Emerging market investors are expected to re-enter the Egyptian domestic debt market, as they are attracted by the Egyptian pound’s depreciation against the US dollar and record returns compared to regional and international peers.
Egypt’s move to a more flexible exchange rate re-flamed interest in its debt instruments denominated in the local currency, which recorded the worst performance in emerging markets last year, according to Bloomberg indicators, as investors withdrew $22bn from the market over a period of six months in 2022, according to Minister of Finance Mohamed Maait.
Bloomberg said that Egyptian treasury bills are now trading at a price that is the lowest ever compared to emerging market debt instruments, making the difference between the return of most Egyptian treasury bills and other developing countries this week widen to the largest extent ever.
Attracting foreign investors back into the domestic debt market is crucial for the Arab world’s most populous country, which has shied away from foreign capital markets for almost a year.
After continuing to reduce the weight of (Egyptian debt instruments) for most of 2022, I finally see favorable conditions to return to the local market, according to Gordon Powers, an analyst at Columbia Threadneedle Investments, based in London.
He added: “I will keep some liquidity available to overweight if the currency continues to exceed its fair value.”
The Egyptian pound fell to a record low of EGP 32.1 against the dollar this month amid the worst foreign liquidity crisis the country has witnessed in years, but some of them will still want to see the currency reach a stage of balance before turning more towards Egyptian debt instruments.
Columbia Threadneedle Investments believes that the Egyptian pound is already undervalued by 25%, when measured at the real effective exchange rate, which is a measure of the currency’s competitiveness vis-a-vis trading partners. But it also says the currency could depreciate further.
For its part, Deutsche Bank expects the pound to weaken by up to 10% to EGP 33 against the dollar before stabilizing.
As one of the largest importers of wheat in the world; Egypt has been hit hard by the economic repercussions of Russia’s invasion of Ukraine last February. Until then, it was a major destination for volatile hot money due to its combination of a fixed currency rate and the world’s highest interest rates when adjusted for inflation.
Nevertheless; recently, the government began to question the country’s dependence on this type of flows, and with the worsening of the crisis last year; it introduced what it called a “permanently flexible” exchange rate system.
A series of currency devaluations followed, which helped Egypt secure a $3bn loan from the International Monetary Fund in addition to agreeing on other borrowing options, the Gulf allies also pledged more than $20bn in deposits and investments to help a country they deem vital to regional security and stability.
The last time Egypt resorted to international bond markets was in March 2022, when it issued securities denominated in Japanese yen, and the last dollar debt deal was in September 2021. Egypt has $39bn in outstanding Eurobonds, according to data compiled by Bloomberg.
With inflation exceeding 21% in December, the CBE may have to raise interest rates further to attract more foreign investment, according to Matthew Vogel, London-based portfolio manager and head of sovereign research at FIM Partners.
“With inflation rising to close to 30% in the coming months, and no fulcrum in the currency market given the change in regime, we still believe that the CBE should continue to tighten,” Vogel said.
In the meantime, the gap between the official price of the pound and its price in the parallel market, which appeared with the Egyptians’ struggle to find dollars through official channels, has diminished.
“It looks like we’re getting closer to the end of the devaluation process,” says Paul Greer, money manager at Fidelity International in London, whose recommendation is neutral on the Egyptian currency and local debt.
He added, “We can expect demand to return, especially in an environment where global inflation, global yields, and the US dollar are declining.”