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EM Monitor - Growth opportunities in the current environment

March 2020

Looking beyond the coronavirus - Ukraine and Egypt

Even in extraordinarily tough markets like we're currently experiencing, opportunities remain.  Find out why Ukraine and Egypt could lead the way once we are past the worst of the Covid-19 outbreak.

Two countries with similarly improving fundamentals

Despite high public debt, both countries are showing encouraging growth prospects, increasing their capacity to reduce debt.

Ukraine is a net debtor, fully dependent on foreign capital flows. At 50.8 per cent of GDP in Q2 20191, the country’s public debt is still too high and unsustainable. 

However, the prospects of an IMF loan deal should be very favourable to foreign capital flows and FX reserves build-up.

The conditions imposed to Ukraine for an IMF loan to be accepted are:

  • Strengthening of rule of law & fight against corruption
  • Competition enhancing measures & markets opening-up
  • Role of the state & oligarchs to be lowered
  • Prudent fiscal policy to ensure medium-term debt sustainability, central bank independence & financial stability

Discussed last December, the deal would entail a 3-year extended fund facility arrangement of SDR 4 billion (~USD 5.5bn), close to 4 per cent of GDP.

Egypt successfully completed its IMF programme in late 2019, leading to a flexible exchange rate regime, a reduction in fuel and electricity subsidies, tax revenue increase and a better business environment. The country’s twin deficit has narrowed and its reserves have reached comfortable levels (Fig.1).

Egypt has accumulated ample FX reserves
Fig.1 - Egypt FX reserves
Fig.1 - Egypt FX reserves

Source: Pictet Asset Management, CEIC, Refinitiv, Bloomberg. Data from January 2000 to January 2020.

Egypt’s public debt (101.2 per cent of GDP in Q3 20192) is on a downward path thanks to fiscal consolidation. The current account deficit has decreased (-2.1 per cent of GDP in Q2 vs -5.1 per cent in Q1 20193) thanks to remittances, the service balance (tourism) and a weaker trade deficit. The country's healthy foreign direct investments (FDI) support the latter and show Egypt does not have a structural external funding issue.
Foreign investments in Egypt remain strong
Fig.2 - Egypt's financial account breakdown
Fig.2 - Egypt's financial account breakdown

Source: Pictet Asset Management, CEIC, Refinitiv, Bloomberg. Data from January 2011 to Q2 2019.

In addition, monetary policy has been sufficiently tight to reduce inflation from 33 per cent in July 2017 to 7.2 per cent in January, keeping real rates high to compensate for higher geopolitical premium, attract further portfolio inflows and minimise the risk of inflationary slippage.
Tight monetary policy has worked in Egypt
Fig.3 - Egypt - Inflation & Policy rate
Fig.3 - Egypt - Inflation & Policy rate

Source: Pictet Asset Management, CEIC, Refinitiv, Bloomberg. CPI and core inflation data from January 2011 to January 2020. Overnight facility data from January 2011 to February 2020.

Favourable growth prospects for both countries

In Ukraine, our growth leading indicator remains well oriented despite recent loss of momentum (see fig.4). Stronger growth in 2020 should be supported by domestic demand on rising real earnings given substantial disinflation.
Our proprietary growth indicator remains strong
Fig.4 - Pictet Asset Management leading indicator for Ukraine
Fig.4 - Pictet Asset Management leading indicator for Ukraine

Source: Pictet Asset Management, CEIC, Refinitiv. Data from January 2014 to February 2020.

Standing at 3.1 per cent year on year in January 2020, CPI inflation is below the central bank target of 5 per cent, which should support further policy rate cuts and trigger lower borrowing interest rates and domestic credit pick-up.

At the heart of Ukraine’s market’s opening-up measures is the land reform, which seeks to end a moratorium started in 2001 on land sales and their use as bank collateral. The aim is to boost private investment and agricultural productivity. Harvest output would be significantly boosted this year.

Similarly, Egypt’s 2020 growth prospects look positive (around 5%) despite our leading index loss of momentum (Fig. 5). Growth has been driven by CAPEX with state and foreign investments in the construction and energy sectors (Suez Canal developments), as well as net exports. With the discovery in 2015 of the giant Zohr gas field (30 trillion cubic feet of gas), Egypt may become a net exporter of natural gas in 2020.
Our growth indicator showing expected positive growth for Egypt
Fig.5 - Pictet Asset Management leading indicator for Egypt
Fig.5 - Pictet Asset Management leading indicator for Egypt

Source: Pictet Asset Management, CEIC, Refinitiv, Bloomberg. Data from January 2018 to January 2020.

What are the main risks?

In Ukraine, recent government re-shuffling impact on sentiment and reforms implementation speed. Delay in an IMF deal would be detrimental to foreign capital flows and investor sentiment. Military escalation in the Donbass region also weighs on businesses and reform implementation.
But unlike many other countries in the world, at time of writing, Ukraine only has mild exposure to Covid-19 supply chain disruptions, and at time of writing, the number of contaminations remains among the lowest in Europe4.

In Egypt, high interest rates are likely to be a drag on non-oil private growth. With single-digit inflation and elevated real rates, the Central Bank has enough room to stimulate further (rates cut by 300 bps on 18 March). Despite the easing, interest rates remain attractive enough for portfolio inflows. The main risks in Egypt are domestic security conditions, under pressure remittances due to the regional oil shock and Emerging Markets sell-off leading to capital outflows. Tourism is now to be added to this list in view of the Coronavirus pandemic.

 

In brief

Ukraine’s fundamentals are still weak but improving.

The prospect of the country starting an IMF programme should stimulate more foreign capital flows and FX reserves build-up. What’s more, the country’s exposure to the Covid-19 pandemic is among the lowest in Europe. As its economic growth is expected to be driven by domestic demand, this should reinforce the case for Ukraine relative to the rest of Europe.

In Egypt, growth, external debt, current account, import cover metrics are comfortable.

The Covid-19 outbreak and the regional oil shock exert pressure on tourism and remittance incomes. However, we think Egypt can hold out in the current environment.