Why Egypt will not default
Also published on Al-Ahram Weekly & Arab Finance
In Finance 101, we learned that when it comes to government borrowing, “full faith and credit” was somehow a given. The definition of this phrase refers to the borrowing power of a government that pledges to fulfill its payment obligations in a timely manner.
For instance, treasury bills (T-bills) are backed by the “full faith and credit” of the government, assuring fixed-income investors of the payment of interest and principal regardless of the economic situation.
On a scale of creditworthiness going from AAA all the way down to C and D, the US ranks at the top with a triple-A rating. All securities issued by the US are deemed by many investors to be risk-free, and the US is almost always guaranteed to have the power to print more money or increase taxes to repay its debt.
However, recently we saw a debt-ceiling debate taking its toll in the US Congress until a last-minute deal was struck, thus dodging a potential default by the US. Even the AAA-rated US could therefore default on its debt, although this is a minute probability.
In fact, the US did default on its debt once, back in 1979, for not making interest payments in time due to technical issues. After a lengthy debate to raise its debt ceiling, the US Treasury failed to issue the required paper cheques in time, marking the first and only time the US has ever defaulted on its debt, albeit for only three weeks.
If an AAA-rated country can have default risk, one would expect that the lower the rating, the higher the risk would be. Hence, Egypt, rated B, should have a considerably higher default risk, according to this logic. Indeed, Egypt’s rating places its debt five notches in the “sub-investment grade” category, which explains the high credit default swap rates seen on Egypt’s five-year debt.
But does this mean that an Egyptian default is really possible? To answer this question, we first need to understand that a default can be summed up in two words: ability and willingness.
Does Egypt have the ability to honor its obligations? In other words, can it afford to pay off its debts? The answer is yes to both local and foreign-currency debts. For the former, Egypt has the power to print money to pay off its local-currency debts, despite running the risk of having to deal with rampant inflation. As for the latter, Egypt cannot print US dollars, but it has more than one way to raise capital.
For instance, the government offering program planned by the country can bring in much-needed foreign currency if executed in a timely manner. If this was not enough, a one-time sale of securities backed by the Suez Canal, Egypt’s crown jewel, at a very low discount rate (given its international significance) could help raise a huge amount of foreign currency. This could then be used to deleverage Egypt’s foreign debt.
But does Egypt have the willingness to honor its obligations? The answer to this can be linked back to the US debt-ceiling debate. The main reason why the US raised the debt ceiling, in my opinion, was to avoid the loss of “full faith and credit” in its willingness to pay off its debts.
A voluntary decision to forfeit outstanding debts is a very difficult decision for any government to make and one that can have long-term political ramifications. At this juncture, with presidential elections around the corner, Egypt cannot risk its reputation by voluntarily defaulting on its debts, especially when it has the ability to pay them off.
In sum, Egypt has the willingness and ability to honor its obligations. The only question is how and when it will do just that.
Al-Ahram Weekly dated Thursday, 22 June 2023 (Page 4)