Though still up by over 40 percent YTD, Egypt’s benchmark equity index looks ripe for a near-term correction—a thesis we’ve put forth in recent weeks primarily on the back of the country’s wobbly and inadequate external financing state which we estimate should continue to strain borrowing costs, adding stress to the country’s terms of trade while further crowding out private borrowers before it is resolved. Adding to our concern are possible negative feedback loops emanating from the country’s financial sector and its repercussions on growth and fiscal performance. A newly released working paper from the IMF[i], for instance, details “significant links between emerging market banks’ asset quality, credit and macroeconomic aggregates” while specifically pinpointing a reversal in [gross rather than net] bank related and foreign portfolio and bank flows [and not FDI] as the most statistically relevant (i.e. highest R-squared correlation) independent variable considered upon which asset quality (NPL/total loans) depends. Ensuing growth contraction, weaker terms of trade and depreciating nominal exchange rates ultimately can negatively impact balance of payments (as well as possibly the feedback channel on investment, per the authors, given “new orders for capital equipment [would be] more expensive in an environment of deteriorating private sector balance sheets”).
The IMF’s findings echo a rather ominous assessment of the Egyptian bank sector from Moody’s last November wherein analysts noted in the midst of various downgrades that “although data published by the Central Bank of Egypt (CBE) points to lower non-performing loans for the system as of June 2011 . . . these figures benefit from the CBE’s directive allowing different NPL classification rules for retail and tourism loans for three and six months, respectively, after the January 2011 revolution . . . [and we] expect that the full extent of asset-quality issues will begin to emerge in the next few quarters…” To wit Commercial International Bank (CIB), Egypt’s largest private creditor by assets (third overall) and one of five institutions whose local and foreign-currency deposit ratings were slashed last fall, disclosed in its recent full-year 2011 earnings report that while its NPL ratio stood at 2.8 percent (up slightly from 2.7 in 2010 but in line with historical averages and well under the GCC mean since Egyptian bank loan books are underexposed to the riskier retail sector in comparison to GCC peers) the absolute number rose by over 20 percent y/y. Taken in tandem with the fact that foreign currency deposits across Egypt rose by 14 percent (an implicit red flag on future asset growth given said deposits must be channeled to foreign currency loans per law) while provisions leapt from LE6mn to 321mn over that same period and one may reason that NPL ratios could indeed be under some strain in future quarters given that net capital flows (as discussed last week) slackened considerably since last July (and are estimated to reach nearly USD6bn FY11/12) while the aforementioned dollar deposit figure grew—suggesting a similar trend for gross flows. Moreover, per the IMF’s capex hypothesis, investment has been a detracting headwind on GDP since early 2011 as real GDP, which averaged ~4 percent annually in the years pre-revolt now struggles to remain above flat.
Note: Where might the EGX be headed? Simple Fibonacci analysis would indicate that because the index failed to retrace even past its .5 retracement (vis a vis the three-year, 2010 high versus the December 2011 low) a broader, secular downtrend remains in tact. Moreover in the short term a weekly close <4300 would indicate that a lower-low from December is likely impending. We expect, however, that a 10 percent correction from today’s levels (~5080), particularly if combined with positive macro and/or geopolitical developments will be well received by investors and offer an impetus for strategic longs to gain traction).