Friday, 4 November 2016

Special Issue: Petrol and gas prices rose last night + Everything you need to know about what happened yesterday

Enterprise+: Inside the float of the EGP

Enterprise+: Inside the float of the EGP is presented in association with

We’re breaking with tradition this morning and running hard news. Long-time readers know we think weekends are for family and friends. That’s why our Weekend Edition includes only a menu of stories, podcasts and videos on the softer side of life and business — pieces to make you think (or laugh) over a cup of coffee on a quiet Friday or Saturday morning. In view of yesterday’s events — and the volume of phone calls we received from friends, readers, clients and sources wanting to chew the fat — we’ve opted to hack together a quick explainer.

Before you start reading, take a moment to give yourselves a pat on the back — you called it. Nearly 1,000 Enterprise readers responding to our first-ever reader survey last week hit the nail on the head: Fully 56% of you said you expected the EGP to be at 11.51-13.50 to the greenback on 1 January 2017, and 12.8% of you said you saw it at 13.51-14.50. Our full survey results are here if you missed our report last week.

Below, our take on the best news to hit the Egyptian economy since March 2015, including what happened, what it means, how markets and business leaders are reacting, and a couple of thoughts on what to watch next. We’ve just pulled back from the brink, ladies and gentlemen. The hard work of building a real economy starts this morning.

** BREAKING NEWS: Egypt cuts fuel subsidies, raises price of petrol at the pumps. With subsidy reform a condition of the IMF executive board’s pending approval of a USD 12 bn extended fund facility and oil prices rising substantially over the Ismail government’s budgeted price for 2016-17, Egypt cut fuel subsidies and raised prices at filling stations just after midnight today. The move was first reported late last night by both Al Shorouk and Aswat Masriya.

As of this morning, fuel prices are as follows:

  • 95 octane petrol will now sell for EGP 6.50 per liter, and the price per liter will be allowed to float
  • 92 octane petrol has risen 35% to EGP 3.50 per liter (from EGP 2.60)
  • 80 octane petrol has risen 47% to EGP 2.35 per liter (from EGP 1.60)
  • Diesel has risen 31% to EGP 2.35 per liter (from EGP 1.80)
  • Kerosene will also sell for EGP 2.35 per liter
  • Compressed natural gas for automobiles has risen 31% to EGP 1.60 per cubic meter (from EGP 1.10)
  • Mazot (fuel oil) will now cost between EGP 1,500 and EGP 2,500 per ton

Natural gas prices for home consumers will also rise. All price rises took effect at 12:01am this morning. You can see the Oil Ministry’s official statement here (jpg) as received via email.

The phase-out of fuel subsidies is the right thing to do… The wealthy benefit most from the subsidies. Simply put: Whether you’re driving a gas-guzzling Jeep Grand Cherokee with a 5.7 liter hemi or a gas-sipping compact, you’re consuming more fuel than you would if you were to take public transport.

…It is also likely to prove inflationary and will hit low and low-middle income earners in a manner in which we argue the float may not. We have further thoughts on this at the end of today’s report, but we remind readers that (1) there’s a good argument to make for EGP 15.00 per USD 1.00 being “priced in” right now and (2) there’s an equally good argument to be made that low income earners will be largely shielded from the float provided the government manages the price and availability of subsidized commodities. That said, the last round of fuel price hikes in July 2014 saw transport and food prices (among others) shoot up significantly for lower income earners and the poor.

Keep your eye on the news this morning: Al Masry Al Youm says Prime Minister Sherif Ismail and ministers of the economic group will hold a press conference today at 9:30am to outline the government’s course of action post the float and price hikes. The risk of socioeconomic backlash will be high on their mind, as Central Bank of Egypt governor Tarek Amer suggested at a press conference yesterday afternoon. More on that below.

So, what exactly happened yesterday?

Welcome to the free float: The Central Bank of Egypt (CBE) took action early yesterday morning (pdf) to devalue EGP to 13.00 per USD 1.00, allowing it to trade within a 10% up / down band until leaving it to the market to decide the currency’s fair value after a 1pm auction. The central bank said it was moving “with immediate effect, to a liberalised exchange rate regime to quell any distortions in the domestic foreign currency market … [to] allow market demand and supply dynamics to work effectively in order to create an environment of reliable and sustainable provision of foreign currency.” Domestic banks, it said, have the green light to bring back the interbank market to price FX.

