12-Feb-2019
Egypt Economics - On the doorstep of macro relief
2019 starting off on a good note
Egypt’s economy was given a boost early this year, with: i) inflation normalising; ii) Treasury yields falling, partially due to an EM risk-off approach, which brought about portfolio inflows; the first since March 2018; iii) lower oil prices which, if sustained, will ensure an accelerated normalisation of the inflation path in 2H19, even after the upcoming subsidy cuts; and iv) positive fiscal numbers for 1H18/19, where targets have been met. This set of developments is lifting off most of the risk factors weighing on sentiment with regard to Egypt’s macro stability over the past year.
EGP appreciates in the “post-mechanism” era
In an apparent response to the above-mentioned positive developments, the EGP has started off the year on a positive note, recording an appreciation in the past two trading days. The risk-off approach towards emerging/frontier economies has brought in relatively sizeable inflows, working in favour of the currency, especially after the repatriation mechanism had been eliminated in December. In addition to the favourable risk-off approach towards EM in general, Egypt also stands out when it comes to fundamentals for carry trade investors, with: i) decent real yield; ii) strong fiscal reforms; and iii) favourable EGP outlook, evident in the small current account deficit (CAD), leaving debt-servicing manageable. With outflows risk diminishing, we think the likelihood of currency weakness in the short term is receding, and we see the USD-EGP trading within a range of EGP17.60-18.00 in 2019. As we near 2020, we are building some EGP weakness in our models as the easing cycle boosts domestic demand and the currency needs to regain some of its lost competitiveness.
Fiscal dominance still leaves us inclined towards rate cuts being pushed to 2H19
Such positive developments ease pressures on monetary policy, raising the chance of a rate cut in 1H19; we see a probability of a 25% rate cut in 1H19, up from zero. Nevertheless, our base case scenario still points to monetary easing cycle commencing only in 2H19 as the Central Bank of Egypt (CBE) is likely to adopt a cautious stance ahead of upcoming fuel price liberalisation planned by mid-year. Moreover, a rate cut in 1Q19 will not necessarily have a wide-range impact on the macroeconomic conditions, given that another cut will not happen before at least six months later.
Oil is biggest risk in the short term; limited rate cuts a medium-term one
In the short term, we still see a rally in oil price above USD80/b as the key risk on Egypt’s macro outlook as it could slow down the pace of monetary easing and derail private consumption recovery. Further global monetary tightening is another key risk, though we think its chances of happening is receding. In the medium term, the economy’s key challenge will rest in its ability to extensively reduce interest rates. Lower rates are critical for: i) the government to reap the benefit of its fiscal reforms, in light of an interest payment bill amounting to 10% of GDP; and ii) the private sector in order to lower the cost of capital. A structural CAD and higher external debt (with rising share of commercial and short-term debt) could pose challenges for the economy to bring interest rates sustainably lower to support private investment growth that will, in turn, sustain +6% real GDP growth.
Mohamed Abu Basha
Egypt’s economy was given a boost early this year, with: i) inflation normalising; ii) Treasury yields falling, partially due to an EM risk-off approach, which brought about portfolio inflows; the first since March 2018; iii) lower oil prices which, if sustained, will ensure an accelerated normalisation of the inflation path in 2H19, even after the upcoming subsidy cuts; and iv) positive fiscal numbers for 1H18/19, where targets have been met. This set of developments is lifting off most of the risk factors weighing on sentiment with regard to Egypt’s macro stability over the past year.
EGP appreciates in the “post-mechanism” era
In an apparent response to the above-mentioned positive developments, the EGP has started off the year on a positive note, recording an appreciation in the past two trading days. The risk-off approach towards emerging/frontier economies has brought in relatively sizeable inflows, working in favour of the currency, especially after the repatriation mechanism had been eliminated in December. In addition to the favourable risk-off approach towards EM in general, Egypt also stands out when it comes to fundamentals for carry trade investors, with: i) decent real yield; ii) strong fiscal reforms; and iii) favourable EGP outlook, evident in the small current account deficit (CAD), leaving debt-servicing manageable. With outflows risk diminishing, we think the likelihood of currency weakness in the short term is receding, and we see the USD-EGP trading within a range of EGP17.60-18.00 in 2019. As we near 2020, we are building some EGP weakness in our models as the easing cycle boosts domestic demand and the currency needs to regain some of its lost competitiveness.
Fiscal dominance still leaves us inclined towards rate cuts being pushed to 2H19
Such positive developments ease pressures on monetary policy, raising the chance of a rate cut in 1H19; we see a probability of a 25% rate cut in 1H19, up from zero. Nevertheless, our base case scenario still points to monetary easing cycle commencing only in 2H19 as the Central Bank of Egypt (CBE) is likely to adopt a cautious stance ahead of upcoming fuel price liberalisation planned by mid-year. Moreover, a rate cut in 1Q19 will not necessarily have a wide-range impact on the macroeconomic conditions, given that another cut will not happen before at least six months later.
Oil is biggest risk in the short term; limited rate cuts a medium-term one
In the short term, we still see a rally in oil price above USD80/b as the key risk on Egypt’s macro outlook as it could slow down the pace of monetary easing and derail private consumption recovery. Further global monetary tightening is another key risk, though we think its chances of happening is receding. In the medium term, the economy’s key challenge will rest in its ability to extensively reduce interest rates. Lower rates are critical for: i) the government to reap the benefit of its fiscal reforms, in light of an interest payment bill amounting to 10% of GDP; and ii) the private sector in order to lower the cost of capital. A structural CAD and higher external debt (with rising share of commercial and short-term debt) could pose challenges for the economy to bring interest rates sustainably lower to support private investment growth that will, in turn, sustain +6% real GDP growth.
Mohamed Abu Basha