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 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 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. The spread narrowed to 857 basis points on Friday, set for its biggest monthly drop in more than two decades, according to JPMorgan Chase & Co. data.
It’s hard to ignore some signs of stability which emerged for the country this month, with a new central-bank chief seen as a watershed reason for optimism alongside ongoing talks with the International Monetary Fund. 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 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 for the week ended Aug. 26, still higher than troublesome 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% — cannot be ignored. Egypt has $47.6 billion of foreign-currency debt outstanding, including more than $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 $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.
The IMF has been a crucial player in emerging markets this year. Pakistan is awaiting $1.2 billion in financing following the fund’s board meeting on Aug. 29. With IMF officials in Colombo for talks through the end of this month, Sri Lanka’s central bank governor expects funds to be disbursed by end of the year.
“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 $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 favoring 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% 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.”
EM Weekly Podcast: Why Egypt is Latest Symbol of Distress
What to watch this week:
China’s falling purchasing managers’ indexes are likely to show its recovery is being hit from all sides as it grapples with a property slump, Covid flareups and power shortages, according to Bloomberg Economics
The Caixin manufacturing PMI, which focuses more on smaller private companies and exporters, is likely to drop into contractionary territory in August
India’s gross domestic product probably jumped 15.5% in the second quarter, reflecting a lower base last year when the pandemic crimped activity
South Korea, the Czech Republic, Hungary, Turkey and Brazil will also report on GDP
Hungary’s central bank is set to lift interest rates by 100 basis points following the forint’s plunge, as the government continues its struggle to unlock crucial European Union funds
Inflation data from Poland, Indonesia, South Korea and Sri Lanka will be closely watched for clues on the outlook for monetary policy
Malaysia’s core inflation climbed to the highest level since March 2016, primarily driven by a record increase in the cost of food