Egypt's painfully slow PPP recovery


Since the revolution in 2011, Egyptian politicians have struggled to agree on a coherent strategy for financing infrastructure development. Even before the revolution, deal flow was restricted to one or two major oil and gas or petrochemicals deals every few years. Egypt’s PPP programme resulted in financial close on just one project – Orascom and Aqualia’s New Cairo wastewater – which is still not operational, despite being ready for commissioning since February 2012.

Lack of broad political consensus and a growing fondness for red tape is making it even more difficult for the cash-strapped Egyptian government to raise its own funding to boost a sickly economy, let alone attract external funding to investment projects. Were it not for recent offers of aid and loans of around $6 billion from Qatar, Turkey, and Libya, Egypt’s rocky transition to democracy might already be at an abrupt end. The loans are more likely simply to postpone an economic crisis than cure it.

The inability of Egypt’s politicians to govern effectively makes it less and less likely that it can attract the foreign debt and equity that will allow it to avoid economic meltdown, though the fact appears to be lost on some of the newer members of its political class.

New sources of foreign borrowing – almost

The clearest demonstration of the paralysing effect of Egyptian politics came when political infighting and religious arguments knocked off track legislation that would create a sukuk (Islamic bond) market. Sukuks are among the most widely-used and liquid of Islamic financial instruments, and the dispute was not between secularists and president Muhammed Morsi’s Muslim Brotherhood party, but between the Islamists themselves.

Under Egypt’s new constitution the Al Azhar scholars, based at Egypt’s most venerable seat of Islamic learning, have been granted a degree of legislative oversight, which they have exercised by demanding that key wording in the new sukuk legislation be changed. The Salafists, who represent a conservative strain of Islamic thought, and are political allies of the Muslim Brotherhood, have contested the new legislation and have threatened to take it to the courts. The Salafists have even opposed the government’s negotiation of a $4.8 billion IMF loan, even though it carries a proposed interest rate of a paltry 2%.

The derailment of the sukuk legislation is unlikely to have denied Egypt a quick financing fix, given the deep junk status of the country’s conventional bonds. In March, Moody’s recently downgraded the country’s rating from B3 to caa1, putting them in similar company to Cyprus, Ecuador, Jamaica and Pakistan. S&P, while noting that more sovereigns in the region may turn to Islamic bonds, has Egypt at B-.

But a few sukuks might have boosted confidence and given the country a foothold in a market that is growing fairly rapidly elsewhere. Given that influential political constituencies are unwilling to compromise for the sake of the economy, the prospects for Egypt’s recent re-launch of its PPP programme look extremely optimistic.

Foreign banks have all but disappeared from the Egyptian project finance market since the revolution. The liquidity crisis among European banks, a series of country downgrades, the depreciation of the Egyptian Pound and dwindling Egyptian foreign currency reserves have combined to make dollar-denominated financing both expensive and difficult to close without export credit cover, or large direct loans from export credit agencies.

Local banks have continued to arrange project debt since the revolution. Most recently, in 2012, Banque Misr, National Bank of Egypt, Commercial International Bank, Banque Du Caire and Arab International Bank lead arranged and underwrote all of the debt for the $1.925 billion Ethydco petrochemicals project. The deal comprised both a $630 million dollar tranche with a ten-year tenor, and a E£2.5 billion 11-year local currency tranche.

But Ethydco is not the norm. The project was billed as having national importance to Egypt’s post-revolution economic recovery and Banque Misr was also an equity investor. Consequently, if there ever was a project that could tap the shrunken pool of liquidity for local debt, and the even shallower liquidity for dollar debt, it was Ethydco. And Ethydco paid high interest rates by having to go local.

Renewed PPP ambitions

Egypt is set to launch 10 PPP concessions to market, meaning that PPP projects will compete with deals in other sectors for access to this very limited pool of local project lenders. The political clout behind each deal may prove to be key to its place in the pecking order for local funding.

The new rash of PPPs includes the Abu Rawash waste water upgrade, the 40,000 m3 per day Hurghada (Al Yosr) and 20,000 m3 per day Sharm El Sheikh greenfield water projects, the Suez Canal hospital, the E£6-8 billion Safaga Port project, pilot components of a national recycling programme, a river bus project in Cairo and a 72km rail link connecting 10th of Ramadan City to Ain Shams.

Of those tenders the most advanced is Abu Rawash. Egypt’s Central PPP Unit was expected to officially announce the qualified bidding groups for the re-launched E£5.5 billion ($794 million) project in the first week of May. The prequalified groups comprise Orascom/Aqualia/Veolia/ICAT, Kharafi National, Metito/Hochtief, Degremont/Arab Contractors and Egyptian Concord/Greater Cairo Drinking Water Company.