The EGP has gone from being the fourth most expensive currency in global emerging markets to the third cheapest, according to data from Renaissance Capital provided in an emailed research report. By its real effective exchange rate (REER) valuation, RenCap sees only Mexico and Columbia as cheaper than Egypt among the EM in its coverage universe.

So what’s the USD worth in EGP terms right now? The short answer: EGP 15.75-16.00.

The long answer: By the end of yesterday’s 1pm auction, the CBE had sold USD 98.7 mn at an average bid price of EGP 14.65. Reuters says the cut-off price at the auction was EGP 14.30 per USD 1 and the maximum rate was EGP 15.60. Banks, however, are free to offer the greenbacks to the market at the price of their choice. The domestic press reported last night that theNational Bank of Egypt and Banque Misr, both state-owned banks, were selling greenbacks for EGP 15.75 to USD 1.00. AAIB was reportedly selling at EGP 16.00 just before 9:00pm, while the EGP closed the day at EGP 15.75 in branches of private-sector leader CIB, according to its website.

Longer term: Bloomberg reports that 12-month non-deliverable forwards for the EGP had sagged to a record low of 16.55 per greenback.

Okay, does this mean the cap on using my credit card or debit card outside Egypt will be raised? Probably, if this brief statement posted last night on CIB’s website is any indication: “Dear Valued Customer: Due to the current changes in the foreign currency markets, we will be looking to enhance the spend limits on CIB cards, which will be communicated shortly.” A similar message was dispatched to CIB clients overnight via SMS, and Al Mal is reporting that the National Bank of Egypt raised the maximum FX it would sell travelers by more than 3x to USD 1,000 from USD 300. Yehia Aboul Fotouh, a member of the bank’s board, made the announcement on Lamees El Hadidy’s Hona El Assema last night.

The float is part of the Ismail government’s economic reform programme, the CBE said. Liberalising the exchange rate aims to bring foreign currency dealing back into the banking system, stabilising rates through clear supply and demand mechanisms. Besides the complete exchange rate liberalisation, the CBE also increased overnight lending and deposit rates by 300 bps, bringing the deposit rate to 14.75% and lending rate to 15.75%. The CBE’s main operations rate and discount rate now stand at 15.25%.

The CBE also allowed (read: forced) banks to stay open until 9pm yesterday and through the weekend to handle FX transactions and to disburse remittances from abroad. Most banks appear set to open 1pm-9pm today and 10am-9pm tomorrow. The central bank assured the market that it would not enforce any conditions on those wanting to sell FX. The bank said it guarantees depositors’ savings in any currency (in other words: No forced conversion of FCY accounts into LCY). Neither retail nor corporate clients face restrictions on withdrawals or deposits of foreign currency,although importers of “non-essential goods” are still bound by the USD 50,000 monthly limit for deposits and a USD 30,000 daily limit for withdrawals.

No fees or commissions on remittances; priority access list for FX goes into the dustbin of history: In a separate directive sent to banks, the CBE instructed them not to levy fees or commissions on any remittances from abroad that they disburse to their local clients. It also ordered that bank branches execute only FX-related transactions in the extended opening hours. The CBE scrapped the priority access list for foreign currency it had imposed on banks, giving them instead free rein on FX transactions. The CBE said the FX market is now the local banks’ responsibility.

Let’s be clear about this: It is not a devaluation, but a free float. Yesterday’s 1pm auction put just USD 100 mn on the market, and our friends in the banking industry tell us the Central Bank of Egypt’s rationale was simple: It was effectively a price discovery session for the banks. As one put it: “The bankers were chickens starting helplessly at oncoming cars. The auction set a guide price, but the message was clear: We can put whatever buy / sell prices we want on our screens.”

Is FX flowing into banks at yesterday’s rate? Anecdotally, yes. A senior banker with whom we spoke reported his institution had pulled in “more in the last few hours than we have in the past six months. The momentum is very positive.”

