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Some investors turn cautious on Egypt’s lucrative carry trade


Egypt’s central bank says its unconventional strategy to deal with the coronavirus pandemic has been successful: raising interest rates on domestic deposits, lowering domestic lending rates and allowing the currency to remain almost unchanged against the dollar.

The stability of the currency and high T-bill yields have led foreigners to buy Egyptian pounds to invest in short-term T-bills only to reconvert them to dollars when they mature, earning hefty returns. A one-year T-bill auctioned on Dec. 20 yielded 13.25% on average, before a 20% income tax.

This has made Egypt a favourite among emerging market investors since it undertook a wide-ranging reform programme under the auspices of the IMF in November 2016. But concerns are growing about whether the central bank can afford to keep supporting its currency and pay out such high yields, especially if there is another economic shock, more than a half-dozen analysts and investors said.

“Egypt is generally perceived by markets as being more vulnerable in a rising rate environment (globally) given its large financing requirement and heavy dependence on the carry trade,” said Farouk Soussa, an economist at Goldman Sachs.

Foreigners held 378.2 billion Egyptian pounds ($24.1 billion) in treasury bills of one year or less at the end of September, an all-time high, according to the latest central bank figures.

“We have seen some unwinding of positions in recent weeks, partly due to a fall in risk appetite in emerging markets, partly due to concerns around Egypt’s external sustainability,” Soussa said.

LOOKING FOR INFLOWS

Viktor Szabo, a portfolio manager at abrdn, said the problem is not whether funds will flow out of Egypt, but how Egypt will meet substantial future financing needs.

“The key question is whether they are willing and able to maintain the exchange rate, because that is why it has been the most sensational trade for emerging markets – because they kept the foreign exchange stable and paid extremely high rates on their bonds.”

Apart from a brief depreciation early in the early months, the Egyptian pound has remained almost unchanged throughout the pandemic at around 15.70 against the dollar.

“We didn’t deal with the foreign exchange in the normal way,” Central Bank Governor Tarek Amer said this month. “Most central banks have witnessed a big devaluation of their currencies – 20%, 15% or 30%,” adding that the monetary authorities felt a weaker exchange rate would not bring back tourists or boost exports.

“We intervened with a substantial amount of reserves, and we made sure that the foreign investors – and it is our philosophy that we don’t want them to lose – didn’t lose money during their exit, which was substantial,” Amer said at a Middle East central bank video conference.

“All central banks reduced interest rates. We increased the interest rate for (domestic) deposits. We created something that was a bit unusual, but it worked,” Amer said.

As evidence of success, the government reported annual economic growth of 9.8% in the July-September quarter, up from 0.7% a year earlier.

NET FOREIGN ASSETS FALL

Still, Egypt’s net foreign assets – dollars and other currencies held by Egyptian commercial banks and the central bank – dropped by 58.7 billion Egyptian pounds, or $3.75 billion, month-on-month in October to 114.19 billion pounds, latest central bank data shows, their lowest since the months after the pandemic broke out in early 2020.

This may have been caused in part by the maturity of external obligations, including a $2 billion loan from Gulf banks over the last few months, refinanced and increased only after a gap, bankers and analysts said.

The current account deficit, which widened to $5.13 billion in the April-June quarter from $3.83 billion a year earlier, is likely to remain a drain on resources.

The government has also been helped by billions of dollars in pandemic-related loans from the International Monetary Fund, the World Bank and other institutions, helping to finance the current account deficit which surged after a collapse in tourism.

It has also been selling less expensive Eurobonds. In September it sold six-year bonds at 5.8%, according to a document from one of the banks on the deal.

“Egypt has become overly reliant on non-resident portfolio flows,” said Shikeb Farooqui, senior macrostrategist at emerging markets-focused asset management firm Emso. “Elevated external financing needs and eroding external buffers leaves Egypt exposed to global shocks.”

($1 = 15.6925 Egyptian pounds)

(Reporting by Patrick Werr; Additional reporting by Karin Strohecker and Aidan Lewis; Editing by Susan Fenton)

By Patrick Werr



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