Economic Analysis - Structural Adjustment Will See Borrowing Costs Fall - JUNE 2017


BMI View: A drastic reduction in subsidy payments, coupled with a steady uptick in revenues as real GDP growth improves, will see Egypt ' s fiscal deficit steadily reduce over the next several years. This is in line with a broader economic readjustment in the wake of its 2016 IMF deal which will see investor sentiment towards the country improve and borrowing costs diminish.

We forecast that Egypt's fiscal position will enjoy a steady improvement over the coming years, falling from a deficit equivalent to 12.5% of GDP in the 2015/16 fiscal year to 10.6% in 2016/17 (ending June 2017) and 9.9% by 2017/18. This is outside the targets stated in the Egyptian government's budget announcement of March 29, which projected that the shortfall would decline to 9.1% of GDP in 2017/18. Our forecast is more bearish owing to our forecast that real GDP growth will come in at 3.6% next year, rather than the 4.6% projected by the budget statement, and the impact this will have on statistical effects and tax revenues. Nevertheless, it would indicate the start of a fiscal readjustment in Egypt which will reduce its budget deficit, minimise the climb in debt levels, and lower its cost of borrowing on international capital markets.

Steady Improvement Ahead
Egypt - Budget Balance (% Of GDP)
f = BMI forecast. Source: Central Bank of Egypt, BMI

Subsidy Cuts Key To Deficit Reduction

Egypt's budget deficit is declining on the back of drastic structural adjustments made as part of an IMF deal agreed in November, which target both a reduction in expenditures and greater tax revenues. Subsidies have long been a major drag on the government's sovereign position, accounting for 17.0% of all spending in 2015/16. However, in the wake of the IMF deal, a number of these have already been cut or substantially reduced. In November, the authorities reduced subsidies on fuel products with prices increasing by 20-50% and in February it was announced that the regulated prices of sugar and cooking oil would be increased by 14% and 20% respectively. H1 figures from 2016/17 show that subsidy payments have already fallen substantially, accounting for just 9.9% of government spending, and we expect this to fall further by year-end. Further to subsidy cuts, the government is also looking to rationalise the public sector wage bill, which makes up around a quarter of spending, although we expect less progress on this given political considerations.

Interest Payments Weigh On Spending
Egypt - Expenditure H116 (LHS) & H117 (RHS)
Source: Egypt Central Bank, BMI

On the other side of the fiscal equation, the government is also boosting tax revenues through measures such as the introduction of a new value added tax (VAT) in August 2016. Initially at 13.0%, it will rise to 14.0% in the next fiscal year, and has already contributed to government revenue from Taxes on Goods and Services climbing by 14.0% y-o-y in H1. With household spending severely constrained by the rampant inflation which has been generated by subsidy cuts, the initial benefits of this will be slow. Nevertheless, it will provide an important new revenue stream for the government in future years, and widening the tax base will leave it less susceptible to shocks, which will further encourage international investors.

High Local Borrowing Costs Will Prompt Further Dollar Debt Issuance
Egypt - 91 Day T-Bill Yield, %
Source: Egypt Central Bank, BMI

Borrowing Costs Will Fall

The improving sovereign profile will see investor sentiment towards Egypt improve, and we think further issuances on international debt markets are likely, helping the country to reduce its sizeable debt servicing cost. Yields on Egyptian treasury bills have climbed to 19.4%, compared to 12.8% a year earlier, and at 35.0% of spending in H1, interest payments present a considerable drag on government finances (by contrast, capital expenditure spending was just 7% in 2015/16). Although we anticipate that yields on local debt will fall as inflation drops off ( see 'Long-Term Decline In Inflation', March 31), with foreign investors looking more favourably on Egypt following the IMF deal, the government is likely to pursue this option to cut borrowing costs and prevent crowding out of private borrowers on the domestic debt market. Egypt was able to raise USD4bn on international capital markets in January, its largest issuance ever. The bonds received orders reportedly totalling around USD13.5bn leading to yields 6.1%, 7.5% and 8.5% on the five, 10 and 30 year instruments, lower than initially had been expected.