What about the USD 4 bn infusion the market expected yesterday morning? It’s not coming. We were all wrong: The CBE isn’t going to use the IMF facility or third-party financing to flood the market with FX liquidity. The CBE defied expectations by going for a full float of the EGP, and they’re essentially removing capital controls and then leaving it to the banking system to bring the USD to a market-clearing rate that will create liquidity by prompting hoarders to sell. As one of the nation’s most respected bankers told us late yesterday afternoon: “What they’re doing is saying, ‘You were begging for a free float — go knock yourselves out. Go get your own money.’ It’s a free market now, and it’s absolutely right that they shouldn’t subsidize us by making FX available to banks at a discount.”

It is possible, though, that the CBE will inject liquidity at some point in the future to smooth-out dry spells of volatility. “The central bank needs to shepherd its liquidity so they have the flexibility to inject a bn here or there if something were to happen to tourism or if anything else should cause inflows [of FX] to dry up,” a banker suggested.

Which brings us to what should be obvious, but still: Expect volatility in the FX market over the next few weeks. Bankers with whom we spoke agree the coming three or so weeks could be volatile, but as one said: “The balance of power is now with the banks. We have the dealers: If the USD overshoots [relative to the greenback], the dealers can underprice to bring it back to its fair value based on what we see as supply and demand. But it could take the USD overshooting two or three times before things smooth-out.” At least one money changer agrees, telling Ahram Online the USD had tumbled to an average of EGP 12.90 in the parallel market after the decision and adding that “traders are waiting for the final price of the US currency to be set by local lenders.”

And the equity market could be just as bumpy: RenCap hit the nail on the head on the volatility front in an emailed research note in which equity strategist Daniel Salter tentatively moved his recommendation on Egypt to overweight from underweight: “…the equity market could be bumpy for several months: 1) as investors determine whether a clearing exchange rate has been established; 2) as previously trapped capital may choose to exit; and 3) if local investors who have been using equities as an FX hedge unwind their positions.”

Inverted yield curve? Following the CBE’s decisions yesterday, state-owned banks National Bank of Egypt and Banque Misr announced they are offering 18-month certificates of deposit carrying an interest rate of 20%. They are also offering three-year certificates carrying 16%, Reuters said. A pretty good offer we think — probably too good to be true, even, and definitely not an instrument that will be around for a long time. So, if you’ve bought USD at EGP 14.00 per buck (assuming no compounding) the returns from holding the 18-month CD keep you in the money even if the exchange rate dropped to EGP 18.20 per USD 1 by the time it matures. With the three-year CDs, you’re making money even if greenbacks were selling for EGP 20.72 in three years’ time.

Don’t expect the NBE / Banque Misr offer to last: Private-sector bankers tell us they wouldn’t be surprised if the two were to call-off the offer early in the new week, speculating that the move isn’t a bid to siphon liquidity from the system to cool inflation (or to on-lend to the state), but rather that the NBE and Banque Misr have maturity gaps they needs to plug. The CDs could temper attempts at dollarisation, but are also likely to pile up pressure on private banks. Banque Misr chairman Mohamed El Etriby told Lamees El Hadidy on Hona El Assema last night that BM and the National Bank of Egypt had recorded combined inflows of EGP 1 bn into their two CD products yesterday.

Private banks are unlikely to match those rates. To be able to make payments on a 20%-interest CD, banks would have to be lending to the government at rates north of 25%, a highly unlikely proposition.

Tarek Amer meets the press

Tarek Amer held a press conference late yesterday to explain the float, the interest rate hike and where we go from here (watch, runtime 35:55). Highlights:

The central bank is implementing a “complete” and homegrown economic reform programme, set together by the CBE and the government acting through the Coordinating Council. According to Amer, the most important things are having the “political will” to enact reforms — and being able to communicate the strategy and challenges ahead effectively. The central bank is concerned with making sure that FX is spent on ensuring that basic commodities are available at affordable prices to those in need.

The CBE could not allow “two markets” for foreign currency to operate in parallel, Amer says, and the CBE has empowered banks to take control of the market. Yesterday, banks took in 8x more foreign currency than they did in “the previous period,” Amer said, refusing to disclose exactly how much flowed into the system. The governor reserved particular praise for former CBE chief Farouk El Okdah, who he says prepared the banking system for this step through the reforms he enacted starting in 2004. The banking system is healthy and profitable, Amer reiterated, but noted that an “open market” will also come with the CBE tightening its oversight of the system.

