It’s May 2011 – the Egyptian revolution unleashes euphoria around the world with Western leaders seemingly seeking to reward democratic transitions in the Arab world with a flow of cash. Against this backdrop, a gigantic Marshall-style plan to shore up Egypt - and Tunisia - is announced with some $20 billion of multilateral loans pledged, on top of bilateral cash from OECD aid donors and resource-rich Gulf states.
In all, an estimated $35 billion is set to flood Cairo’s public coffers, generating expectations that the central bank's FX reserves will be easily replenished and boosting Egypt’s economy. That should be a boon for the Egyptian bond market, industrial stocks and trade financiers, among others.
Fast-forward to February 2012: Egypt’s economic and political story has gone awry in equal measure. Cairo is still waiting for bilateral lenders to make good on their lavish promises of yesteryear and the economy faces a litany of challenges. Reserves have halved since the revolution to $16.35 billion, while $63 billion of debt is due to mature in 2012 – which will force domestic banks to soak up yet more debt, crowding out the public sector. Tourism and FDI revenues, the main sources of hard currency, have vanished, and the budget deficit is projected at an uncomfortably high 8.7% of GDP.
Against this backdrop, Egypt is still courting the IMF for a $3.2 billion loan but needs alternative financing sources – fast. So perhaps this announcement via Reuters comes as no surprise. :
| The Egyptian government, seeking to head off a funding crisis, is preparing to raise about $2 billion through its first issue of Islamic bonds, an Islamic scholar familiar with its planning said on Tuesday. "The Egyptian government is convinced that a foreign currency sukuk will fund the country's development projects and can also bridge the gap in its currency reserves," Sheikh Hussein Hamid Hassan told Reuters. "The sukuk will be in dollars or euros or maybe a combination. It will be around $2 billion, issued in several tranches targeting mainly Egyptians living outside Egypt." |
At present, Egypt is marching towards a financing crunch. Last Monday, Egypt’s central bank could only sell E£1 billion ($165.74million) of a target E£2billion in five year 16.35% bonds at auction - with yields in the record high range of 16.65%-16.85% - as banks choke on an over-supply of government paper.
It is understood that the prospective sukuk issue will be issued by the country’s finance ministry and National Bank of Egypt has been appointed. According to EuroWeek, our sister publication, “Egypt has hinted since January that it may bring a sukuk to market before the end of its fiscal year on June 30.”
At first blush, the sukuk market is enjoying near-record liquidity, a boon for a prospective Egyptian issue. This year, Middle Eastern issuers have received competitive financing in the sukuk market, including a $400 million debt sale from Majid Al Futtaim, a Dubai property, hospitality and retail group, and Abu Dhabi’s First Gulf Bank, which raised $500 million, among others.
As a Standard & Poor’s report, released today, observes:
| In our view, European banks are reducing their overseas exposure as their capital requirements have increased and their domestic economies faltered. Governments in the Middle East and Asia have therefore turned instead to local investors to back their infrastructure projects. Banks in the Middle East and Asia that comply with Sharia law have also demonstrated a strong appetite for new assets that meet their requirements. Until the global credit crisis of 2008, most sukuk issuances came from corporate issuers; now, most comes from governments and GREs. In our view, many sovereign issuers hope that Islamic finance will provide them with an alternative means of supporting their economies by tapping into the excess liquidity available in regions that were less hard hit by the economic downturn, such as the GCC region and Asia. Given the slowdown in global economic growth, we expect this trend to continue in the short term. |
What’s more, a yieldy sukuk deal in dollars would provide liquid Gulf and Asian banks an outlet for their excess liquidity – and the scarcity value of Egyptian paper is another potential selling point.
But can Egypt raid the sukuk market at competitive rates when the conventional bond market is effectively shut for the sovereign and an IMF programme not yet finalized?
The sovereign is manifestly a special case. It’s by no means clear that Egypt will be able to receive a cheaper cost of funding than through the conventional bond market given its economic and political difficulties, which means European investors would shy away from any sukuk deal.
What’s more, Egypt has been whipped by all three ratings agencies recently with downgrades left, right and centre. Most recently, On February 2, Standard & Poor’s cut Egypt from BB+ to BB, citing the sovereign’s financing risks.
For sukuk investors, it’s not a ratings question per se; it’s a solvency issue, Said Hirsh, Middle East economist at London-based Capital Economics, tells us. “At present rate, Egypt has just two months before the central bank won’t be able to cover its financing needs so investors will no doubt demand a high premium”.
If a deal with the IMF gets off the ground, it’s capped at $3.2 billion while Egypt needs $7billion of external cash in total since its external financing needs for the year stand at around $11billion, according to the Capital Economics analyst. That’s based on a perhaps-generous forecast of $4billion of portfolio flows.
So there are a couple of scenarios:
- The IMF arrangement is upsized significantly – entailing big cuts in social spending and politically-unpalatable structural reforms.
- OECD aid donors and/or Gulf partners wade in.
- An IMF agreement is fleshed out and a dollar sukuk issue helps to make up the financing shortfall.
- Some combination of any or all of the above - or Egypt goes bust.
But even if the sukuk deal materializes, it will take some time to get off the ground, with many hurdles - including achieving consensus on a shariah-compliant product and ring-fencing physical assets to back the structure against, before a roadshow kicks off and the deal is priced. And yet, the clock is ticking. Above all, Egyptian policy-makers need to flesh out a vision for its medium-term financing plan and economic blue-print for action, in order to give confidence to the markets, both sukuk and conventional.