Risk fluctuations

With the ongoing political unrest and sporadic violence on the streets, Egypt’s market indicators have followed suit, eliciting a mix of positive and negative numbers and economic outlooks.

Chief among these is a significant reduction in the cost of insuring Egypt’s debt in the credit default swap (CDS) market, where fluctuations have mirrored the uncertainty surrounding developing events since mass protests broke out on June 30.

After spiking to more than 900 basis points in the beginning of July, Egypt’s five-year credit default swaps have since declined.

Credit default swaps protect investors in case the government is unable to pay its debt, whereby the seller is obliged to compensate the buyer if they default on a loan.

The insurance cost of Egyptian debt against default rose to a record high early this month in the five-year CDS market, recording 925 basis points, according to pricing agency Markit. It then fell significantly after an army ultimatum deposed President Mohamed Morsi, reaching 625 bps, according to Markit.

However, like many market indicators, the number moves up and down coinciding with sentiment regarding a path towards political stability.

When Islamist political forces boycotted the transitional government, headed by Prime Minister and economist Hazem al-Biblawi, Egypt’s five-year credit default swaps climbed 50 basis points to 725, Bloomberg reported last week.

Mohamed A. El-Erian, CEO and co-CIO of PIMCO, wrote earlier this month in Business Insider, “With all the focus on Egypt today, people are scrambling to find a simple market-based measure that speaks to both the extent of the economic disruptions and the potential financial spillover effects on other countries.”

He argues that the most commonly-viewed stock market prices are not the right measure, instead, a relatively “better data series measures the spread on the 5-year CDS,” though he adds that it is still far from being comprehensive.

“It is a good — not perfect — market indicator of sovereign risk; and it dominates the information content provided by the much more popular stock market index. The higher the spread (and it just traded at around 1,000 basis points), the harder it is to encourage investment in new plant and equipment; the more difficult and expensive it is to secure trade financing (including for critical imports of food stuffs and other basic needs); and the lower the job and income opportunities for average Egyptians,” he wrote.

In a related development, traders are reportedly having an easier time conducting bank transactions.

“For the first time in months, some countries are not requiring [traders] to open another letter of credit at a bank abroad to import goods, which used to raise the cost of imports,” says Mohammed Mostafa, a manager at the credit department of a commercial bank.

Some countries had stipulated that Egyptian traders open a letter of credit in a bank abroad as well as one at a local bank in order to import goods, which represented an added burden on importers. Mostafa attributes the positive development to the decrease in the cost of risk on Egypt’s debt.

“It is evidence that the country is moving towards the right path and that the political and economic roadmap is reassuring, something the country has been missing in the last year during which CDS remained on the rise,” he says.

Last week, the National Bank of Egypt said it opened a letter of credit worth $230 million for the Petroleum Authority to allow the import of crude oil from Kuwait, without the Kuwaiti side asking for another letter at a bank abroad.

In the coming months, experts foresee more stability and improved security, which if true, should translate into replenishing foreign reserves with better tourism and foreign investment inflows.  

An aid package worth $12 billion from Saudi Arabia, the United Arab Emirates, and Kuwait – countries that were not on good terms with the Muslim Brotherhood and Morsi – has helped Egypt avert an impending balance of payments crisis and possibly defaulting on its debt.

The money will boost the Central Bank’s foreign reserves as well as come in the form of petroleum products that will reduce the import bill.

However these are temporary reprieves that need to be cushioned by a number of tough structural reforms that have been delayed for too long, adding stress to already embattled public finances. Last fiscal year, Egypt’s deficit reached more than 11 percent of GDP.

Economic conditions have also led to a slight strengthening in the pound against the US dollar, which has led to a fall in the price of gold on the domestic market, according to Rafiq Abbasy, deputy chairman of the gold division at the Federation of Egyptian Chambers of Commerce.

The CBE announced last week a decline in foreign reserves, which fell by $1.12 billion in June to reach $14.92 billion. This latest drop was a result of the bank’s revaluation of the country’s gold reserves in June — in the context of a fall in global gold prices.

“Under normal circumstances, a decline in the gold prices for local or international reasons would have been accompanied by increase in gold sales, increases in production and eventually rise in profits for the whole trade. But it has been suffering from a deep recession for the past two years due to weakened purchasing power,” Abbasy said.

He says consumers do not have enough money to buy gold due to the dire economic conditions, so a decline in its prices does not have a major impact.

The transitional government that has just been sworn in, full of more liberal-minded ministers, will have to face the sobering mission of putting the roadmap into effect.

“Forming a strong representative government is a must to build public consensus and to be able to confront a difficult and expectedly long period of economic reform,” says Mohsen Adel, a financial expert and member of the board of directors at the Egypt Stock Exchange.

While the stock market has been on the up since late June, recovering much of its losses form earlier this year, it has slid into the negative on days when violence broke out on the streets.

Adel expects more fluctuations, without any sharp declines on the short term, adding that the market and the economy in general will be facing heightened pressures and challenges in the coming period.

“The new government will have two frightening jobs: stabilize the economy for the short term and work out some needed reforms for the longer term,” says Adel.

In the face of rising political turmoil, Fitch reduced Egypt’s credit rating on Friday from B to -B, indicating the possibility that Egypt may fail to pay its long-term debt in foreign and local currencies.

Last week, Standard & Poor’s affirmed Egypt’s rating at CCC+, seven levels below investment grade, with a stable outlook, Bloomberg reported.

Adel noted that the downgrade is natural because it is closely linked to the political situation, which in turn affects economic activity and growth rates, but that it will increase the difficulty of external borrowing and may push up the cost of CDS.

On the long term, massive reform is needed: to unburden the economy of the huge subsidies, to approach the prevalent corruption that strangles any project, and to fix the lack of lucid rules and laws that drive away foreign investors.

Adel does not think the new government will be able to force any type of austerity measures due to the delicate socio-political balance, where any opposing political faction could easily shake the current fragile regime. 

Noha Moustafa 

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