The 20-year concession (inclusive of a three-year construction period) is for the upgrade, maintenance and operation of an existing plant, taking its capacity from 1.2 million m3 per day to 1.6 million m3 per day, and construction of a secondary treatment stage. National Bank of Egypt (NBE), Commercial International Bank (CIB) and Banque Misr have already promised the Egyptian government that they are willing to lend to the concession.

But the most significant PPP test case for 2013 will be the financing for the 20-year concession for the E£6 billion Alexandria University Hospitals. Alexandria would be Egypt’s second PPP project to reach financial close, and its first since the revolution.

The project was launched more than four years ago, and 14 consortiums prequalified in 2010. Interest in the project cooled significantly after the revolution, and only two groups submitted final bids.

The winning bidder was a G4S-led consortium that includes Arab Academy, Bareeq Capital, Detac and Siemens. The project entails building a 200-bed general hospital and blood bank in the Smouha district of Alexandria, and a 224-bed hospital in Mowassat. The contract value for each facility is roughly E£3 billion over the 20-year concession period. This value includes capital expenditure, as well as operations, maintenance and financing costs.

The International Finance Corporation is financial adviser to the Egyptian government on the procurement, and the cashflows for the concession benefit from a Ministry of Finance guarantee. The deal is expected to use local debt from National Bank of Egypt, Ahli United Bank, HSBC Egypt and Commercial International Bank.

Market messaging

The tenor on the Alexandria Hospitals debt package will be of interest to future potential PPP investors. The 15-year debt on Egypt’s first PPP, New Cairo, set a record for local project debt offerings, but the deal closed before the revolution broke out, in 2010. Since the revolution, only the Egyptian Refining Company (ERC) project financing has gone beyond 11 years. But ERC was also arranged before the revolution (and narrowly survived it), featured international lenders, and benefited from both covered and direct loans from ECAs.

The debt pricing on Alexandria will need to send the right message to the market. The project cashflows will be denominated in Egyptian pounds, creating a natural hedge for the locally raised debt. And with a government guarantee backing the deal, despite Egypt’s recent downgrades, the overall cost of financing will be within the same range as debt from international banks, were it still available.

The biggest hurdle to Egyptian projects, PPP or otherwise, is the devaluation of the Egyptian Pound, which recently hit an all-time low of E£6.92 to the dollar and has dropped 11% against the dollar since December 2012. Even PPP projects that are naturally hedged will probably to have to buy at least some equipment from abroad, and with the Pound dropping at such a rapid rate those equipment costs are rising fast in local currency terms.

For those projects with local income streams and major foreign currency outlays project costs become prohibitive. Compounding this problem is the lack of currency hedging instruments in the local bank market, though they would in any case probably be too expensive, given the Pound’s weakness.

Projects with dollar-denominated revenues are already having to cope with the unwillingness of international banks to lend to Egyptian projects. For example, the Ethydco sponsors agreed to sell 70% of its output to foreign buyers. They had hoped to carve out a tranche from its debt at a later date and refinance it with ECA loans, as well as close a $250 million ECA facility to replace a contingent equity commitment. The sponsors – ECHEM (20%), SIDPEC 20%, GASCO (11%), Al Ahly Capital Holding Company (21%), National Investment Bank (14%), Banque Misr (10%) and Nasser Social Bank (4%) – had to put up the contingent equity to cover a gap between what the local bank market could provide and total project costs.

For all Egypt’s problems, it is getting some things right. The marketing of the PPP programme to potential investors is stirring a remarkable amount of interest, given the economic backdrop. For example, the spread of bidders on Abu Rawash is split 50/50 between domestic and foreign players.

Furthermore, the country’s 2010 PPP legislation is still in place and may yet be revised to mitigate some of the impact of currency risk on financings. The European Bank for Reconstruction and Development has given the legislation the status of “high compliance with internationally recognised standards.” When the EBRD examined the implementation of the legislation, however, ti assigned the law “medium compliance” status, pointing to a lack of clarity over PPP policies, and unclear thresholds regarding its application to past concessions and the use of public utility legislation for concessions and PPP projects.

The test case for the new legislation will be Alexandria Hospitals, because New Cairo water closed before the 2010 law was in place. But even if the legislation functions properly, Ministry of Finance guarantees will be meaningless if the country goes bust. With foreign cash reserves down to around $13 billion in January, and the Egyptian Pound continuing to devalue, that scenario looks more probable than possible.

Commodities-backed projects in the country are still likely to find takers in the international debt markets, although full ECA cover will become vital as political risk continues to rise. As things stand, the Egyptian project market mostly endures on paper.