Will Egypt remain a debt market darling despite rate hikes and war?

By Sherif Tarek
Posted on Tuesday, 1 March 2022 17:56, updated on Wednesday, 2 March 2022 10:40

An employee counts Egyptian pounds at a foreign exchange office in central Cairo, Egypt, March 20, 2019.
An employee counts Egyptian pounds at a foreign exchange office in central Cairo, Egypt, March 20, 2019. REUTERS/Mohamed Abd El Ghany

Amid fears of anticipated rate hikes by the US Federal Reserve System (Fed), and energy and food prices that continue to rise against the backdrop of the Russian-Ukrainian war, Egypt is bracing itself on both fronts as it tries to shield a high foreign appetite for its debt instruments.

In January this year, US consumer prices signalled the biggest leap since 1982, pushing investment banks to ratchet up their monetary tightening forecasts, which – if realised – will pressure emerging markets, including Egypt.

A month later, JP Morgan Chase & Co said the Fed may raise interest rates by 25 basis points in as many as nine meetings on the trot to tame the soaring inflation, which analysts say is expected to persist through mid-2022.

A worldwide inflationary wave is largely fuelled by unmet normalised demand as supply chains are still suffering the lingering impact of the pandemic-induced lockdowns. Rate hikes by the Fed would draw the interest of portfolio investors towards the US rather than the riskier emerging markets, which – as a result – would suffer currency depreciation.

The Russian military attack on Ukraine has turned up the heat on Egypt – a net importer of food and energy – with prices in both categories taking off to new levels. Wheat, of which Egypt is the world’s largest importer, is one of the commodities that will significantly become costlier, as Russia and Ukraine are two of the biggest exporters of the popular grain. Brent, meanwhile, broke above $100 a barrel.

The war is also bound to take a toll on Egypt’s tourism sector, one of its key sources of hard currency, as Russian and Ukrainian tourists make up two of the largest foreign vacationer groups that the North African country receives.

Highly dependent on external financing, Egypt has one of the world’s highest real interest rates and, as such, its carry trade is among the most lucrative. The Arab world’s third-biggest economy has been taking steps to cushion the impact of rate hikes, and the war, so as to remain a debt market darling. How much it can weather the storm is down to multiple factors.

JP Morgan listing

In a widely lauded step, Egyptian sovereign bonds were listed on JP Morgan’s GBI EM indexes by the end of January. Egypt’s comeback, after it was removed in the politically-turbulent 2011, came following years-long economic reforms, in addition to a great deal of recovery from the pandemic ramifications, with the government expecting a growth rate of up to 6.5% in the current fiscal year ending on 30 June.

JP Morgan analyst Sean Kelly cites the buoyed tourism sector and increasing Suez Canal receipts as improvements that bode well for Egypt’s economy. Remittances, another pivotal source of foreign currency for the most populous Arab nation, have also jumped.

  • Tourism revenue exceeded $13bn in 2021, deputy minister of tourism and antiquities Ghada Shalaby was quoted as saying by Reuters in January, close to the record-high of $13.03bn in 2019.
  • The Suez Canal, despite the infamous blockage that lasted for almost a week in March 2021, registered an all-time high of $6.3bn worth of revenue last year, a 12.8% year-on-year rise.
  • Remittances recorded an all-time high of $31.4bn in the previous 2020/2021 financial year, a 13% year-on-year increase.

Mohamed El-Sherbiny, director of asset management at the Cairo-based NI Capital investment bank, tells The Africa Report that increases in Egypt’s foreign currency inflows “reduce the risk of default or inability to transfer funds at any time when a foreign investor wants to get out of the market”. He further brands the JP Morgan listing as a testament to Egypt’s sound economy.

New investors

In February this year, deputy finance minister Ahmed Kouchouk said the country had attracted 33 new investors targeting Egyptian bonds in the first 10 days following the JP Morgan listing, which he describes as a “very positive” indicator.

Major foreign funds have been increasingly targeting portfolio investments in Egypt, Sherbiny points out. “If we look at the [government] offering programme … the two offerings, whether e-finance [in October] or Abu Qir” in December, they attracted numerous foreign funds, he says.

Total foreign investor allocations were approximately 72% for the e-finance IPO, Egypt’s all-time largest in terms of value ($372m). Global leading investment bank, Goldman Sachs, was among the prominent non-resident investors.

“This reflects faith in Egyptian investment vehicles in general,” Sherbiny says. “The fear over the US interest hikes has been lingering for six or nine months, and yet there was still demand for the Egyptian debt instruments.”

Foreign portfolio holdings of Egypt’s local-currency T-bills and T-bonds were nearly $32bn in October 2021, up from less than $10bn in June 2020. The all-time high was in September 2021 at $34bn.

Along with Egypt’s maiden sovereign sukuk (Islamic bonds) issuance, which is slated for this year, the JP Morgan listing will attract new investors, the analyst says.

