Egypt: calm voting soothes markets

After a week of dire predictions and market turmoil, Egypt’s equity markets saw their biggest single day rise in almost two years on Tuesday. The benchmark EGX index jumped 5.5 per cent as two days of peaceful polling gave investors hope that a new government could be formed and power transferred smoothly from the ruling military council.

But Egypt’s economy is not out of the woods yet and Tuesday’s equities gains did little to reverse the 43.5 per cent fall the EGX index has suffered this year. Voting continues for the next six weeks – surely a stern test of investors’ nerves.

Egypt was downgraded by Standard & Poor’s for the second time in five weeks last Thursday. S&P kept its outlook negative. Its pessimism was based on more than political instability.

Egypt faces a budget deficit of 10 per cent this year and its foreign reserve position is still deteriorating. According to Capital Economics, Egypt has burned through some $14bn of its reserves this year supporting its currency and is sitting on, at most, $22bn – a figure, says Capital, that is approaching the critical 3-months of imports cover widely accepted as a minimum – though central bank figures put the cover at between 4 and 5 months.

And Egypt’s pound remains under real pressure despite direct government intervention in FX markets and the central bank hiking its key interest rates last Thursday even as inflation eased and growth continued to falter. The pound is currently trading at just over E£6 to the dollar and has lost 3.4 per cent against the greenback since the start of the year in what analysts have suggested is an attempt at a managed devaluation.

The futures market is pricing in a much larger devaluation with the pound trading at E£7.2 to the dollar in the 12-month non-deliverable forward market – a difference of 20 per cent over its current value. Any gains Egyptian exporters might make from a weaker pound would be offset by increasing costs of imports. Egypt’s imports amounted to some $50bn in 2010, compared to exports of $27bn. And a sudden, serious fall in the pound’s value would be disastrous.

Any chance of rebuilding its reserves will only come once political stability is restored and either investment resumes or Egypt’s new government can negotiate with the International Monetary Fund. That will only happen once elections are completed.