“We are also building Egypt’s international reserves,” Amer said, noting that the CBE is still aim to reach the reserve base he had “targeted at the start of the year.” (He stopped short of specifying the figure — it was USD 25 bn.) Egypt’s fiscal and monetary positions will continue to improve, creating surpluses that will be used to shore up the health and education systems, he added.

Expect Egypt to be able to “go to” the IMF and present its programme within a “few days,” Amer said, explaining that yesterday’s moves were part of a process designed to unlock the agreement with the IMF. There are no pending issues with the Fund now. Egypt is also set to issue eurobonds right after signing the IMF agreement, Amer announced. The exact value of the issuance will depend on the Finance Ministry’s view of its needs. Together, the IMF package and eurobond issuance are set to increase Egypt’s reserves by “more than 100% of the reserves adequacy metrics that the IMF recommends for countries that adopt flexible exchange rates.” It has also secured pledges worth USD 16.3 bn from G7 countries, China and Arab allies to plug this year’s budget deficit.

It will take a year and half for us to see clear improvements in the economic performance, Amer said. “We’re not just repairing a damaged factory … we’re reversing years of economic mismanagement… We are fixing the fundamentals to deliver sustainable development.”

So, what caused the FX problem in the first place? Blame the increase in M2: Amer says it’s a byproduct of the large volume of EGP in circulation as it drove up the demand for FX. He says it was not possible to continue recording large balance of payments deficits and finance them through foreign borrowing.

…Oh, and Tarek Amer doesn’t like Bloomberg, apparently. He refused to take a question from Bloomberg’s Ahmed Feteha, calling him “not objective” and someone who “never writes something positive on Egypt.” We suspect that Feteha won’t have to buy himself his own ethanolic beverage / coffee / drink of choice for some weeks to come as he’s celebrated by his peers in the press.

Stock market cheers the float

Enough of the facts. How did the market react? The stock market always provides a bright, shiny gauge by which to measure sentiment, and if it’s any indicator at all, the full float is just what the doctor ordered. The EGX30 closed up 3.4% yesterday in very heavy trading, with shares worth EGP 1.6 bn changing hands. That’s nearly 280% above the trailing 90-day average. Foreigners, institutions and Gulf-based investors were all net buyers. Only local and retail investors were sellers.

GB Auto closed up a stunning 17.4%, leading the day’s gainers, followed by Arabian Cement Co. (+8.8%). Food manufacturers Edita (+8.5%), Domty (+5.58%) and Juhayna (+3.9%) confounded widespread expectations that consumer shares would be hammered in a sell-off after the float; conventional wisdom is that post-devaluation inflation would curb consumer spending on luxuries such as yoghurt, cheese and packaged snacks. The day’s worst performers included Qalaa Holdings (-3.9%) and Orascom Construction (-3.6%). EFG Hermes (-2.0%) and Oriental Weavers (1.9%) also closed in the red, the former as investors dumped GDR trades when the devaluation made moot the most expensive (but reliable) way to transfer funds out of the country without question.

Who’s tipping which shares? One analyst with whom we spoke sees EFG Hermes recovering in the coming period as investors line-up in expectation of a one-time super dividend promised after the firm’s exit of Lebanese lender Crédit Libanais. EFG Hermes has itself upgraded Egypt to overweight from underweight and likes financials (including CIB) and real estate. It also sees room for industrials to recover, with Oriental Weavers being in favour, it said in a research note issued yesterday, and has Integrated Diagnostics Holdings, Eastern Tobacco, and Global Telecom on its MENA Top 20 list. Renaissance Capital, which also raised Egypt to overweight (if tentatively), says its target price for Elsewedy implies a 50% upside, making the share its “highest-conviction Egypt pick.” It also likes CIB, and while it sees consumer shares coming under pressure, RenCap thinks Cleopatra Hospitals, Eastern Tobacco and possibly Integrated Diagnostics Holdings are good defensive plays and believes “real demand [for real estate] still looks strong.”

