Egypt’s post-IMF pain is a lesson for indebted emerging markets

(Bloomberg) – Egypt’s IMF-led strategy to overcome its debt overhang sounds like a perfect recipe for a national debt rally – except fund managers are skeptical about the plan’s execution.

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In quick succession last month, the North African nation won an International Monetary Fund bailout, tied up billions more in bilateral financing, adopted a more flexible monetary regime and raised interest rates. But any expectation that the tide of good news would trigger market euphoria was quickly belied: Egyptian bonds began to slide and the cost of insuring the country’s debt against default soared.

Bondholders’ dubious response to Egypt’s groundbreaking announcements could serve as a lesson to countries with similar fiscal vulnerabilities, such as Pakistan, Argentina and Ghana. Mere promises are no longer enough and investors are demanding evidence that nations are taking the tough steps needed to close funding gaps and reduce debt. Additionally, the Federal Reserve’s latest hawkish swerve has reduced appetite for risky turnaround themes in the emerging world.

“A staunchly hawkish Fed is dampening enthusiasm for investing in risky assets, especially frontier markets like Egypt,” said Todd Schubert, head of fixed income research at Bank of Singapore. A rebound in Egyptian bonds will require “an improvement in the global climate for risky assets and a more concrete plan for how the country will meet its sizeable financing needs.”

Egyptian bonds offered investors the seventh-best return in October among the 72 developing countries tracked by Bloomberg as its talks with the IMF neared a climax. But this month, they trail most of their peers with marginal losses. Meanwhile, five-year credit default swaps jumped 210 basis points in five days to hit 1,245, well above the 1,000 basis point level that analysts like Gordon Bowers of Columbia Threadneedle Investments regard as the distress threshold.

“Egypt remains a ‘show me’ story,” Bowers said. “The involvement of the IMF is a good political anchor, but does not in itself solve any of the problems of external financing, since the success of the program depends largely on the execution of the program of privatization and foreign direct investment. , of which investors remain skeptical given previous disappointments.”

This is a wake-up call for other emerging market governments with struggling debt and an unfinished reform agenda. The IMF has warned Argentina against unconventional monetary measures. In Ghana, the lender said authorities had to assume restructuring liabilities in order to qualify for assistance if government debt was found to be unsustainable.

It’s time to act

The amount of loan Egypt will get from the IMF – $3 billion – came in at the lower end of expectations. Goldman Sachs Group Inc. and Bank of America Corp. had estimated that Egypt might need to secure $15 billion.

The country needs $28 billion until the end of 2023 to refinance maturing debt, pay interest and fund its current account deficit, according to Deutsche Bank Research, with another $20 billion needed the following year. Egypt’s net international reserves, at just over $33 billion, can barely support the burden. This has fueled fears that Egypt will continue to turn to debt markets.

Egypt strikes IMF deal, expected to get $5 billion from international partners

Investors need clarity on the external financing outlook for the country beyond the next 12 months and to see foreign direct investment from Egypt’s Gulf allies materialize, said Alia Moubayed, chief executive of the Economics and Strategy EMEA at Jefferies International.

But fund managers fishing for cheap distressed debt haven’t completely given up on Egypt. Its bonds maturing in 2029 and 2030 are attractive after investors seized on shorter and longer maturities in recent weeks, according to Deutsche Bank.

“IMF-led reforms and a more flexible exchange rate should shore up the macroeconomic story and help attract foreign flows,” Deutsche Bank analysts, including Samira Kalla and Anthony Wong, wrote in a report.

This is Egypt’s second major program with the Washington-based lender since 2016. Still, progress on reforms has been slow in some areas, Callee Davis, an economist at Oxford Economics Africa, wrote in a report. The state – especially the military – maintains broad control over the economy, and the successes of the government’s IPO program have been limited so far, she said.

A major food importer, Egypt has turned to international lenders for help after battling high commodity prices following Russia’s invasion of Ukraine. Tourism revenues could also be hit by falling visitor numbers from Russia, a key market.

Under the latest agreement, the IMF asked Egypt for tax reforms aimed at reducing debt and improving tax collection. He also wants the country to stimulate the growth of the private sector by “reducing the footprint of the state”.

“Some of the inputs and projections underpinning the IMF program that the authorities have shared look very ambitious,” said Adriaan du Toit, London-based director of emerging markets economic research at AllianceBernstein. “So there are significant risks and with the positioning in the credit market remaining relatively heavy, bonds could tread water for the foreseeable future.”

What to watch this week:

  • World leaders gather in Sharm el-Sheikh, Egypt’s Red Sea resort town, for the UN-sponsored COP27 climate talks which run until November 18

  • A flurry of data out of China will likely show a growing slowdown, Bloomberg Economics says

  • Poland and Mexico should raise interest rates to control inflation

  • Indonesia, the Philippines and Malaysia will report their gross domestic product, while Thailand, Chile and Taiwan are expected to report inflation figures

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