By Yomna Mohei Eldine,
Harvard Kennedy School
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Context of the “Mega-Deal”
Since the Russia-Ukraine war broke out in February 2022 and the resulting $20bn capital outflow, Egypt has come under scrutiny. Experts and investors have diverging views when it comes to Egypt’s prospects. Some predict economic turmoil and a possible default, while others anticipate that the international community will need to provide a bailout, with the country being considered “too big (or too strategic) to fail”.
Egypt faces two key challenges when it comes to financing. Firstly, a lack of funds due to a foreign liquidity squeeze, which led to credit downgrading. Secondly, a growing perception that regional partners’ support for the Egyptian economy is declining. Moreover, a series of privatization transactions in late 2023 failed to completely reassure credit rating agencies and investors. As a result, the February 2024 announcement of a UAE deal is seen as a game-changer for Egypt.
On February 23th, Egypt’s Prime Minister Madbouly announced a “Mega Deal” between Egypt and the United Arab Emirates’ investment and holding company ADQ. The deal involves a $35bn investment in a major development project in Egypt’s Ras Al-Hikma region, around 300 km West of Cairo. The project aims to build a touristic and residential hub along the Mediterranean, as well as a financial and business district, a free zone, an investment zone, and an airport. Egypt will retain 35% shares in the project and intends to remain a strategic partner.
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Filling the external financing gap
The deal announced $24bn in fresh flows, which was a lifeline for the country, and $11bn to be swapped from the existing UAE deposits at the Central Bank of Egypt. This effectively transfers almost all of UAE deposits at the CBE to FDI flows. As of September 2023, UAE deposits at the CBE stood at $5.6bn and $1.4bn for medium and long-term deposits and currency swap agreements, respectively. Moreover, total short-term deposits by Arab states amounted to $20.7bn, of which the UAE is thought to own a reasonable share.
With central bank reserves standing at $35.2bn as of December 2023, the UAE deal represents a significant increase in foreign liquidity for the Egyptian economy. With a 2022 GDP in current USD terms of 477 Bn, the ”Mega Deal” represents around 7% of the country’s GDP. In addition to the deal’s large ratio of GDP, it also has a significant effect on Egypt’s external financing needs.
While it is hard to accurately gauge Egypt’s external financing gap, we can use the current account deficit forecast from the latest World Economic Outlook and the external debt payment schedule from the latest IMF Article IV, to get a rough estimation of Egypt’s external financing needs. For 2024, the current account deficit forecast is $8.5bn, and the debt amortization estimate is $13.1bn, which altogether makes Egypt’s financing need for 2024 stand at $22bn, excluding GCC deposits at the CBE. In 2025, the forecasted current account deficit is expected to increase to $10.5bn-$11bn, while the debt amortization estimate is likely to decrease to around $12.7bn, leading to gross external financing needs of $23bn.
With an average FDI net inflow of $8bn-$9bn over the last 3 years, the $35bn Ras Al-Hikma deal is a significant positive shock to Egypt’s available financing. Assuming that Egypt maintains its annual FDI inflow average, the UAE deal will be enough to cover the rest of the gross financing needs for 2024 and 2025.
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Turning around market perceptions
The announcement of the deal was welcomed positively by both global and domestic markets. This triggered a series of positive shocks for the Egyptian economy, indicating that the deal exceeded the market’s expectations. On the day of the announcement, Egyptian bonds rallied with the 8Y USD bond yield decreasing from 13.5% on February 25th to 10.08% on March 6th and then further decreasing to 10.04% on March 8th following the CBE decisions. Similarly, the domestic market reacted favorably, with the USD/EGP rate appreciating in the black market from USD/EGP 63 to USD/EGP49 in the 2 days following the deal’s announcement.
Figure 1: Egypt 2032 Eurobond YTM
Source: Bloomberg
During a press conference on March 6th, Egypt’s Prime Minister announced that an agreement had been signed with the IMF to expand the original $3bn 46-month Extended Fund Facility that the IMF struck with Egypt in December 2022. The agreement was expanded by $5bn, bringing the total funding to $8bn. Although the IMF did not explicitly state that funding from regional partners was a prerequisite to continue the December 2022 EFF program, the signing of an expanded agreement days after the announcement of the Mega Deal indicates that the financing from the UAE had favorable effects on sealing ongoing negotiations with the IMF. A senior IMF official stated that the Mega Deal was separate from the fund’s negotiations, but acknowledged that the UAE deal had alleviated near-term financing pressures.
Hours before the Prime Minister’s announcement of the extended IMF deal, the CBE let the currency float and raised interest rates by 600 basis points in a special Monetary Policy Committee meeting. The large volume of fresh funds from the UAE deals relative to CBE’s foreign reserves provided the central bank with additional liquidity to introduce flexibility into the exchange rate system without risking excessive overshooting from speculation transactions in the domestic market or global markets. With the exchange rate in the parallel market decreasing from a peak of 73 USD/EGP in January to 48 USD/EGP on February 29th, the depth of depreciation required to eliminate the parallel market and bring remittances back into the banking sector had decreased. Following the floatation decision, the exchange rate in the official market increased from 30.4 USD/EGP on March 4th to an average of 50.4 USD/EGP on March 6thth, effectively eliminating the black-market premium. The monthly headline inflation rate for February 2024 has been recorded at 11.4%, which represents a significant increase from the 1.6% rate of January 2024, reflecting the impact of the earlier depreciation of the Egyptian pound that was observed in December and January. Therefore, it is not expected that the official depreciation in March will have a significant impact on March inflation rates given that the depreciation has already been factored in through the black-market rates. Nevertheless, the impact of the official depreciation on fuel prices and subsequent wage increases cannot be dismissed, and inflation in Egypt could hover around the 30% level at year-end.