IMF, EBRD are bullish

The IMF praised Egypt for the move: Managing Director Christine Lagarde was full of praise on Thursday, saying, “This is a welcome move given the economic circumstances … The way in which it is handled is welcomed and it’s a decision clearly that the Egyptian authorities have matured and deliberated and are putting in place for the Egyptian economy and for the Egyptian currency." Echoing a similar sentiment, the Fund’s mission chief for Egypt, Chris Jarvis, who led talks with Cairo for the USD 12 bn extended fund facility, said “this will make more foreign exchange available. The flexible exchange rate regime, where the exchange rate is determined by market forces, will improve Egypt’s external competitiveness, support exports and tourism and attract foreign investment.”

The EBRD also issued an official statement welcoming the decision. It says the move “will help reduce foreign exchange shortages which have been impairing the private sector’s ability to import production inputs, to plan and to repatriate profits. In addition it will increase the economy’s flexibility in response to external shocks, strengthen Egypt’s official reserve position and boost investor confidence. The decision on interest rates will help mitigate inflationary implications of the currency move. The devaluation of the EGP will also improve the competitiveness of Egypt’s exports and unlock private sector activity which has been hampered by the lack of foreign exchange availability.”

What Business is Saying

CIB boss Hisham Ezz Al Arab: “It’s a historic move for Egypt. It proves the government is serious about the reform. … Now, for the first time in 60 years, the exchange rate will become a tool rather than an objective. The price equilibrium will determine how much you want to reduce your imports, how much you can increase your exports, consumption, everything." (Reuters and Bloomberg)

Nevine Loutfy, CEO at ADIB Egypt said the float would “drive growth and put the reform process on track,” adding that the bank would extend its operating hours in line with the Central Bank of Egypt’s directive. (Emailed statement)

Ali Tawfiq, head of the Automotive Industry Feeder Association said the move will be net positive for the feeder industry: The more expensive USD will prompt demand for local components, and a functioning FX market will allow component manufacturers to import production inputs. (Al Mal)

Mohamed Mohieldin, vice-chair of the Egyptian Private Equity Association praised the float, saying it would “eliminate the black market” and “confirms Egypt is on the right track.” The timing meshes nicely with the package of tax breaks and investment incentives announced this week by the Supreme Investment Council. (Al Borsa)

What the Analysts are Saying

Angus Blair, Chief Operating Officer, Pharos Holding: “There will be relief in the market and with companies that the devaluation has happened. The resetting of Egypt’s economic equation has begun at last, but much more needs to be done by the government to reform the economy.” (Reuters, via Business Insider)

Mohamed Abu Basha, EFG Hermes: “This is a very positive, courageous step on many levels, firstly, the extent of the move, and secondly the fact that it is effective immediately. We are looking at what is very likely the end of the [foreign-exchange] crisis.” (Wall Street Journal)

Jason Tuvey, Capital Economics: “The decision this morning by the Central Bank of Egypt (CBE) to finally adopt a floating exchange rate regime is a positive step and moves the government closer to securing a USD 12 bn financing package from the IMF. There will inevitably be fresh pain for the economy in the near term – inflation is likely to rise further and the CBE hiked interest rates by 300bp today. But, over time, a weaker pound and IMF-backed reforms should lay the foundations for stronger economic growth. … a devaluation could bring substantial benefits in the long-run.” (Emailed research note)

Tariq Qaqish, Al Mal Capital, Dubai: “Before we increase our exposure to Egyptian assets, we want to see that the entire process is seamless. Like getting money into and out of the country.” (Bloomberg)

The Macro Fallout

The economic impact: While praised generally, the move will require a very delicate balancing act to execute efficiently. The government will have to secure funding sources that work against its aim to narrow the budget deficit. A handy solution would be to reduce dependency on the domestic money market in the short term in favour of using the expected influx of foreign funding, including the IMF’s, as cash cover to increase the growth rate of M2.

Inflation will be a delicate dance, and the impact of yesterday’s moves — the float and fuel prices — will be a fine yardstick by which to measure how receptive the streets will be to the reforms. We await the government’s plan on how it will monitor the markets to ensure that prices are under control while balancing the requirements to subsidy reforms and cash transfer programmes.

