Egyptian equities: wishful thinking?

Egypt’s stock market is a paradox. Political tensions are getting worse, the economy is deteriorating and foreign exchange reserves are falling dangerously low. And yet equities are up nearly 40 per cent, the biggest gain in the world for 2012.

Clearly investors are betting that the closer the country edges to economic collapse, the greater the chances of the politicians seeing sense and the IMF leading an early bail-out. But what if they’re wrong?

The scope for disappointment is, to put it mildly, considerable. Even after Tuesday’s profit-taking, which saw the EGX30 index slip 1.7 per cent, the market is up 39.8 per cent on the year, in both local currency and dollar terms.

The index is still some 30 per cent below the levels seen in January last year, just before the start of the protests that swept ex-president Hosni Mubarak from power. However, in valuation terms equities are well on their way to where they were in December 2010 – with the trailing price/earnings ratio on 17, compared to 17.6, and the price/book ratio on 1.3, versus 1.9.

This is hardly justified by the economic outlook. In late 2010, Egypt was an economy growing at 5 per cent a year, with $36bn in its foreign exchange reserves. Now it is an economy growing at 1-1.5 per cent, with reserves of just $16.4bn at the end of January.

Admittedly, the stock market features some strong companies with extensive international businesses, which can offset their troubles at home with their advances abroad – Orascom Telecom, for one. Indeed, if the central bank failed in its hitherto successful efforts to prop up the currency and the Egyptian pound plunged, such companies could be big beneficiaries as their local costs would fall.

But even the most export-oriented of Egyptian companies can isolate themselves from the Egypt’s economic and political difficulties.

Foreign exchange reserves now cover only a little more than 2½ months’ imports of goods and services. The very liquid portion of the reserves cover only 1½ months’ imports. This is dangerously low in a world where economists like to see three months’ cover as a minimum.

Reuters reported that finance minister Mumtaz al-Saeed said on Sunday that Egypt expected to sign a $3.2bn loan agreement with the International Monetary Fund next month – and would receive one-third of the funds immediately upon signing,

But this would not be enough even with contributions from other sources, including the World Bank (possibly $1bn), long-standing bilateral donors headed by the US, and the oil-rich Gulf states. Economists estimate Egypt needs around $10bn-$12bn in total.

None of this money will come unless the IMF is satisfied that it won’t be wasted – and the Egyptian authorities can implement IMF-backed economic policies, including tough fiscal controls.

There’s the rub. Egypt is a country where so much is still the subject of uncertainty – starting with the mood of the crowds in the streets and ending with the future constitution. The IMF deals a lot with countries with political difficulties, such as, right now, Greece. But Egypt’s uncertainties are of a different order.

Raza Agha of RBS told beyondbrics: “I think the valuations in the stock market are very misplaced. The growth prospects are bad. The financing looks difficult. The government – borrowing at 15-16 per cent – is crowding out the private sector. So I don’t see where growth for companies is going to come from.”

Of course, investors are riding a wave of optimism about markets in general, which has swept through emerging markets with particular force. And they have – quite rightly – gone looking at markets that did especially badly last year, including India, Turkey and Hungary, not to mention Greece.

But this might be a moment to think less about global trends and more about the local realities.