Effectively priced out of the international bond market, the Ministry of Finance has been compelled to turn to the domestic banking sector to meet the demands of the state budget. For local banks faced with reduced borrowing demand, the easy yield offered by a steady supply of treasury bills (T-bills) represents an attractive route to growth. However, the government has paid a high price for its reliance on local lenders. After ramping up its T-bill programme in 2011, yields on government debt surpassed 13.5% for a nine-month note by October 2011. The decision to reduce the local currency reserve requirement on banks to increase liquidity brought only momentary relief: during April 2012, yields on government securities began to decline as the regulatory change took effect and the banks directed their excess liquidity towards T-bills, but by the following month the effect had run its course and yields on the government’s weekly offerings began to climb once more. An auction on May 3, 2012 saw record prices, with 182-day bills selling at 15%, while 357-day bills climbed as high as 15.7%. Since then, domestic banks have become accustomed to securing government debt at between 14% and 15%.
CONSEQUENCES: The government’s resort to large-scale T-bill issuances has altered the exposure profiles of Egypt’s banks. According to Central Bank of Egypt (CBE) data, just LE149bn ($21.2bn) of aggregate banks’ exposure in 2008 was to government debt, with lending activity (LE401bn, or $57.1m) and balances with other domestic banks (LE278bn, or $39.6bn) accounting for much higher portions of the overall exposure in the banking system. By November 2012, however, the credit profile of Egypt’s banks had changed markedly: exposure to government debt now represented the single-largest credit concentration in the sector, at LE536bn ($76.3bn), exceeding balances with domestic banks, which were nearly two-thirds smaller than in 2008 (LE102bn, or $14.5bn), and even accounting for a greater share of overall exposure than lending activity, which stood at LE512bn ($72.9bn).
The preponderance of government debt on balance sheets represents the largest credit risk facing the system, and one which has had a negative effect on credit ratings. Since the 2011 uprising, Egypt’s sovereign rating began a gradual downward trajectory which, by May 2013 had seen the three-largest credit ratings agencies make 16 downward revisions among them.
DOWNGRADES: Moody’s was the first to act, cutting Egypt’s credit rating in January 2011 from Ba1 to Ba2, and by the following month both Standard & Poor’s (S&P) and Fitch had followed suit in dropping the nation a single notch on their systems. Ongoing political turbulence was cited as the reason for further drops over the course of 2011, and by February 2011 S&P had lowered Egypt to B status, five steps below investment grade. A weakening external payments position, the failure to secure an important IMF loan and falling confidence in the elected Freedom and Justice Party’s ability to enact a credible economic agenda saw a further deterioration of the sovereign rating over 2012 and into 2013. By May 2013 Moody’s and S&P had moved Egypt to Caa1 and CCC+, respectively, which places the country’s long-term debt in the “substantial risk” category according to the definitions of both companies, and only two grades away from default. Fitch, meanwhile, cut the sovereign long-term rating from B+ to B in January 2013, placing the country in the “highly speculative” category. The descent of Egypt’s sovereign rating coupled with the exposure of the sector to sovereign debt has, in turn, had a direct bearing on the credit rating of Egypt’s banks. In March 2013 Moody’s downgraded the local currency deposit ratings of five lenders due to the “government’s reduced capacity to support the banks; the high credit linkages between the banks’ balance sheets and sovereign credit risk; and the downgrade of the foreign currency deposit ceiling for Egypt”. National Bank of Egypt, Banque Misr, Banque du Caire and Commercial International Bank moved from B3 to Caa1 (or, from “highly speculative” to “substantial risks”), while Banque Alexandria fell from B1 to B2 (a degeneration within the “highly speculative” band).
TREND SPOTTING: In 2013, in spite of several multibillion-dollar infusions first from Qatar, then from Kuwait, the UAE and Saudi Arabia after the removal of the Morsi administration, the government’s reliance on T-bills to meet its financial obligations shows little sign of abating, despite some public pronouncements that suggest that it is aware of the problematic nature of its current strategy. In May 2013, the recently appointed minister of finance, Fayyad Abdel Moneim, announced that Egypt was weighing the possibility of refinancing its debt, stating that the ministry was “considering loans from the Central Bank of Egypt at the announced rate instead of resorting to the Treasury bill mechanism at 13%.”. While little detail is known about the proposal, the ministerial statement implies that the government would borrow from the central bank at the less costly interbank rate of 10% in order to reduce the amount of government securities it is selling to banks for considerably higher yields. This strategy carries a number of potential risks – chief among them the erosion of the CBE’s independence from the government and the perception that it is acting more as a ministry of finance than a central bank. By the end of the first half of 2013 the government had yet to elaborate on any possible change to its T-bill policy, and the major credit rating agencies remained convinced that the banking sector’s already significant exposure to government debt will only increase as a result of continuing fiscal deficits and an absence of foreign funding.
The long-term solutions to Egypt’s funding problem are as much political as economic. Peaceful and credible elections, increased confidence in the economy following a loan from the IMF, a return of rising trade and investment and a concomitant improvement in Egypt’s external position are all crucial to the recovery of the nation’s balance sheet. “If we are successful in our negotiations with the IMF, we will see many of our problems subsiding because it will prove we have a viable economic programme,” Sherif M Elwy, deputy chairman of the National Bank of Egypt, told OBG. Until then, however, the aggregate credit portfolio of Egypt’s financial institutions is likely to remain notably unbalanced.
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