Hot money flows into Egyptian debt

October 18, 2019

High yields and relative stability pique interest of foreign buyers

© APEgypt’s economy, the fastest-growing in the Middle East, expanded 5.6 per cent
in the year to June © AP

by Heba Saleh

Attracted by some of the highest yields in the world, foreign debt investors have
been piling into the Egyptian market since late 2016 when the country signed
a $12bn loan agreement with the IMF, floated the pound currency and
introduced harsh austerity measures aimed at restoring fiscal balances.

Foreigners have predominantly been buying short-term maturity paper, most of

it under one year, for carry trades — where money borrowed at one interest rate
is invested in assets that pay a higher rate.

Egypt’s reputation as the darling of emerging market investing was briefly

called into question last month, after allegations of corruption and misuse of
public funds by the army and president triggered mass protests — claims that
President Abdel-Fattah al-Sisi has dismissed as lies. The authorities arrested
more than 3,000 people to pre-empt any repeat of the unrest.
The protests do not appear to have had a lasting impact on investor appetite for
the country’s debt, however. In October overseas investors held some $20bn in
Egyptian T-bills and bonds. Even after the country’s central bank reduced
interest rates twice this year, by a total of 250 basis points, yields remained
attractive, analysts say.

Yields on one-year T-bills hovered between 15.2 and 15.9 per cent in early
October after the second rate cut of 100bp. Investment bank Citi estimates as
much as $800m flowed out of Egyptian debt in the wake of the protests, but
analysts say a significant portion could return by early 2020 if there is no further
unrest.

“Egypt remains popular because it is a high-yield jurisdiction that is relatively

stable and especially attractive in comparison to other emerging markets
because of its macro-stability,” says Farouk Soussa, Middle East and north
Africa economist at Goldman Sachs. “Importantly we do not expect major
fluctuation in the exchange rate given significant [foreign exchange] liquidity
buffers that have grown in recent months.”

Egypt has earned praise from the IMF for its reforms and it has seen significant
improvement in macro indicators. The economy, the fastest growing in the
Middle East, expanded by 5.6 per cent in the fiscal year that ended in June. The
debt issued will help pay down the budget deficit, which dropped to 8.2 per cent
of gross domestic product, down from 9.8 per cent the year before. Reserves
grew from about $15bn in 2016 to $45bn in September 2019.
The country’s overall debt, however, remains hefty and, analysts say, a major
vulnerability at 90.5 per cent of GDP in the June 2019 fiscal year. The
government aims to bring it down to 82 per cent by next June.

But the interest bill continues to be a huge drain on the budget, accounting for
36 per cent of spending in the current fiscal year.

“For investors buying Egyptian debt, the main credit strength is the reform
implementation and the reserves or buffers established on the external side,”
says Elisa Parisi-Capone, vice-president at Moody’s, the rating agency.

“The main challenge we see is the large fiscal deficit and the interest bill is still
very high. It takes time to reduce it consistently and sustainably.”
Despite the inflows of hot money from overseas buyers, the country has not
been able to attract much foreign direct investment beyond its oil and gas sector.

Even as Egypt emerges from a three-year IMF programme with improved fiscal
discipline and a cheap pound, it has failed to boost manufacturing and non-oil
exports.

Economists say domestic consumer demand has not bounced back to levels seen
before the 2016 currency devaluation, and inflation has sharply eroded
Egyptians’ purchasing power. They also point to structural obstacles impeding a
take-off of private sector-led growth, from bureaucracy to concerns about fair
competition.

Investors are buying long-term bonds to take advantage of potential

further rate cuts

But these are not pressing concerns for yield-hungry investors after a quick
profit. “In the short term investors worry about political stability, the exchange
rate and questions such as what relation will the government have with the IMF
after November when the current programme has expired,” says David Cowan,
Africa economist at Citibank.

Longer-term investors, he adds, are more likely to be worried about the

country’s overall debt level and ability to service it.

As interest rates are pared back, analysts expect more investors to move out of
the carry trade into longer-term instruments.

Mr Soussa says the $20bn held by foreigners includes up to $5bn in longer-

maturity bonds — something that was not the case in January 2018. “As rate
terms come down and the pound strengthens, the carry trade becomes less
lucrative. But investors are not leaving Egypt. They are buying long-term bonds
to take advantage of the potential for further rate cuts,” he says.

Mr Soussa says the advantage for longer-term investors is that as yields fall, the
value of their bonds rise so they do not need to hold them to maturity and can
make a profit on selling their holdings. Yet once this play on rate cuts comes to
an end, he adds, “you get less interest from buyers, so the sustainability of these
flows becomes questionable”.

Unwilling to lock itself into paying high rates on long-term bonds, Egypt has
focused more on issuing treasury bills. But as inflation and interest rates fall,
officials say they want to extend maturities and change the profile of the
country’s debt.

Mohamed Maait, the finance minister, told Bloomberg in early October that
Egypt would raise the share of longer-dated debt to 40 per cent of its annual
domestic issuance by the end of the current fiscal year, up from 5 per cent in the
year ending June 2018.

“In a world of zero interest rates, at which point will Egyptian debt stop being
attractive?” says Mr Cowan. “We suspect only when yields fall to single digits
will investors have to start weighing up the costs and benefits more carefully.”