Egypt’s economy freefalls as experts look to lessons from Lebanon’s crisis

Egypt’s economy is facing severe headwinds, with worsening debt and foreign exchange shortage issues exacerbating a bruising crisis. The country’s external loans have ballooned to over $160 billion in recent years, weighing on fiscal stability, while foreign exchange shortages have driven pound devaluations and restrictions on offshore debit card use.

The country is also grappling with record inflation expected to accelerate further, denting households’ spending power amid currency weakness. Delays obtaining IMF programme reviews and a credit rating downgrade have also intensified concerns about the country’s sizable external financing gap as financing needs outstrip available resources.

Progress addressing these deep-seated challenges through reforms to boost confidence and inflows, including potentially further devaluations ahead of elections, has proven sluggish.

Policymakers face an uphill battle calming markets and restoring stability unless solutions accelerate.

History repeats itself

In Khalid Ikram’s assessment, Egypt’s current crisis echoes chronic issues that have characterised economic downturns in the country for 50 years – unsustainable budget and current account deficits resulting from a failure to enact necessary reforms.

As a former World Bank director and chief economist, Ikram observes that “the root cause of these chronic crises is a failure to carry through to completion the necessary reforms.”

On the budget side, Egypt has consistently failed to boost revenues enough to cover essential expenditures on what the country considers to be its socially and politically irreducible items: defense, interest on debts, consumer subsidies, and administration.

Ikram warned that the absence of a coherent economic reform strategy erodes investor confidence that any new initiatives will be fully implemented.

While successful reforms could stabilise conditions, he noted that external factors like the war in Ukraine, severely impacting wheat and fertiliser imports, complicate the situation.

Debt levels also weigh heavily, with interest payments consuming a large portion of the budget.

“Egypt will recover from the crisis, but the costs of recovering could be higher than in the past,” he warned.

“The Egyptian pound has undergone a significant nominal devaluation in recent months. But what policymakers have apparently not adverted to is that what matter for an export policy is the effective exchange rate, i.e. the nominal exchange rate adjusted for differences in the inflation rate between Egypt and its competitors,” he said.

“Given the rate of Egypt’s inflation, the country’s effective exchange rate has likely been appreciating.”

Unlike previous economic downturns for the northern African country, the challenges are now more complicated, he said. A major factor that was absent in earlier crises is the Russia-Ukraine war.

“The hostilities have increased the prices of some crucial Egyptian imports, principally wheat and fertilizer. Since almost 60 percent of Egypt’s wheat consumption depends on imports, the effect on the balance payments is heavy,” he explained.

Both domestic and foreign investor confidence was also impacted due to “repeated failures to carry through economic reforms to completion.”

“This would encourage them to hedge their bets and/or increase the risk premium when dealing with Egypt.”

Lessons from Lebanon

Lebanon’s devastating economic crisis shows few signs of abating as the country’s political leadership remains deadlocked.

The tiny Mediterranean nation’s economy has contracted by a staggering 40 percent since late 2019 when mass protests erupted against corruption and mismanagement, according to IMF estimates.

The Lebanese pound has plunged to less than 3 percent of its formerly pegged value, inflating prices beyond what many can afford. Unemployment has skyrocketed to top 40 percent as businesses crater, with over 80 percent of the population now living below the poverty line.

A brief respite appeared last year as tourism returned after COVID-19 lockdowns lifted and remittances from the Lebanese diaspora rose.

Electricity blackouts plague private businesses and households for over 22 hours daily due to a bankrupt power sector. Banks still restrict dollar withdrawals and transfers, locking citizens out of savings.

The fiscal deficit widened to an estimated 5 percent of GDP in 2022 despite plummeting state revenues, reflecting a bloated public payroll politicians are loath to trim. Foreign reserves have sunk below $15 billion as the import bill for fuel, wheat and medicines balloons amid price inflation of 270 percent.

“Since the beginning of the millennium, the Lebanese economy has been suffering from the twin deficit. What made this more harmful was that there was no clear government plan to fix the situation. Rather, the government was trying to obtain more and more loans to postpone the crisis – [a] Ponzi scheme,” Nasri Harb, Professor of Economics and Dean of the Faculty of Management, Finance, and Economics at the University of Sciences and Arts in Lebanon, told Arabian Business.

