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StudiesEconomics

Is the Egyptian economy vulnerable to bankruptcy?

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The persistent bad conditions of the Egyptian economy due to the government’s economic policies, along with the repercussions that hit the nation’s economy resulting from the covid-19 crisis and later the Russian invasion of Ukraine, ultimately push towards major risks including likely inability to meet external obligations, amid rapidly volatile global conditions.

This paper attempts to answer the question about likeliness of bankruptcy of the Egyptian economy.

Sovereign default:

The sovereign default is the state’s failure or refusal to repay its debt in full, or to seek funds from external parties to pay for its imported goods and commodities, which may be accompanied by an official announcement by the government of non-repayment or partial repayment of its debts (due amounts), or thactual cessation of due payments.

This usually comes as a result of the government experiencing cash flow problems due to various factors such as political instability, poor investment, mismanagement of investor funds, etc.

When they invest in sovereign debt, bondholders closely monitor the political stability and financial environment of the sovereign entity to determine the sovereign default risks. When bondholders suspect a government may default on its debt obligations, they may seek to review interest rates to compensate for the increased default risks.

Such a scenario is known as a sovereign debt crisis, which is common among governments that rely on short-term borrowing, as it creates a mismatch between short-term bonds and the long-term value of debt-financed assets.

In general, sovereign default occurs after years of excessive spending and emergency budgets, with settlement of the budget deficit by obtaining loans from local and international investors, and relying on new loans to service old debts, which indicates corruption of the state’s administrative structure, and absence of transparency.

1- Countries that have been declared bankrupt

Ecuador comes on top of a list of the world’s most bankrupt countries, as it has declared bankruptcy 10 times; followed by Brazil, Mexico, Uruguay, Chile, Costa Rica, Spain and Russia – which have declared bankruptcy 9 times over the past two centuries; then comes Germany, which declared bankruptcy 8 times.

On 17 August 1998, Russia declared bankruptcy, after its inability to repay its accumulated external debts as a result of the government’s issuance of short-term bonds, and the economic crisis resulting from the nation’s transformation from a communist country into a capitalist country, after the collapse of the Soviet Union on 25 December 1991.

In 2001, Argentina declared bankruptcy, due to the financial crisis and its growing debts, which amounted to $ 132 billion.

2- Repercussions of sovereign default on countries:

Some may see that a state’s declaration of bankruptcy represents a good opportunity to escape the grip of creditors, and a bold step that some countries can take to save their economy. However, they ignore the repercussions that take place immediately after a state declares bankruptcy, including:

– When a country defaults on its debt, it becomes less attractive to investors, and it will become more difficult to access new funds from the international bond market.

– A state’s declaration of bankruptcy is followed by a violent economic shock at the local level, as investors and holders of savings – who expect a strong decline in the value of the local currency – rush to withdraw their money from bank accounts and transfer them outside the country.

– In order to stop the depreciation of the currency and money withdrawals, the government, which has trouble in repayment of debts, resorts to closing banks and imposing restrictions on the movement of capital.

– On the external level, capital markets either impose punitive borrowing rates or refuse to provide loans again, and then credit rating agencies issue warnings about investing in such troubled country.

– Debt settlement or restructuring between troubled governments and creditors is done without the presence of international laws regulating this matter, where negotiations are costly and exhausting to all parties.

– The repercussions of default will be painful for the debtor state, especially if it is unexpected and unregulated, where it affects its economy immediately, in addition to its negative impact on the country’s credit rating.

Is the Egyptian state at risk of bankruptcy?

At the outset, it should be noted that declaring bankruptcy is a government decision in which economic, social and political factors overlap, depending primarily on the nature of the existing regime and its relationship to the main societal actors, as well as on the depth of the economic crisis and the nature of the available internal and external sources of economic support.

It should also be noted that the state of bankruptcy has many economic manifestations, which means that the fall does not come suddenly, but rather gradually, over a period of time that may extend to a decade or more.

