Egypt: Budget deficit widens 8% y/y to EGP 411bn in Jul-Apr

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• As percent of full-year GDP, fiscal gap edges down to 5.2% of GDP as economic growth outpaces increase in deficit
• Tax revenues rise strong 15% y/y mostly due to higher VAT revenues, however, outlook has deteriorated
• Interest payments accounted for 65% of tax revenues in Jul-Apr and remain major credit weakness
• Spending on subsidies rises 18% y/y; social payments jump 14% y/y because of Treasury contributions to pension funds
• War in Europe to cost additional EGP 15bn for subsidy in current FY

Egypt's overall fiscal deficit widened by 8.2% y/y to EGP 411bn (USD 22.1bn) in the first ten months of FY 2021/22 (Jul-Apr), as strong y/y increase in interest payments, social spending, grain subsidy, and purchases of goods and services outpaced strong y/y increase in tax revenues, according to the finance ministry's monthly report. Interestingly, the fiscal gap-to-GDP ratio narrowed to 5.2% from 5.5% a year ago, because of strong nominal GDP growth. Egypt's economic growth has been resilient to the COVID shock, supported by large public investments, telecoms and trade, which has helped the government focus on its fiscal reform program. The finance ministry succeeded in extending the debt maturity to 3.4 years in June 2021 (compared to 1.3 years in June 2013) and plans to extend the maturity profile of its debt to 3.8 years by the end of June 2022. The budget deficit target was revised a couple of time since Russia invaded Ukraine in late February, but now it stands at 6.1% of GDP compared to the initial target of 6.7%. Following the surge in global wheat and fuel prices, the government said the subsidy bill will increase by EGP 15bn while the increase of interest rates by the central bank added another EGP 6bn in higher interest. The government revealed in March EGP 130bn stimulus package that includes increased spending on social security and measures to support the stock exchange.

The government recorded a primary surplus of EGP 59.7bn (0.75% of GDP) in Jul-Apr, compared to a primary surplus of 0.7% of GDP a year ago. The government has continuously confirmed its commitment to its reform program, which is built around fiscal consolidation and primary surpluses, but the conflict in Europe forced the government to lower its primary surplus target for FY 2022/23 to 1.5% from 2.0%. Egypt has also reached out to the IMF, which we see as further commitment to reforms. The IMF has been pleased by Egypt's commitment to reforms and commended the recent policy steps, which include 15% pound devaluation and a cumulative 300bps interest rate hike. Egypt still needs to enhance revenue mobilization in order to lower the high public debt and large gross financing needs.

Budget implementation FY-to-date

In the breakdown, fiscal revenue rose by 9.8% y/y to EGP 919bn in Jul-Apr, accounting for 11.6% of full-year GDP. Tax revenues rose robust 15% y/y to EGP 725bn driven by VAT as the COVID pressure on consumption eased in 2021 and early 2022. Income tax revenue rose 6% y/y, and tax revenues from Suez Canal edged up to EGP 28. We remind the Suez Canal Authority has raised transit fees by about 6% in February and announced additional fees on petroleum tankers. Meanwhile, non-tax revenues fell by 7% y/y to EGP 194bn driven by lower non-grant miscellaneous revenues. We remind the government has worked on a medium term revenue strategy in which it aimed to increase tax revenues by 2% of GDP over the next four years by integrating the informal economy into the formal economy, expanding the tax base, and collecting public treasury dues. The linking of tax and customs databases was scheduled to be completed before the end of 2022 and there has been some progress in digitizing the tax system. However, the war in Europe is expected to have a negative impact on Egypt, through lower tourism revenue, higher subsidy and social security spending, while higher consumer inflation will drag on real disposable incomes and demand and may ultimately weigh down on tax revenues in 2022.

The total expenditure rose strong 10.2% y/y to EGP 1,332bn in Jul-Apr, which accounts for 16.8% of GDP. The increase in spending came on the back of higher interest payments, wages, and subsidy and social payments. Interest payments rose sharp 10% y/y to EGP 471bn and account for 35% of total spending and 65% of tax revenues in the period. Debt service costs are thus the single largest category in spending and constitute a major credit weakness. Domestic debt had risen sharply driven by persistent and large fiscal deficits. The government had launched an ambitious fiscal consolidation program, underpinned by primary surpluses and tax reforms. Following the COVID-19 outbreak, gross public debt has reversed its downward path and rose for second year in a row, reaching 90.6% of GDP as of June 2021 from 86.6% a year before that. The war in Europe may again halt the reduction of public debt, because of higher interest rates and financing costs, larger fiscal deficits, and smaller primary surpluses. According to IMF projections, public debt will peak out at 94.0% of GDP as of June 2022, but will start falling afterwards, reaching 80.7% of GDP in 2027.

Public investments fell 5% y/y to EGP 174bn, which came from high base as the government has stepped up investments in construction, and machinery and equipment. The expenditure on social benefits rose by sharp 14% y/y to EGP 132bn, because of increased contributions from the treasury to the pension funds. Meanwhile, subsidy payments rose by strong 18% y/y to EGP 93bn, mostly due to higher subsidy to the state grain buyer GASC (up 12% y/y). Egypt had eliminated all fuel subsidies (excluding on butane gas cylinders, and fuel for bakeries and electricity plants), and was planning to reduce the costly bread subsidy before Russia's invasion of Ukraine. The government had signalled the bread subsidy would be reduced gradually, but the uncertainty around global wheat supplies and prices may force the government to postpone its plans. Bread prices are a very sensitive issue in Egypt and given the mounting inflationary pressures on the population, it will be a risky political move. Egypt has announced an increase in social security spending as a result of higher consumer inflation, and had also raised pensions and the minimum wage for public servants by 20% from July 2021.