Egypt turmoil raises borrowing costs for generals
CAIRO — The bloody struggle between the generals in charge of Egypt and their Islamist opponents is raising the cost of financing the country's budget gap and leaving little room for the government to spur growth.
Yields on local-currency debt the government relies on to fund its deficit are rising from two-year lows hit after the military's ouster of Mohamed Mursi on July 3. Egypt sold one- year notes at an average 12.86 percent this week, more than twice what Lebanon pays for its local debt. The budget gap may widen to 12 percent by year-end from 11 percent in 2012, according to the average of 11 analyst estimates compiled by Bloomberg, the highest among 65 countries it tracks.
Demand for government debt is slumping, forcing up borrowing costs, following the crackdown on Mursi supporters that has left 1,000 people dead. Egypt, which spends more than a quarter of its budget on interest payments, is facing 565 billion Egyptian pounds ($81 billion) of maturing debt by the end of 2014, most of which is in the form of local treasury bills, according to data compiled by Bloomberg.
"It's hard to see the government implementing any of its plans to improve the economy while people are killing each other," said Souheir Asba, a frontier-markets strategist at Societe Generale SA in London. "I see a worsening of economic indicators across the board to the point where the government will have no choice but to start implementing reforms."
The budget gap reached about 14 percent of economic output in the year to June, Finance Minister Ahmed Galal said this week. The International Monetary Fund estimates the deficit will be 11.3 percent in 2013 — a projection made before Mursi's ouster. That would make Egypt's general government borrowing as a percentage of GDP the sixth worst in the world after countries including Kiribati and Eritrea. Egypt is unlikely to even meet that forecast, Asba said.
Demand for local debt from the banks, the primary buyers since foreign investors exited following the January 2011 uprising that toppled Mursi's predecessor, Hosni Mubarak, slumped this week. One-year bills sold Aug. 19 attracted bids 1.7 times the amount offered, the lowest in seven weeks. The lenders are operating this week under reduced hours by order of the central bank.
The economy is set to grow at about 2 percent this year, the lowest in the Middle East, according to data compiled by Bloomberg. That would mark the third consecutive year of growth at that rate compared with an average 6.2 percent in the five years before Mubarak's ouster.
"It is in a vicious cycle of weak growth, rising unemployment and social unrest," said William Jackson, London- based Emerging Markets Economist at Capital Economics Ltd. "Eventually, if the deficit gets worse, they may come to a point where banks are no longer able to fund this."
Tightening fiscal policy at that point "could lead to further unrest or they may have to print money, but that would lead to higher inflation," he said.
Despite the recent increase, borrowing costs have been tamed as bank deposits swelled amid the economic decline, adding 15 percent in the year to April compared with less than 7 percent a year ago, central bank data shows. With loans at less than half of the 1.2 trillion pounds banks held at the end of April, demand has kept borrowing costs below February 2012 peaks when the one-year yield hit a record 15.98 percent.
The government has also tapped the central bank for funding, almost tripling the size of its outstanding obligations to the regulator from January 2011, according to central bank data.
"The blowout of the deficit and debt levels is likely in the near term, but it's financeable," said Farouk Soussa, London-based head of Middle East economics at Citigroup Global Markets Ltd. "Banks are still fairly liquid and are a captive audience for Egyptian debt buying out whatever is issued by the government."
The country can rely on aid it has already started receiving from the Persian Gulf and higher tax revenues as the new government improves sentiment, he added. Egypt received $5 billion last month out of $12 billion pledged by Saudi Arabia, Kuwait and United Arab Emirates. Talks with the International Monetary Fund for a $4.8 billion loan have been postponed, Planning Minister Ashraf El-Arabi said this week.
The nation's benchmark 5.75 percent eurobonds due in 2020 have been battered over last week's violence, sending the yield up 108 basis points to 9.4 percent. That compares with a 17 basis-point advance in the average yield on Middle East sovereign debt over the same period to 5.29 percent, according to HSBC/Nasdaq Dubai indexes. The yield was at 9.24 percent at 10:10 a.m. in Cairo.
The premium demanded by black market currency dealers for dollars, which had been reduced to just 1.3 percent over the official interbank price of 6.9879 pounds, has also started to increase. The U.S. currency traded at 7.12 pounds, or a 1.9 percent premium in the parallel market this week.
"Eventually, something has to be done to reverse the deterioration in public finances," Soussa said. "But until then, the interim government knows it has to do what Mursi and the military generals before him have failed at: improve people's lives. And that's going to cost money."