In the Egyptian case, it is likely that the internal political situation of the current regime -that had seized power through a military coup- does not allow even the slightest threat of a partial suspension of repayment, which prompts the government to use all possible means that would enable it to escape the trap of bankruptcy, whatever the economic, strategic and social costs of using those means may be. Thus, the bankruptcy in this case may differ from the natural cases referred to above, as it is likely to take the form of a sudden fall and rapid decline as a result of continuing resistance, to the last breath.

Accordingly, an analysis of the means available to the Egyptian authority in the medium and short term may clarify the degree and duration of the Egyptian economy’s resilience against the specter of bankruptcy.

In fact, the Egyptian economy has fallen in the vicious circuit of loan rotation, which means new borrowing to repay interests of old loans; where escaping this situation requires the provision of approximately $ 140 billion, the amount of foreign loans, in cash, an amount that may be twice the value of the remaining assets of the Egyptian public sector.

This simply means that continuing to borrow and rely on hot money has become a permanent state on which the government relies, even in the long term, especially in light of the local production deficit, export failure, and the authority’s determination to move forward with its “dazzling” megaprojects.

Therefore, it is likely that the effects of external loans will transcend the current authority to the upcoming Egyptian authorities, which is likely to answer the question about the vulnerability of the Egyptian economy to bankruptcy through reviewing current and future sources of funds.

These means are mainly represented in domestic debt instruments, external borrowing of various types, selling state-owned assets, as well as austerity policies, where the regime will resort to all or some of these means, according to global and local economic conditions that are not likely to continue at the same degree of flexibility and availability for a long time, especially in light of the expected escalation of debts and external obligations, in addition to the political changes that could affect the nature of international and regional support for the current ruling regime.

However, two of the above means are theoretically under the control of the Egyptian authority, namely, austerity policies, whether by reducing spending or increasing public revenues through various tools, as well as selling state-owned assets. Yet, the implementation of any of the two means is subject to calculations that may go beyond economic borders to security and political aspects that are outside the framework of this paper.

For example, increasing public revenues by imposing more taxes is technically subject to the financial capabilities of tax payers. In light of the continuous economic downturn that the Egyptian state is suffering from on the one hand, and the rising inflation on the other, it is likely that the number and capabilities of tax payers will shrink, and the tax revenues will erode.

The same applies to the rest of the public revenues, including fees on government services, which have almost reached their maximum, compared to their counterparts in different countries of the world. Even the hypothesis that the local banks’ abilities to finance public loans will remain unchanged, is highly questionable.

As for reducing public expenditures, the debt interests already devour expenditures of the public budget, and soon there will be no internal source to cover wages, which means that the government margin of tools to reduce these expenditures is very limited, no more than a few billion Egyptian pounds, which will not be of any use to the government.

However, it is likely that sale of the state’s public propertywill be the only means that the state owns, both in theory and in practice, where the Egyptian state owns a huge chain of these assets, varying between different sectors of economic activities, such as mining, petroleum, health, industry, and others. Also, the productive assets are characterized by availability of cheap labor, hungry internal market, internal transport network and ports ready for export, all of which are extremely attractive to the foreign investor, whose embassy and allies inside the Egyptian interior guarantee him a treatment that is far more distinguished than his Egyptian counterpart, even in light of the extensive pervasiveness of the sovereign bodies on the stages of various production and marketing processes.

One of the factors that attract a foreign investor is his ability to bargain and buy at the lowest prices, in the absence of clear pricing mechanisms, in addition to the possibility of choosing the project he wants, even if it is not on the state’s selling agenda.

In short, the state is likely to over-rely on sale of its public property during the coming period as a primary means for fulfilling its obligations, taking into mind that it will be able to market this behavior publicly in one way or another. What increases the likelihood of this trend is the fact that it does not place any burdens on large segments of citizens; where the buyer, with the help of the tight security grip, will be able to silence the affected workers.

It is noteworthy that the increase in selling public properties and reliance on them as an important source to meet the needs of foreign exchange, does not mean in any way that the rest of means will not be used, but the truth is that they come in the first place based on the authority’s complete control over them and the indifference of the people, in light of the fact that they are not greatly affected (ostensibly and immediately) as a result of selling them, while the use of the other three means remains hostage to internal and external conditions.

