Egypt: Capital markets on the up

Renewed confidence in the medium- and long-term outlook for Egypt’s economy is buoying its capital markets, with stocks up strongly in 2012 and bond issues attracting plenty of interest. In spite of lingering political uncertainty, good growth prospects, a large and growing domestic market, and likely backing from the IMF are all helping to restore much-needed investor confidence.

The Egyptian Exchange (EGX) has risen almost 50% in the year to date, as investors have returned to the market. Liquidity levels and volumes are recovering as well: in the week ending March 9, total value traded reached LE3bn ($495.74m), twice the average of the previous six months. International press reports suggest the exchange could gain 80% to 100% in 2012, following a 50% fall last year.

GDP growth of an annualised 0.4% in the final quarter of 2011, while low by the standards of recent years, is seen as an indication that the economy is regaining momentum, following the revolution of early 2011 and subsequent political uncertainty, as well as the difficult international climate. Political activity continues to have an effect on the stock market, however, seen most recently on March 26 when the EGX index plunged more than 5% after mass sales amid tense political rhetoric.

But fundamentals are strong, and the 80m-person market’s long-term growth trajectory is likely to surpass that of developed economies over the short and medium terms, driven by domestic demand, exploitation of natural resources and important service sectors, such as tourism and outsourcing. Until the political upheavals of last year, Egypt had performed remarkably well during the protracted global economic crisis, having already enjoyed excellent growth rates in the previous decade.

“Egypt fundamentally is still a very solid market for investment,” Mohammed Omran, the executive chairman of the EGX, said. “The country experienced 7% growth before the financial crisis and 4.8% during the crisis, when Western economies were struggling. And, as a country of 80m people, Egypt still represents the biggest market in the Middle East.”

The economy has also been buoyed by the prospect of a new financing deal from the IMF, due to be discussed in late March. The government has requested a $3.2bn loan package from the organisation to cover its budget deficit and a balance-of-payments gap. It is also lining up a two-year programme of deficit and public debt reduction, which is expected to increase the likelihood of an IMF deal and reassure the markets.

The expectation of a successful loan agreement has already caused yields on government debt to fall and demand to rise, with recent auctions of bonds attracting bids of up to 1.8 times the value of the sale.

The government is now thought to be lining up its first-ever issue of sukuk – sharia-compliant or “Islamic” bonds – as a further source of funding. International press reports suggest that Egypt will issue $2bn in dollar-denominated sukuk. Due to their sharia compliance, these instruments are particularly popular with cash-rich Gulf institutional investors, and are also expected to attract interest from wealthy Egyptian expatriates.

“Sharia-compliant bonds will primarily target the external market and Egyptians living abroad,” said Mahmoud Attalla, the CEO and vice-chairman of Egyptian financial services firm CI Capital. “Further market activity will be supported by the confidence gained by the IMF loan and will reflect positively on the bond issue.”

While investor confidence is certainly returning, analysts and industry leaders strike a cautious tone on the stock market recovery, noting that it comes after a plunge in values last year. The recent rally may partly be associated with a general appetite for greater risk in emerging markets, and some have cautioned that the rapid rise of certain stocks may indicate a degree of speculation.

Furthermore, there are a number of downside risks, including renewed political instability around elections later this year, and wage demands and other cost factors affecting businesses.

“Corporate earnings (excluding one-time items) are expected to grow by 33% this year since 2011 was an exceptional year,” Attalla said. “However, this will still not bring them back to pre-revolution levels, if we exclude Orascom Construction Industries and Orascom Telecom. Large-scale wage increases will have an impact on profit margins.”

Volumes may be on the up, but they remain rather low. This can partly be attributed to caution among foreign institutional investors, who are waiting to see how Egypt’s next government takes shape – particularly whether a new government may feel the need to engage in destabilising expansionary fiscal policy to buy support. The strength of the Egyptian pound is another challenge, with some investors holding out for a de-valuation that the central bank is currently reluctant to deliver.

Egypt’s capital markets certainly indicate the economy is recovering, both through rising private stocks and increasing appetite for government bonds. There are certainly caveats to bear in mind that justify a degree of caution, but recent performance demonstrates good long-term fundamentals.

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