Euromoney: Egypt’s post-revolution revolution and the markets

Euromoney, August 2013

After a second revolution in two and a half years, Egypt’s new interim government has other things to worry about than falling out of an MSCI index. But the possibility of Egypt’s bourse falling from emerging markets to frontier status, and the foreign exchange liquidity problems that have led to it, are symptomatic of broader challenges facing the volatile country.

In June, in its annual market classification review, MSCI said it was “closely monitoring the situation in Egypt, in particular the negative developments in the foreign exchange market.” It said it “may be forced to” launch a public consultation on excluding Egypt from the MSCI Emerging Market index, because this shortage of foreign currency makes it difficult for foreign investors to repatriate funds. A drop from the index would, at the least, mean that all passive money tracking that index would leave Egypt.

“Repatriation can range from a few days even to months, and that’s deterring a lot of foreigners from buying into the market,” says Wael Ziada, head of research at EFG Hermes in Cairo. He adds that the foreign exchange dynamics themselves, with the Egyptian currency in continuing decline through 2013, and the fear of the stock market shutting down as it did after the January 25 revolution in 2011, have also impeded foreign participation in the market.

This matters because one thing Egypt has going for it in these troubled times is the oldest and sometimes deepest bourse in the Middle East. “There is a long history of capitalism here,” says David Mcilroy, chief investment officer and portfolio manager at Alquity Investment Management, which runs a pan-African equity fund. “It’s the oldest exchange in Africa and the second most liquid after South Africa.” A loss of liquidity in that exchange, and a further flight of foreign capital, would exacerbate existing problems elsewhere in the economy: the lack of foreign exchange in Egypt in order to cover imports, and the increasing pressure on that import bill caused by the declining currency. MSCI withdrawal would be representative of a damaging spiral.

In itself, an MSCI decline would be neither quick nor desperately bad news. “It’s not easy to get into an MSCI index, and it’s extremely difficult to get out,” says a treasury and securities services banker at a multinational in Dubai. “It takes a long time: even in Morocco it took three years for them to be removed when there was no market activity at all. But the Egypt situation is pretty tough, and it leaves fund managers in a very difficult situation.” Fund managers themselves say that a drop from the index might lead to a one-off shock but would have no major lasting implications as they believe only a few hundred million dollars of the money in Egypt is passively tracking the index anyway. But it doesn’t look good, nor does it encourage greater foreign participation.

A further problem is that the biggest company, Orascom Construction Industries (OCI), which accounted for 24.3% of the EGX 30 index at the start of this year, is in the process of moving its primary listing from Cairo to Amsterdam; well before the MSCI remarks, brokers including Deutsche were warning that the flight of listed companies could pull Egypt out of the emerging market index and worsen existing problems.

Still, since the MSCI announcement, Egypt has undergone a second revolution, and this one appears to have been positively received by stock markets. At the time of writing Egyptian stocks were up 15% since late June, largely because the new interim government cabinet, sworn in on July 16, is considered to be made up of individuals who are economically liberal.

On top of that, Gulf states have rushed to Egypt’s assistance with $12 billion of pledges in the space of a week, giving the market valuable breathing space. The money, $5 billion of it from Saudi Arabia, $4 billion from Kuwait and $3 billion from the United Arab Emirates, will be made up of a mixture of grants, loans, central bank deposits, and oil, all of which in the short term should help the challenges around the value of the currency and the availability of foreign exchange reserves with which to cover vital exports. Hisham Ramez at Egypt’s central bank said in July that the aid would lift Egypt’s foreign exchange reserves above $20 billion, compared to just $14.92 billion in June and $36 billion before the 2011 uprising, and he may well not have factored the Kuwait contribution into those numbers.

“We’ve been adding more to Egypt in the past month rather than taking money out,” Mcilroy at Alquity says. “The Gulf money coming in will more than likely comfortably cover any potential shortfalls.

“Everyone wants Egypt to succeed,” he adds. “The direction the Muslim Brotherhood were taking the country wasn’t an entirely positive one, and while in strict terms this is a step back in terms of democracy, from a pro-market point of view it’s a short term positive. The medium term remains to be seen, but there’s no rush to the exits from us.”

Not everyone agrees: Renaissance Capital’s influential managing director and global chief economist Charlie Robertson says he expects Africa funds to stay out of Egypt for now, favouring South Africa and Morocco – ironically, since Morocco has just been turfed out of the MSCI EM index itself.

But, as before, the future direction of market sentiment – be it equities, foreign exchange or FDI – is likely to rest on resumption of negotiations with the IMF over a $4.8 billion loan, which would likely trigger several billion dollars of other loans from elsewhere. There has been some concern that Egypt’s new government has not appeared to make the IMF facility a priority – perhaps because the Gulf aid has given it breathing space. The IMF loan is dependent on widespread reform, in particular around subsidies.

As for Egypt’s exchange, it has a new chairman, Atef Yassin, who stepped into his role on July 1, and whose timing appears to have been rather good, as the jump in the stock market has also coincided with a dramatic increase in trading volumes. The cynical view, though, is that the market’s resilience is partly due to exactly the sort of problem that threatens the market in the first place: that nobody can get money out of Egypt even if they want to.