07-Nov-2019
Egypt Economics: 2Q19 BOP Chartbook: Devaluation gains subside in FY18/19; depressed global yields support a stable EGP
CAD widened in FY18/19, despite record tourism revenues, energy surplus
Following two years of external adjustment, where CAD narrowed sharply by c70%, FY18/19 marked the year where these savings came to a halt. CAD widened both nominally (37% Y-o-Y) and in real terms (2.7% of GDP vs. 2.4%), sending signals that the gains from the 2016 devaluation are coming to an end. The disappointing performance came on the back of three key developments: i) normalisation in remittances, which resulted in USD1.5bn drop in FX inflows; ii) 1% drop in non-oil exports, which came as a negative surprise, given the sharp devaluation of the EGP; and iii) 31% Y-o-Y increase in investment payments, most likely reflecting payments to international oil companies. We provide more details on these key three factors below. It is notable that the CAD’s widening came against a backdrop of strong performance by the tourism and energy sectors, two of the key drivers of notable external imbalances in the pre-2017 years. Tourism revenues hit an all-time high, while the hydrocarbons balance turned to surplus for the first time in five years.
Fiscal and monetary easing set to drive further CAD widening in FY19/20 and beyond
We see CAD’s widening that started in FY18/19 continuing in the next couple of years to USD10.6bn in FY19/20 (2.9% of GDP) and USD15.2bn in FY20/21 (3.6% of GDP). Last year’s mixed dynamics are likely to still be in force: While the hydrocarbons surplus is likely to expand and tourism records new highs, these will be balanced against growing imports – with fiscal and monetary policy easing, following the past three years’ austerity – and remittances showing low single-digit growth. The quantum of imports in the CA makes its growth outweigh improvements in the other indicators. Overall imports, i.e., both goods and services, are typically the largest item on the current account balance: they stood at USD78bn; hence, a 10% growth rate will result in cUSD8bn in outflows, which will clearly outweigh a USD1bn expansion in the hydrocarbons surplus and USD2bn in tourism revenues. In this context, Egypt’s BOP dynamics will remain highly dependent on the capital account, where the carry trade is likely to become even more important in stabilising the BOP. There remains some significant upside risks in case Egypt is included in global indices for local currency fixed income, providing more inflows into the market. We do not see this happening, though, before end of 2020.
Depressed global yields support short-term EGP stability
We see the attractiveness of Egypt’s carry trade, with its competitive real yields in a world where investors are hungry for high-yielding assets, driving limited volatility in the USD-EGP over the coming 12 months, barring any major global events. High yields are complemented with an improving macro backdrop, making it challenging for investors to find equally attractive alternatives. And while we do expect to see outflows in the range of USD3-5bn in 2020 as trade normalises and the easing cycle comes to an end, we believe the buffers within the system – both at the CBE and banks – will largely absorb these outflows. We, therefore, expect only a slight weakness in the USD-EGP in 2020, averaging 16.25, compared to 16.10 in end-2019. We also see the gradual pick-up in domestic demand as not providing imminent pressure on the USD-EGP. Beyond the coming 12 months, external balances will have to yield some structural improvement, manifested in a stronger recovery of exports and FDI inflows, in order to maintain a healthy BOP position. This has been made somewhat challenging, considering the EGP’s sharp real appreciation, where our model suggests that the REER is now trading above its long-term average only three years after the 2016 devaluation. It is, therefore, key to keep a close eye on the non-hydrocarbon trade deficit in order to assess macro stability, especially with accommodative macro policies and EGP’s real appreciation helping boost domestic demand.
Mohamed Abu Basha
Mostafa El Bakly
Following two years of external adjustment, where CAD narrowed sharply by c70%, FY18/19 marked the year where these savings came to a halt. CAD widened both nominally (37% Y-o-Y) and in real terms (2.7% of GDP vs. 2.4%), sending signals that the gains from the 2016 devaluation are coming to an end. The disappointing performance came on the back of three key developments: i) normalisation in remittances, which resulted in USD1.5bn drop in FX inflows; ii) 1% drop in non-oil exports, which came as a negative surprise, given the sharp devaluation of the EGP; and iii) 31% Y-o-Y increase in investment payments, most likely reflecting payments to international oil companies. We provide more details on these key three factors below. It is notable that the CAD’s widening came against a backdrop of strong performance by the tourism and energy sectors, two of the key drivers of notable external imbalances in the pre-2017 years. Tourism revenues hit an all-time high, while the hydrocarbons balance turned to surplus for the first time in five years.
Fiscal and monetary easing set to drive further CAD widening in FY19/20 and beyond
We see CAD’s widening that started in FY18/19 continuing in the next couple of years to USD10.6bn in FY19/20 (2.9% of GDP) and USD15.2bn in FY20/21 (3.6% of GDP). Last year’s mixed dynamics are likely to still be in force: While the hydrocarbons surplus is likely to expand and tourism records new highs, these will be balanced against growing imports – with fiscal and monetary policy easing, following the past three years’ austerity – and remittances showing low single-digit growth. The quantum of imports in the CA makes its growth outweigh improvements in the other indicators. Overall imports, i.e., both goods and services, are typically the largest item on the current account balance: they stood at USD78bn; hence, a 10% growth rate will result in cUSD8bn in outflows, which will clearly outweigh a USD1bn expansion in the hydrocarbons surplus and USD2bn in tourism revenues. In this context, Egypt’s BOP dynamics will remain highly dependent on the capital account, where the carry trade is likely to become even more important in stabilising the BOP. There remains some significant upside risks in case Egypt is included in global indices for local currency fixed income, providing more inflows into the market. We do not see this happening, though, before end of 2020.
Depressed global yields support short-term EGP stability
We see the attractiveness of Egypt’s carry trade, with its competitive real yields in a world where investors are hungry for high-yielding assets, driving limited volatility in the USD-EGP over the coming 12 months, barring any major global events. High yields are complemented with an improving macro backdrop, making it challenging for investors to find equally attractive alternatives. And while we do expect to see outflows in the range of USD3-5bn in 2020 as trade normalises and the easing cycle comes to an end, we believe the buffers within the system – both at the CBE and banks – will largely absorb these outflows. We, therefore, expect only a slight weakness in the USD-EGP in 2020, averaging 16.25, compared to 16.10 in end-2019. We also see the gradual pick-up in domestic demand as not providing imminent pressure on the USD-EGP. Beyond the coming 12 months, external balances will have to yield some structural improvement, manifested in a stronger recovery of exports and FDI inflows, in order to maintain a healthy BOP position. This has been made somewhat challenging, considering the EGP’s sharp real appreciation, where our model suggests that the REER is now trading above its long-term average only three years after the 2016 devaluation. It is, therefore, key to keep a close eye on the non-hydrocarbon trade deficit in order to assess macro stability, especially with accommodative macro policies and EGP’s real appreciation helping boost domestic demand.
Mohamed Abu Basha
Mostafa El Bakly