Ship and Stocks Grounded in Egypt

As the world watches the containership Ever Given stuck in the Suez Canal, emerging markets investors navigate the divergence in performance between Egypt’s local stock and bond markets.  The stock exchange has fallen some 5 percent in the past month in USD terms on the MSCI Index. In recent days trading was suspended several times after the main EGX100 index triggered the bourse’s circuit breaker with a 5% fall.  Lack of liquidity and institutional participation have long plagued the exchange. The Financial Regulatory Authority (FRA) and Central Bank of Egypt have just agreed to establish a fund to help finance brokerage firms and insure against insolvency, which could increase liquidity as the government again begins to revisit its decades-old privatization plan.  At the same time, the FRA requested local asset management firms submit a working paper on ways to increase institutional investment in the market.  Through mid-March, local investors have dominated equity trading this year, accounting for 84.6%, while foreign and GCC investors accounted for 8.8% and 6.6%. Their inflows are minimal despite cheap prices after last year’s 25% fall in dollar terms.

The stock exchange plans to launch a new SME index this year, while plans to inaugurate a commodities exchange are advancing, according to the head of the ESX, with a handful of listings expected at launch. The bourse reports that a futures market is also being considered.  The FRA expects the IPO pipeline to re-open this year as the economy recovers from Covid-19.  However, domestic and foreign investors are skeptical.  In 2018 the Finance Ministry announced that 23 state-owned companies would be listed, including Banque du Caire and Middle East Oil Refining.  At the time the state expected to raise USD 4.6 billion. Longtime analysts note that these and other companies have been on the “privatization list” since the 1990s and the last time state-owned companies were listed was in 2005 when landline monopoly Telecom Egypt and two oil companies were floated. 

In stark contrast and despite the rise in US Treasury yields, foreign investors have poured into Egypt’s local bond market lured by a steady currency and high real rates.  As of end-February, holdings of local bills and bonds stood at a record USD 28.5 billion, reversing with gusto the estimated USD 17.5 billion which fled in the early months of the pandemic. The Central Bank has held the key interest rate at 8.25% for months, after cumulative cuts of 850 basis points in 2019-20, with inflation relatively benign at 4.5%.  Egyptian debt is likely to be settled by Euroclear later this year, which could attract even more foreign interest despite not being included in any indices, although JP Morgan gauge entry is under consideration.

The African Development Bank projects that the economy will grow 3% this calendar year after an estimated 3.6% in 2020. Fitch Ratings, affirmed the sovereign’s B+ rating with a stable outlook this month, but noted that the grade was contained due to large fiscal deficits, high debt/GDP, and domestic and regional security vulnerabilities.  After coronavirus support estimated at 1.7% of GDP in FY 20/21, the fiscal deficit is expected to jump to 8.5% from 7% a year earlier, while government debt/GDP is likely to hit 90%. However, if the Suez Canal remains blocked, the deficit will widen. In 2020 the government received USD 5.6 billion in canal tolls despite the slowing of global trade during the pandemic, while remittances grew 10.5% to more than USD 29.5 billion.  It also secured USD 2.7 billion in a rapid emergency line and a 12-month USD 5.2 billion stand-by loan from the IMF.

While bond market bulls praise the “steady currency,” the EGP has been supported by regular central and state-owned bank intervention, which has eroded the competitiveness gains that came from the 2016 devaluation demanded by the IMF at the beginning of a previous 3-year reform program.  At the same time, the current account deficit, already over 3% of GDP, is expected to widen as import demand ticks up on economic recovery while tourism-related revenues lag on slow vaccine roll-out, especially in Europe a visitor mainstay.  Prior to the pandemic, tourism accounted for about 5.5% of GDP and nearly 10% of employment.  A long shutdown of the Suez Canal would leave remittances and debt financing, along with unreleased IMF funds through mid-year, as the key sources of hard currency.  While reserves cover some 5 months of external payments, according to Fitch, inadequate inflows will likely halt market intervention by the CBE and state banks, and the strong currency will devalue, derailing overseas bond high-yield positions may too be unable to budge.

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