Egypt faces financing bottleneck

10 August 2015

Cairo has a huge demand for finance, but local banks are thinly stretched by government borrowing while international lenders are wary of currency risk

Egypt’s government is committed to kick-starting the economy, which has suffered from years of underinvestment and then political uncertainty following the 2011 Arab uprisings.

Cairo estimates it needs between $200bn and $300bn to invest in infrastructure and job-creating projects to revive its economy and provide jobs for a growing population. But securing the sources of this funding will be a major challenge, and could mean many of the planned projects are impossible to implement.

With the government budget already stretched to the limit, Egypt is hoping to attract financing and foreign direct investment (FDI) to fund the majority of its schemes. Gulf states have pledged $130bn of investment in Egypt.

Stalled projects

Egypt has promised much, to huge publicity, but has yet to deliver.

On 6 August, the inauguration of the Suez Canal expansion was held amid much pomp and ceremony. It was hailed as a gift to the world and as a symbol of Egypt’s rebirth. But other projects championed by President Abdul Fattah al-Sisi have failed to move forward.

Megaprojects such as the UAE-based Capital City Partners’ $45bn Capital City have already stalled. The project’s delay is reportedly over financing disputes, with the Egyptian government insisting the project is financed from abroad rather than by thinly stretched local banks.

[Cairo needs] to decide how to prioritise, as the number of projects exceeds the capacity of financiers

GCC-based project finance banker

International financiers that traditionally dominate project finance are keen to expand their position in the important Egyptian market. But they are held back from committing equity and debt by currency risk worries, as Cairo’s supply of dollars remains limited.

Lenders are inundated with requests and are calling on the government to streamline its investment plans. “They need to decide how to prioritise, as the number of projects exceeds the capacity of financiers,” says a GCC-based project finance banker. “There are one or two megaprojects which, if they go ahead, will drain liquidity. There is not an infinite amount of funding.”

Local banks

With international lenders reluctant to commit, a large burden will inevitably fall on domestic banks, which are already stretched by government borrowing and are unwilling to lend to infrastructure schemes.

A recent report by US-based Moody’s Investors Service on Egyptian banks found they were exposed to government debt to the tune of £E843bn ($118bn), or 43 per cent of assets, an amount that is expected to increase. This means capital buffers are tight, with an equity-to-asset ratio of 6.6 per cent.

The Egyptian banking sector weathered the years of upheaval beginning in 2011 well, with non-performing loan ratios remaining at manageable levels of about 8 per cent.

“Domestic banks didn’t lend much for a few years when the market wasn’t moving, so they have built up a war chest,” says the GCC-based banker. “But there are so many projects, and if someone goes to Egyptian banks for an $800m or $900m project, then they don’t have appetite for $10m-$50m wind farms.”

Growing deposits

Local banks have some capacity to lend in Egyptian pounds, which will benefit local companies with mainly in-country supply chains. This is thanks to a strong base of customer deposits, partly built up through remittances totalling more than $45bn a year, which allows the banks to finance lending, says the Moody’s report.

This deposit base, which is growing at more than 20 per cent a year, means the banking sector avoids the cost of relying on the market for funding. On the other hand, it may mean local banks have a poor appetite for infrastructure or even real estate lending.

“There is a mismatch between the type of project and local finance, even if they have enough money,” says Wahdan al-Sherif, a Cairo-based financial adviser. “Most savings are short-term while infrastructure finance is long term and therefore needs longer-term institutions such as pension funds.” Pension funds are underdeveloped in Egypt due to the current environment and frameworks.

Banking sector liquidity will eventually become stretched if lending accelerates. Loan growth has already reached 19 per cent a year, according to Moody’s.

While Egypt’s central bank has the ability to print money to boost liquidity, it will be cautious in doing so to avoid stoking inflation, which was already at 11.4 per cent year-on-year in June.

International lenders

The limited role the domestic banking sector can play means that international banks, which have the asset base for project finance lending, are the focus for clients and developers.

“Banks are supportive, but they are still waiting to see how the market is developing,” says the GCC-based project finance banker. “My team can’t cope with the volume of projects. Egypt needs to clarify what it is going to work on.”

The ongoing negotiations for a $3.7bn loan to cover part of German firm Siemens’ $9bn contract to build three power plants and 2GW of wind power are promising. This suggests that for priority projects, international lenders – in this case the UK’s HSBC, and Germany’s Deutsche Bank and KfW-Ipex Bank – have the appetite for large tranches of debt.

