Egypt’s Emerging-Market Status at Risk on FX Woes

Report

Egypt is back in the spotlight ahead of index compiler MSCI’s annual market classification announcement this week.

The Arab emerging market is not officially under review, but many investors believe the country’s foreign exchange woes might push organizations such as MSCI to consider downgrading it to frontier status, which could hurt its investment profile. Rival index-provider Russell has already moved Egypt from its emerging category to frontier.

Egypt’s foreign-exchange liquidity has been severely hit by political unrest in recent years as investments and tourist inflows ebbed, with international reserves falling by more than half since early 2011 to the end of March.

Aid from its Arab Gulf neighbors such as Saudi Arabia and the U.A.E. helped shore up these reserves—in May they stood at about $19.6 billion—but its finances remain strained.

Egypt’s external position continues to deteriorate, according to the latest balance of payments data released by the central bank, Emirates NBD said. The foreign aid-adjusted current account deficit also weakened, with the shortfall expanding 17% year-on-year, Emirates NBM added.

To ease the FX pressure, the country imposed certain limitations on repatriations but that is acting as a deterrent for foreign investors, analysts say.

A dearth of foreign exchange is resulting in a “repatriation queue”, which is hurting stock market investments, Mohamed Ebeid, the head of brokerage at Cairo-based EFG Hermes, told The Wall Street Journal.

“Investors wait an average period of a year to receive their funds,” Ebeid said. For the market to repeat its performance of last year, this obstacle needs to be removed, he noted.

Egyptian stocks are trading in the red this year, down about 3% to date, despitereceiving a huge boost last month when the government put on hold the implementation of a controversial tax on capital gains that had spooked investors. The market was up more than 30% in 2014.

Egypt’s FX-related woes are not new. In June 2013, MSCI warned the country that it might lose the coveted emerging status if its FX situation worsened resulting in the inability of international investors to repatriate their funds. The injection of funds from its Gulf friends helped Egypt boost its reserves and avoid the possibility of such a downgrade last year.

This year might be different. “The worst case scenario would be for MSCI to begin a consultation on a change of classification for Egypt,” an EFG analyst told clients in a note last week. “However, we believe that MSCI will move cautiously, and a more likely scenario would be another warning, similar to that issued in June 2013.”

MSCI couldn’t be immediately reached for comment. It has previously declined to comment on market speculation.

Even if Egypt gets away with a warning from MSCI this week, not all analysts are buoyant on its prospects in the near term.

The sentiment toward the market, bolstered by the economic reforms that Egypt has undertaken in the past year or so, is mostly positive. Investors are also optimistic about potential investments after the Arab world’s most populous nation received commitments worth tens of billions of dollars at an investment conference in March.

But Mohamed Radwan, the head of equities at Cairo-based Pharos Securities, is not so convinced. He said the positive sentiment that triggered the 18-month rally after mid-2013 can’t be sustained unless investors start seeing some changes on the ground. “After so much talk of mega projects and successful economic conferences, very little action is happening,” Radwan said.

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