For example, the largest proportion of the variables that control the flow of hot money and external borrowing, do not fall under the control of the government, and therefore cannot be relied upon to a large extent.

In theory, high interest rates attract investment in domestic debt instruments, but safe havens for those funds, which are invested in dollars or stable international currencies, remain a dangerous and permanent competitor to emerging countries, where these funds quickly flee upon a little increase in the interest rate in safe havens, which means a race for more interest rate hikes on such funds.

The fluctuations in the flow of hot money in and out, and the continued raising of domestic interest to preserve the largest amount of it, lead to putting pressures on the production cost, domestic inflation, and items of the general budget. However, this means, the hot money, will remain of great importance during the coming period, in light of the continued raising of the interest rate, and perhaps with political directives from international investment portfolios that are working on a combination between local assets offered for sale and hot funds, which will help create artificial economic stability in Egypt, that remains fragile in all cases.

Regarding the external borrowing as a source of financing dues on the Egyptian economy during the coming period, it is important to note that Egypt’s credit rating is still good, which supports purchases of Egyptian bonds of various types. Even in the case of a credit rating downgrade (if such rating was issued before Egypt obtained the IMF loan), the solution would be to raise the interest rate, even by 1 or 2%. However, with the completion of the new loan agreement with the International Monetary Fund, the major attraction of Egyptian bonds due to the high interest rates, will remain; where bond offerings abroad will remain one of the important sources of facing the dollar gap.

The International Monetary Fund will undoubtedly agree to Egypt’s request to borrow again, and it will not be the last loan; where only one year will hardly pass before initiating discussions about borrowing from the IMF again.

The inflows resulting from Egypt’s inclusion in the JP Morgan Global Emerging Market (emerging markets index) will constitute one of the important sources of income during the second half of this year and next year.

Conclusion

After reviewing the key means that the Egyptian economy is likely to rely on to meet the challenges of the dollar gap and the external obligations resulting from foreign loans and their interests, the following can be concluded:

1- Egypt has already slipped into the malicious circuit of foreign loans, where rotation of loans in their various forms has become inevitable; and this situation is likely to extend, perhaps, for decades to come.

2 The Egyptian authority will resort to following four paths – some of which have already begun, to confront the crisis of repayments of its external debts and their interests, whether currently or even in the post-Ukrainian war period:

a) Sale of state-owned assets at the lowest price, especially to Gulf buyers.

b) Seeking recovery of hot money balances through a frantic competitive race to raise interest rates.

c) The external borrowing in its various forms will constitute an important lever for the Egyptian economy, where the borrowing programs from the International Monetary Fund will continue, as well as bilateral loans, especially from China, and the pursuit of Gulf deposits, and so on.

d) Further austerity policies to be imposed on the state’s general budget, with more burdens on citizens.

4- The government may rely on some of these paths more than the others, according to internal and external conditions. However, in the event that the current crisis continues, the government will resort to activating all these tools – if possible – at the same time.

5- The successful use of all or some of these means is likely to extend the ability of the Egyptian economy to face the threatening risks in the short term.

Thus, it is unlikely that the Egyptian economy will be exposed to bankruptcy during the next few years, at least, as the authority will use all available tools to prevent this, especially in light of the international and regional support for the existing regime. But that will also depend on the extent of the gap between the needs and availability of foreign exchange, and also on the extent of stability of the international and regional situation, taking into mind that the Egyptian economy depends on the outside for meeting most of its requirements.

6- The use of these means does not mean that the Egyptian economy may improve within five years, for example, because there is neither will nor ability to change this reality at the present time.

7- Resilience of the Egyptian economy may decline within a few years; and under the pressures of reliance on the outside world – whether under a new authority, or even under the same existing authority – the government will find itself prompted to declare economic bankruptcy.

Egypt’s declaration of economic bankruptcy is inevitably coming. Despite different assessments of duration of the economy’s resilience, yet it is highly likely in light of the current data.

It is certain that after exhausting all the tracks referred to above, declaration of bankruptcy will be inevitable, regardless of its consequences[1].

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[1] The views expressed in this article are entirely those of the author’s and do not necessarily reflect the views of the Egyptian Institute for Studies

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