The key element of the deal is the involvement of France-based export credit agency (ECA) Euler Hermes. It insures the banks against any problems they may have in converting Egyptian pounds to dollars to expatriate their profits.

Export credit

ECAs will not be able to guarantee every financing deal, especially on long-term public private partnership (PPP) projects, as they only cover the construction stage. Currency risk is the main worry for investors.

“Irrespective of the involvement of ECAs, projects will need to manage a long-run, dollar-denominated financing while being paid in local currency,” says Clint Steyn, a partner at US law firm Bracewell & Giuliani, which is working on feed-in-tariff renewables schemes in Egypt. “With a locally denominated tariff, the availability and transferability of dollars will remain a concern for developers and some lenders. Developers are still worried there will not be enough dollars.”

Egypt’s supply of foreign reserves has inched up over the past few months to just over $20bn, after reaching lows of $15bn in early 2015. The central bank’s decision to devalue the Egyptian pound against the dollar has also encouraged FDI.

The rebound of the $20bn tourism market, remittances, Suez Canal revenues (estimated at $5.3bn in 2015), and Gulf support through $6bn of long-term deposits in the central bank, have all contributed to the recovery.

Intervention argument

Confidence is just as important as reserve levels for FDI and lending. From the Egyptian side, currency risk is simply a factor that investors have to allow for.

“If FDI doesn’t come in, there are no dollars, and that discourages FDI,” says Al-Sherif. “The government can’t say it will provide hard currency, and everyone knows what the sources are in Egypt – it’s quite transparent. Some people will invest anyway and might make 20 per cent returns, but it’s riskier.”

Foreign developers disagree, and are lobbying the Ministry of Finance to provide guarantees that it will make dollars available in case of scarcity. No decision has been publicised.

Availability is only part of the problem; late payment, allocation of the hard currency available and repatriation of funds are also causes for concern. The central bank is thought to be prioritising the allocation of dollars to strategic sectors, although this has not been officially confirmed.

Development banks

Development banks are showing themselves willing to finance vital infrastructure projects such as sanitary networks, renewables schemes and investment in the electricity grid.

While these institutions do not report an overwhelming rush of funding requests, they play an important role in setting up financing frameworks and increasing commercial banks’ and investors’ confidence in the market.

The most recent loan was worth $550m and was granted by the Washington-based IMF to improve rural sanitation networks. Other funds such as the European Bank for Reconstruction & Development and the European Investment Bank are working in the power generation sector, financing the Damanhour combined-cycle power plant, which is worth $1.3bn.

Resource allocation

But this draws resources such as gas allocations and funding away from private sector schemes including the $2.5bn Dairut independent power project (IPP).

A wider version of the same dynamic is under way across different sectors in Egypt, as projects compete for financial, material and institutional resources. A revision of strategies would be welcomed.

“With so many infrastructure projects being implemented at the same time, there will be a serious resource allocation challenge for the authorities,” says Steyn. “They are doing well at the moment and are probably ahead of the market’s expectation on progress, but it will be interesting to see how the authorities cope with running multiple projects in parallel, especially when they move into the negotiation and implementation phases.

“The authorities may also need to decide on how they prioritise between the bigger bilateral power deals, the smaller feed-in tariff projects and the other infrastructure projects.”

Case study: Egypt’s renewables feed-in tariff scheme

The revised power purchase agreements for Egypt’s feed-in tariff wind and solar schemes have yet to be released. Despite the lack of visibility on terms, developers have incorporated project companies and have signed memorandums of understanding for plots of land.

They are already trying to line up financing packages, but the large number of small projects – 52 at last count – is contributing to the overload for lenders.

Development banks are taking a leading role in developing bankable contracts, pushing for guarantees on currency risk and syndicating developers into manageable groups. The International Finance Corporation, part of the Washington-based World Bank group, is taking the lead. It will arrange financing for at least eight projects, as it did for Jordan’s feed-in tariff scheme. The European Bank for Reconstruction & Development has similar plans. Local and commercial banks may play a secondary role.

Some developers on the scheme are more concerned than others over the availability of hard currency.

“There is a wide cross-section of developers in the scheme, so they have varying responses to currency risk,” says Clint Steyn, a partner at US law firm Bracewell & Giuliani. “The local developers are obviously most comfortable. Some international investors are looking for contractual guarantees from the government that, on being paid in local currency, when they apply to convert it, dollars will be made available and they can transfer the money out.”

The real test of confidence will come when developers have to put large amounts of capital into project companies and secure financing.

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