Common wisdom now is that inflation is, for the most part, already priced in, as the businesses and individuals alike were resorted to the parallel market to source their FX needs. This is also CBE Governor Tarek Amer’s view: The spike in inflation, he said, “has already happened.” Any unjustified price increases will have to be scrutinised, but we have full faith in the vigilant watch of Mona El Garf (without reservation our favourite civil servant) and her Egyptian Competition Authority.

While it is designed to slow inflation down, the CBE’s step to add 300 bps to its interest rates would also have the challenging effect of slowing down the economy. The bet now must be that growth will primarily be driven by the external sector. Keep an eye on this: The gauge of economic growth in Egypt in the short run will be heavily skewed by the performance of the current account.

In fact, we’re not sold on the notion that raising rates will slow inflation, as we noted last week. The textbook says you raise rates to curb inflation. The catch: “The textbook doesn’t work in Egypt. Interest rates are not an effective means of transmission for monetary policy in a nation in which maybe one in 10 people have a bank account, the grey economy probably dwarfs the official economy, and SME credit is little more than a myth. Hiking interest rates will make borrowing more expensive for the government and push the very few SMEs able to access credit out of the marketplace. Worse, the state will likely pay more in debt service than it would have had it chosen to boost commodity subsidies or extend new cash benefits to the poor. As for corporations? Banks will still offer preferential borrowing rates to their largest clients — and those few SMEs able to borrow will face credit-card-like interest rates.</rant>

And all of this, of course, accounts only for the impact of the float. Rising fuel prices will also spur inflation in the short-term, making transportation more expensive for people (microbuses, buses, taxis, personal automobiles) and for goods such as food. Readers will remember that after President Abdel Fattah El Sisi’s July 2014 decision to cut fuel subsidies, there was a temporary Spike in food prices and widespread reports of disputes after microbus drivers raised prices. The impact of the fuel price hike is not “priced in,” and we have long held that it is impossible to overestimate the greed of the Egyptian trader: The rise in food prices in 2014 far outstripped the increase in fuel prices.

Our take-home message: The float will (by and large) not be an immediate issue for the poor provided the government can continue to make subsidized commodities available. It will squeeze the middle class, particularly on items such as tuitions at international schools. The more important things to watch for will likely be how (1) the fuel price hike affects all income levels, particularly lower-middle and lower-income earners; and (2) how the float impacts the middle class, who holding on by their fingertips right now.

What to Watch For

A bold prediction on interest rates: The FX market is likely to settle “within six to 12 months, allowing the central bank to aggressively cut rates. ‘Within six to 12 months from now, rates could be down by 700 basis points,’” CIB Chairman Hisham Ezz Al-Arab said.

Will the carry trade come back? A 300 bps hike in rates will make Egypt enticing for the carry trade. How significant is the carry trade? In January 2011 — on the eve of 25 Jan — foreign investors owned about 20% of Egypt’s short-term treasury bills, the FT estimated in a BeyondBrics blog post at the time. In the two years to January 2011, foreign holdings had “soared … from around EGP 5 bn to over EGP 60 bn,” or about USD 10 bn at the time. A JPMorgan survey of EM investors in December 2010 “showed Egypt was one of the four markets where investors had the biggest currency exposure.”

(The carry trade is essentially the practice of borrowing at a low interest rate — say, in USD — then buying another asset that’s likely to provide a higher return, such as another currency that grants a substantially higher interest rate. Like, in theory, the EGP. Still foggy on the carry trade? Khan Academy has a reasonable primer that breaks it down. Watch: run time 4:02.)

What happens to the money changers? Said one of the smartest bankers we know last night: “My only worry is what are they giving to the bureaux de change? You’ll know the government is serious about including them in the process if there’s one in the airport soon.”

When will the IMF executive board approve the USD 12 bn extended fund facility? We think it could happen as early today. Yesterday’s developments and the cut of fuel subsidies overnight were both key IMF conditions. And the CBE and the Ismail government are clearly pushing hard to send the message that “this is really happening” with their decision to keep the banking system open for the weekend. We understand that there is nothing preventing the IMF board from meeting via a previously unscheduled conference call to approve the loan agreement. Otherwise, the board will have multiple opportunities at which to approve the facility in the days ahead: Its public meeting schedule notes sessions scheduled for 4, 7, 9 and 11 November.

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