crunch is caused by the maturity of short-term liabilities. Third, the shortage is expected to extend into 2025. And fourth, government policies are addressing the issue by all means available.