“I have no data on Egypt. However, accumulating debt that does not increase productivity will eventually harm the economy either sooner or later. After all, the government will have to tax economic agents to pay off its debt,” said Harb.

Agreeing with Ikram’s sentiment, he added that this would hinder further investment and growth through the “crowing-out effect.” As a result, servicing the debt will become unsustainable, leading the monetary authority to follow an inflationary policy that will materialise into a currency devaluation.

When asked about lessons from Lebanon’s experience, Harb stressed several priorities: transparency in policymaking and finances, greater privitisation to boost efficiency, and restored faith in the financial system through judicious monetary policy.

Ikram was more circumspect, noting that he does not know enough about Lebanese politics or economics to draw direct parallels but he agreed that swift implementation of reforms impacting institutional, educational, and regulatory frameworks are essential for regaining growth momentum and investor trust in the long run.

“I do not know much about Lebanon’s politics or economy, and I am therefore reluctant to comment on such matters. However, Egypt in the opinion of many political commentators is regarded as “too important to fail.” I do not know whether Lebanon falls in this category,” said Ikram.

In late 2022, the IMF launched a $3 billion 46-month programme for Egypt under the Extended Fund Facility in an effort to preserve macroeconomic stability, restore buffers, and enable inclusive, private sector growth. It aims to shift to a flexible exchange rate, gradually reduce inflation in line with central bank targets, fiscal consolidation to lower debt while boosting social safety nets, and structural reforms to decrease the state’s role and facilitate private business.

In the short term, Ikram identifies completing Egypt’s IMF programme, broadening the tax base, and instituting an effective export strategy as top policy priorities. While external shocks pose challenges, he does not believe Egypt faces the same risk of spiralling collapse if reforms stay on track.

Not too late for Egypt to change course

“We think Egypt can implement policy measures to reduce its economic imbalances and unblock multilateral and bilateral funding. Lebanon was unable to do so,” Trevor Cullinan, Lead Analyst at S&P Global Ratings, told Arabian Business.

Last week, S&P lowered its long-term foreign and local currency sovereign credit ratings on Egypt to ‘B-’, down from ‘B’ before.

The report assessed that economic growth slowed to around 4.0 percent in 2023 due to foreign currency shortages restricting imports and depressing economic activity. Unemployment was estimated at 7.3 percent while inflation reached 38 percent in September.

In terms of external pressures, Cullinan noted that the war in Ukraine resulted in capital flight from Egypt and the depletion of foreign reserves despite emergency $13 billion deposits from GCC countries in early 2022. Higher commodity prices have also damaged the economy.

However, Cullinan agreed with comparisons to Lebanon’s situation only to an extent, believing Egypt has more capacity to implement reforms than Lebanon did. S&P expects the current account deficit to remain under 3 percent of GDP if exchange rate flexibility increases as reforms progress.

“The outlook is stable. The downgrade reflects the recurring delays to the implementation of monetary and structural reforms, exacerbating imbalances in the currency market, deteriorating the net foreign asset position of systemic banks, and delaying critical IMF disbursements and other multi- and bi-lateral financing,” said Cullinan.

“The stable outlook balances the risk that the Egyptian authorities may be unable to finance high external debt redemptions or address the country’s foreign currency shortage against the possibility of an acceleration of key monetary and economic reforms that would help bridge Egypt’s large external financing gap.”

Domestically, Cullinan highlighted very high interest costs consuming over 40 percent of government revenues as a concern for debt sustainability. S&P projects the fiscal deficit to average 6.8 percent of GDP through 2026 without reform acceleration.

He added that S&P could lower the ratings if the government’s already elevated interest costs rise further and if authorities fail to implement the macroeconomic reforms required to reduce the country’s economic imbalances and to unlock funding.

On the other hand, however, the company could raise its ratings if Egypt reduces net government debt levels and gross external financing needs.

“Under such a scenario, we would expect renewed bilateral and multilateral financial support.”

While external pressures like high inflation pose difficulties, Cullinan and S&P maintain that Egypt retains potential to change course through swift reforms – but risks intensify the longer solutions are delayed. Implementing an agreed policy programme remains crucial to economic and financial stability.