‘Priced in already’

Even so, the impact of the JP Morgan listing might have been over for the most part, according to Krisjanis Krustins, director of sovereigns at Fitch Ratings. “JP Morgan index inclusion certainly adds structural support to investor demand, but this was anticipated for a while and may have been priced in already,” he tells The Africa Report. 

“Egypt has already seen significant outflows of non-resident investment between September and November 2021. Outflows stabilised in December 2021,” Krustins says. “Euroclearability of Egyptian bonds could provide further support.”

Egypt has exited its IMF programme; its real interest rates, though still comparatively high, are being eroded by inflation

Egypt’s agreement with the Belgian-based Euroclear, a clearinghouse that will give Egyptian bonds a greater exposure, should be wrapped up in the second half of 2022, according to Kouchouk.

The positive impact of Egypt’s economic reforms, which started in 2016 on the back of a $12bn IMF loan programme, might also die down, Krustins says. “Egypt’s attractiveness to non-resident investors up to now has been supported by its record of reforms, IMF programmes, high real interest rates and a stable exchange rate.

“Many of these factors have become less supportive, in our view. Egypt has exited its IMF programme; its real interest rates, though still comparatively high, are being eroded by inflation; and global financial-market conditions are contributing to risks,” he says.

In 2020, when Egypt was badly hit by the pandemic, it reached new agreements with the IMF to secure Rapid Financing Facility and Stand-by Arrangement, both worth around $8bn.

New IMF programme?

In a note released last December, Fitch Ratings said “another IMF programme is likely, particularly if Egypt were faced with a liquidity shock. Index inclusion and improvements to market structure will provide some structural support to investor demand.

“The nominal effective exchange rate of the Egyptian pound has appreciated by close to 20% from its trough following the 2016 devaluation. Real appreciation has been even starker, eroding a large part of the competitiveness gain[ed] from the devaluation,” the note says.

Egypt’s weakening external liquidity position will make it increasingly difficult to absorb further outflows

“In our view, this trend could undermine confidence among portfolio investors and drag on current account performance, increasing the risk of another sharp future exchange rate adjustment in the future, which could usher in a new period of macroeconomic instability.”

Even though Egypt’s foreign reserves have been broadly stable, the net foreign liability position of commercial banks has notably worsened, slipping to about $10bn in January from less than $5bn in September 2021 and a net asset position of over $6bn in February 2021, amid continued current account deficits and some debt maturities.

According to central bank data reported on Tuesday 1 March, Egypt’s Net Foreign Assets (NFAs), which represent banking system assets owed by non-residents minus liabilities, fell in January by LE26.1bn ($1.66bn), the fourth monthly drop in a row. Egyptian NFAs amounted to LE11.8bn ($751m) by the end of January, the lowest level since April 2017 and down from LE186.3bn (nearly $11.86bn) as of end-September 2021, Reuters reported.

“Egypt’s weakening external liquidity position will make it increasingly difficult to absorb further outflows of non-resident portfolio investment without higher interest rates and/or exchange rate depreciation,” Krustins says.

Starting from March, Egyptian importers will need to submit letters of credit to banks in order to bring in a wide variety of goods, as per new regulations introduced by the central bank in February. The rules, which exclude staples, are expected to prolong the importing process of different items, and overall decrease the number of imports altogether. This, analysts reckon, would alleviate pressures on the Egyptian pound.

Silver lining: LNG

Meanwhile, Russia’s attack on Ukraine might have a single silver lining for Egypt: the possibility of increasing its liquefied natural gas (LNG) cargoes to Europe at higher prices. The lion’s share of the EU’s imported gas is from Russia as the 27-nation bloc has been on the lookout for alternatives.

This could help, to a limited extent, shrink Egypt’s current account deficit, which widened to $18.4bn in the last financial year compared with $11.2bn in the previous one.

“Apart from [state-owned] EGAS, which has in any case been seen selling spot volumes, Egypt’s offtakers include European majors Shell, ENI and Total,” Robert Songer, LNG analyst at commodities intelligence firm ICIS, tells The Africa Report. “This […] has the potential to make Europe a more likely destination should Russian flows to Europe be reduced or sanctions applied.

In 2021, Egypt exported a total of 6.71m tonnes of LNG from Idku and Damietta LNG plants, with 1.83mtpa, or 27%, going to Europe, including Turkey, according to ICIS data.

Both Egyptian export plants represent short toll-free journeys to Europe

“US exports have been heading to Europe in record levels so far this quarter, so there’s no reason why we couldn’t see other suppliers like Egypt sending more volume to Europe if demand is there. Both Egyptian export plants represent short toll-free journeys to Europe,” Songer says.

“In 2021, according to I.C.I.S. LNG Edge, the biggest Asian buyers were China (1.28mtpa), India (1.08mtpa) and Pakistan (0.8mtpa) so there could be scope for some of this volume to head to Europe, if the price justifies it.”

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