The good news kept on pouring with the announcement of a Euro 7.4bn financial and investment support package between Egypt and the European Union, representing another nod of political support for Egypt. The package includes Euro 5bn in concessional loans, Euro 600Mn in grants, and Euro 1.8bn of FDI. The investment aspects of the package are dedicated to projects in energy transition, green transition, digital transition, and food security. The EUR500Mn grant includes EUR200Mn dedicated to increasing EU-Egypt cooperation on migration efforts. This includes fighting human trafficking and illegal migration as well as facilitating legal migration. The largest pillar of the package, i.e. Euro 5bn in concessional loans, aims to provide foreign liquidity to stabilize Egypt’s external imbalances and support to regain macro stability and attract investments.
In March, the CBE raised its interest rates by 600 basis points and officially lowered the value of the Egyptian pound. This move managed to reposition Egypt on the list of attractive carry-trade investments, with real rates currently approaching the positive territory. The risk of further depreciation has decreased thanks to the influx of USD to the Egyptian economy, contributing to the CBE’s foreign reserves increasing to USD40.4 in March, the highest level observed since February 2022. Thus, the increase in interest rate represents a high-yield opportunity for portfolio flow investors. In March 2024, the yield spread between Egypt's 3-month local currency yield and the US 3-month T-bill yield reached a new record. The yield differential will only increase over time as US rates decrease, while rates are expected to remain tight in Egypt in the medium term to control inflation. Accordingly, portfolio flow investors have already started pouring their money into Egypt, with demand for the 364-day bill surging to an all-time high of EGP400bn in March.
Is this time different?
The Ras Al-Hikma deal is not ADQ’s first investment in Egypt. In 2023, the Dubai-based fund purchased shares in three key petrochemical state-owned companies as well as a 31% stake in Egypt’s major steel company, Ezz El-Dekheila. ADQ’s presence as a strategic partner in Egypt can create positive spillover effects given the fund’s mission to accelerate the transformation of the Emirates into a knowledge-based economy. ADQ can play an important role in bringing new know-how into the Egyptian economy through its investments in multiple state-owned companies. With skin in the game through direct investments in multiple sectors, the UAE and ADQ can play a pivotal role in meaningfully pushing the privatization agenda and constraining vested interests that benefit from the continuation of the state’s economic footprint.
Large privatization deals during periods of economic downturns are not new to Egypt. In 1991, coinciding with the 1991 standby agreement with the IMF, Egypt passed Law 2003 with the aim of privatizing more than 300 public-sector companies. In the early 2000s, the Nazif government undertook more privatization efforts, the largest privatization deal at the time being the sale of a majority share in the Bank of Alexandria.
According to the Marshall Lerner condition and J curve theory, a sharp depreciation is expected to initially worsen the trade balance. However, over time, this can lead to a new equilibrium with enhanced trade balance and an expansionary effect, provided that the elasticity of imports and exports to prices in local currency is high. A sharp depreciation can benefit the trade balance in two ways. Firstly, as the relative price of tradable goods increases compared to non-tradable goods, producers are expected to increase their production of tradable goods to export them and benefit from the increased profits. Secondly, as the price of tradable goods increases relative to non-tradables, Egyptian consumers are likely to decrease their demand for non-tradables, leaving more quantity to be exported.
On the other hand, sharp depreciations can have contractionary effects on the Egyptian economy. This is because it leads to an increase in the price of imported goods, which can also limit the ability of exporters to access raw materials and intermediary goods, which are required to increase their production. Additionally, the interest rate hikes required to bring down inflation are also expected to have a contractionary effect on the economy.
While this deal is likely to represent a bailout lifeline to Egypt, one question continues to linger: “is this time different?”. The 2023 depreciation is not the first episode of sharp depreciation for the Egyptian economy. A similar depreciation episode happened in 2016, with little impact on the non-mineral trade balance. 2003 also had a similar episode of large depreciation, accompanied by privatization efforts. However, this time, the regional support to Egypt through FDI to the real economy represents a higher quality of flows that can boost Egypt’s services exports, particularly through tourism. Yet, tourism remains a vulnerable source of foreign currency income compared to good exports, as it can be affected by regional or domestic security concerns.
While Egypt’s regained access to capital markets is good news for the country’s reform story, reliance on flows from portfolio investors can temporarily mask external vulnerabilities and leave countries vulnerable to “sudden stops”, similarly to what happened to Egypt following the Ukraine war. Therefore, the question remains whether Egypt can turn this fresh start into a period of private sector-led growth, with increased goods exports and sustainable enhancement in its external sector vulnerabilities.
Table 1. Balance of Payment estimates for 2024-25, before and after the Mega-Deal
| 2024 | 2025 | |
| - Current Account Deficit[1] | 8.5 | 10.5 |
| - Amortization, excluding GCC deposits at CBE[2] | 13.1 | 12.7 |
| Gross Financing Needs | 21.6 | 23.2 |
| Original External Financing Estimates | ||
| -FDI estimates before Mega deal[3] | 8 | 8 |
| - Portfolio Investments [4] | 2.8 | 3.5 |
| Funding Gap | 10.8 | 11.7 |
| -Mega Deal | 24 | 0 |
| -IMF Expanded Program | 3 | 3 |
| Current Funding Gap (- is surplus) | -16.2 | 8.7 |
[1] October 2023 WEO estimates
[2] July 2021 IMF Article IV
[3] Average FDI inflows 2018-2023
[4] Average of JP Morgan and Goldman Sachs estimates