June 7, 2013 8:08 pm

The hieroglyphs are on the wall for Egypt

John Dizard warns Cyprus was the last straw for the IMF – there are no more straws for Egypt
Men sell bread as they balance the trays on their heads near Al Hussein mosque in Old Cairo

Flounder, you can’t spend your whole life worrying about your mistakes! You f . . . d up . . . you trusted us! Hey, make the best of it! Maybe we can help.

“Otter”, Animal House, 1978

Now even the global macro investors and bankers have a Washington-disastrous-incompetence-admission-then-denial-of-error mess to talk about: the International Monetary Fund’s so-called mea culpa over its role in the troika’s calamitous Greece programme. Unlike some, I’m too nice to say “I told you so at the time”. All right, I did.

The real significance of the IMF’s statement (Greece: Ex-Post Evaluation of Exceptional Access under the 2010 Stand-By Arrangement), is what it suggests about the fund’s actions, and those of other lenders who follow its lead on lending to distressed sovereigns, next time a big, politically important country is in trouble.

For example: Egypt. Ever since the country’s 2011 democratic revolution, the IMF has been in negotiations over the terms on which it would advance the money to support “reforms”. In the Egyptian context, that means moving from the government handing out heavily subsidised bread and fuel to supporting the development of prosperity through employment of the people in more productive work. Easy to say.

What’s on offer from the IMF is $4.8bn, but that is subject to the Egyptian government agreeing to something closer to market pricing on food and fuel, substantially reducing the waste and fraud in what is supposed to be poverty relief, imposing income taxes, etc. The usual.

The Egyptian government has never agreed to any of this, and doesn’t look as though it will in the foreseeable future. Any agreement along those lines would probably result in the population going not only into the streets, but through the police barriers. Also, they have read lots of European and US commentators saying that Egypt is too big to fail. So they think they can get that cash, and more, without agreeing to enforceable “conditionality”, or economic reforms.

Could the Egyptian government be wrong? There are many examples of states, and even empires, that were not too big to fail, but too big to save.

The Greece Ex-Post Evaluation tells me that the IMF staff and most of its board are so upset by the loss of “the building’s” credibility that they will take a hard line with the next member government across the table.

In the fund’s committee-language: “The report considers the broad thrust of policies under the programme to have been appropriate. Rapid fiscal adjustment was unavoidable given that Greece had lost market access and official financing was as large as politically feasible. Competitiveness-boosting measures were also essential, as were fiscal structural reforms to support deficit reduction. However, the depth of ownership of the programme and the capacity to implement structural reforms were overestimated.”

Note the phrase “depth of ownership”. That means that “the building” doesn’t want to sign any more deals that are based on fictitious commitments. The Cyprus bailout was the last straw, the IMF is saying. No more straws.

Furthermore, the IMF is aware that if they do front the $4.8bn, that money will already have been spent. Along with food imports (Egypt is the largest wheat buyer in the world), Egypt is now a big fuel importer. Libya and Qatar are providing supplier credits for fuel, but insisted on repayment within the next 18 months. The IMF’s programme money would just cover those commitments.

So an “orderly” resolution of Egypt’s insolvency is not on the cards. How about a disorderly resolution? And, apart from the humanitarian considerations, what does this mean for international investors?

At the beginning of this year, we were looking back at a counterintuitive rally in Egyptian-listed equities. It now appears that local investors with cash locked up in not-fully-convertible Egyptian pounds were buying shares in companies with assets outside the country, a form of legal capital flight. Now the crowd has moved on, and there is an accelerating bear market.

Most of Egypt’s foreign debt is in the form of official or semi-official loans that don’t trade. There are, however, two significant Eurobond issues, one a $500m issue due in 2040, the other, more widely traded, a $1bn issue due in 2020. That has a 5.75 per cent coupon, and is being offered at a bit less than 90, for a yield of 8.9 per cent.

This suggests the holders believe that while Egypt’s economy is in rapid decline; its foreign exchange resources are coming in, at best, on a hand-to-mouth basis; and its bond ratings have plunged into the Cs, there is little default risk to price in.

There is a Roadrunner-over-the-cliff aspect to this picture.

The Egyptian government appears to believe that it can raise something in the order of $10bn annually from next year through the issuance of sukuk bonds, which are supposed to be Islamic law-compliant because they do not guarantee a fixed rate of interest. This way, the country is supposed to avoid the strictures of the IMF and bond rating agencies.

In real life, Muslim sukuk investors in the Gulf states, Asia and London look for more certainty than is on offer in Egypt, having even less security than they do with Western-law bonds. The borrower can get a 30 to 50 basis point break on the coupon, but it’s not free money.

There are a lot of buying opportunities (that is, price plunges), coming in emerging market debt, thanks to the shortage of dollar liquidity that will only get worse in the months and even years to come. Egyptian Eurobonds may well be a good bet at some point, since they really are a small part of the country’s economic and financial burden.

Unfortunately, it seems a near-cert that it will take a much worse situation to motivate foreigners to put up anything like the cash that Egypt needs to pay for critical imports, never mind debt service. Stay away.

john dizard@ft.com

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