Do stock market gains affect the wider economy?

Egypt’s stock market made historic gains at the end of 2016, but analysts say the main index has less of an impact on the wider economy currently than in the years prior to the 2011 revolution.

The benchmark index EGX30 reached historic levels on December 22, 2016, recording 12,420 points, peaking an upward trend following the liberalization of the exchange rate a few weeks earlier. The main index was boosted by a surge in stock purchases by foreign investors, says Hany Tawfik, former head of the Egyptian and Arab Associations for Direct Investment. Foreign investors saw an opportunity after the exchange rate was liberalized that enabled them to transfer their profits in dollars, he explains.

The Central Bank of Egypt (CBE) liberalized the exchange rate on November 3, cutting the value of the pound by half in just a few days, to settle at 18.11 to the dollar in early January, compared to 8.88 prior to the flotation. Interest rates were simultaneously raised by 3 percent in one move, and the government announced further fuel subsidy cuts.

Financial sector profits from foreign inflows

The liberalization of the exchange rate led to a fall in the value of assets for foreign investors, including stocks, says Tawfik. As company stocks include shares in buildings, plants, machinery and equipment, foreign buyers ultimately own these assets at half their previous value.

The revaluation process “often takes a few months for fixed assets, which is reflected in the prices of the stocks. Consequently, whoever buys at the stock market now expects their value to rise in the coming months,” says Omar al-Shenety, managing director at the Cairo and Dubai based investment bank Multiples Group.

Foreign investors were net buyers to the tune of LE3.750 billion in November 2016, and LE1.38 billion in the three weeks ending December 22, 2016. Egyptian financial institutions were net sellers to the tune of LE2 billion in November and LE952 million in the three weeks ending December 22, according to the bourse reportsNotably, non-Arab foreign investors achieved net purchases worth LE5.8 billion from the beginning of 2016 to December 22.

Market Capitalization on December 25 represented 25 percent of Egypt’s GDP in 2015/16, according to stock market data. This is much lower than prior to the 2011 revolution, when it peaked at 107 percent in 2007, according to World Bank data.

The number of listed companies fell to 222 in November 2016, from 435 companies in 2007, as a result of stricter regulations by the bourse, Tawfik explains. This period also saw an improvement in economic indicators, in response to investment-favorable policies by former Prime Minister Ahmed Nazeef, including tax incentives and the privatization of several state-owned companies. The GDP growth rate reached 7.2 percent in the 2007/8 Fiscal Year, while net foreign direct investments climbed to US$13 billion, according to CBE data.

Foreign interest in portfolio investment in Egypt after the liberalization of the exchange rate wasn’t limited to the stock market.

The Egyptian stock market is currently less influenced by economic fundamentals than other stock markets, according to financial economist Mohamed Sultan. “In times of affluence, we are better off looking at the reasons for why speculation is so successful, rather than the reasons for market recovery,” Sultan says, adding that the stabilization of the exchange rate is one of these reasons.

New companies were listed at a value of LE6 billion in 2015, with chief executive officer for the state-owned NI Capital for financial consultations Ashraf Ghazaly indicating that the bourse should expect several initial public offerings by state-owned banks and petroleum companies in the coming period.

Foreign interest in portfolio investment in Egypt after the liberalization of the exchange rate was not limited to the stock market. Foreign investments in government securities increased in the period November 3 to 16, from US$700 to $900 million, according to Ahmed Kouchouk, deputy finance minister for fiscal policies, as cited by Reuters.

“Investors who buy government securities expect there will not be any hurdles in transferring their profits in dollars, because Egypt received a loan from the IMF that boosted its dollar liquidity,” Shenety explains.

This type of short-term foreign investment, or “hot money” is beneficial, in that it materializes quickly. The problem is that it also leaves quickly, which is what happened in 2011, Shenety told Mada Masr in a previous interview.

Egypt received the first tranche of a $12 billion IMF loan on November 11, 2016.

Despite the rise in foreign investment in Egyptian securities, the accompanying inflow of foreign currency was not reflected in the value of the pound, which has depreciated by around 112 percent since the liberalization of the exchange rate. According to Shenety, “the pound has not yet been influenced by foreign investment inflows because the currency is going through an adjustment period in which the pound will continue to fluctuate until it reaches a fair rate in the coming months.”

The recent fall in the value of the pound can be explained by other factors, including the rise in the value of dollar commitments by importers who opened letters of credit in dollars and suddenly saw their commitments double. Additionally, companies that are seeking to transfer their profits out of the country are also pressuring the pound. “Consequently, there is a high demand on the dollar from importers and foreign companies operating in Egypt that led to current fluctuations in the currency,” says Shenety.

The non-banking financial sector is not the only beneficiary of the liberalization. The banking sector is also set to benefit if the government succeeds in attracting foreign investment and improving Egypt’s competitiveness in international trade, as this would result in a higher liquidity of dollars, according to a report by credit rating agency Moody’s.

The real economy suffers, Egyptians’ livelihoods threatened

At a time when foreign investors and the Egyptian financial sector are benefiting from the liberalization of the exchange rate and rises in interest rates, general costs of goods and employment rates have suffered. The annual inflation rate hit its second highest level in 25 years, reaching 24.3 percent in December as a result of these economic measures and the implementation of value-added tax and increasing customs on some products.

The private sector continued to shrink for the fourth consecutive month in November, impacted by the rise in purchases, reaching its highest level since April 2011, according to the Purchasing Managers Index survey, published by Emirates NBD in December. This resulted in a plunge in employment rates for the 18th consecutive month, as, according to the study, several companies made employee cuts to offset the increases.

Poverty rates are expected to rise from around 27.8 percent (in 2015) to 35 percent.

Similarly, the business barometer issued by the Egyptian Center for Economic Studies for the period July to September 2016, shows that a lack of liquidity in foreign currency placed financial pressure on companies and led to a rise in the costs of materials and production. Consequently, the growth expectations index fell to its lowest level in two years, which was reflected in the employment index.

Tawfik expected more and more companies would go bankrupt as a result of the rise in prices, leading to higher rates of unemployment and continuing economic recession.

The rise in the inflation rate that resulted from these economic measures led to the “erosion of peoples’ purchasing power,” explains Shenety, who anticipates an increase in poverty rates.

Heba al-Leithy, consultant for the official statistics agency and supervisor of the income, spending and consumption national survey, told the privately owned Al-Shorouk newspaper that she expects poverty rates to rise from around 27.8 percent (in 2015) to 35 percent. These estimates were based on assumptions of a 15 percent inflation rate, which is lower than in November, as well as a hike in electricity prices and the implementation of value-added tax amid fixed wages.

Investors want more

Can stock market rises continue in this economic context? Tawfik believes that the sustainability of growth in bourse indices and investment in the stock market are dependent on the completion of the government’s structural program. “This includes implementing the 17 decisions of the Higher Council for Investment, issuing the new investment law, offering land and continuing operations in the Suez Canal economic zone, and offering projects to foreigners,” he adds.

The Higher Council for Investments, headed by President Abdel Fattah al-Sisi, approved 17 investment-favorable measures on November 17, including tax incentives that aim to lower imports and boost exports, and the allocation of free land in Upper Egypt at discounted rates in new urban communities. The government is also set to review several economic legislations, including a new investment law, the tax measures bill, a new customs bill and a new tax bill for small and medium enterprises.

What matters more than a rise in the main index is the size of funds entering the Egyptian stock market, says Tawfik, who adds that “the main index can be manipulated into rising,” and, “people were buying with the expectation of devaluation and economic reform.” For the stock market to keep receiving financial inflows, Tawfik says, economic measures need to continue.


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