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Monday, 21 March 2022

It’s surprise interest day

Good afternoon, friends, and welcome to a blockbuster, single-story issue of your favorite afternoon read. We don’t normally go heavy on news in EnterprisePM, but we don’t have much of a choice this afternoon:

In a gutsy move, the Central Bank of Egypt this morning went for a surprise interest rate hike — and allowed the EGP slip against the USD. The CBE raised rates by 100 bps, its first hike in five years, after calling a special monetary policy meeting early this morning. The bank acted to stave off inflationary pressure and support economic activity, it said in a statement (pdf).

Minutes following the interest rate announcement, the CBE allowed the EGP to slide against the greenback, with the pound settling at 18.27 to the greenback by the end of the trading day.

WAIT, WAIT, THERE’S MORE- Just minutes before dispatch, Finance Minister Mohamed Maait announced the outline of an EGP 130 bn stimulus package. The package includes slashing the capital gains tax on gains made from IPOs on the EGX by 50% for the next two years and creating a tax exemption for share-swaps between listed and unlisted companies. The government will revive the customs exchange rate, fixing it at EGP 16.00 / USD 1.00 for imports of basic commodities and raw materials for manufacturing. The package will also include 450k new families eligible for handouts under the Takaful and Karama social security programs, as well as rises to annual pension payments and salaries for civil servants that will come into effect next month, and raising the ceiling for income tax exemptions. We’ll have chapter and verse on the stimulus package and all the finer details in tomorrow morning’s edition of EnterpriseAM.

AND MORE AND MORE? Prime Minister Moustafa Madbouly and Central Bank of Egypt Governor Tarek Amer are expected to hold a press conference shortly after we hit “send” on this afternoon’s issue.

It wasn’t just us, BTW: Ghana’s central bank also hiked its main lending rate by 250 bps to 17% today — the bank's highest rate hike in more than 20 years, according to Reuters.

KEY TAKEAWAYS right now:

  • One USD was changing hands at EGP 18.27 (CIB’s sell rate);
  • There are no capital controls in place, according to three bankers we spoke with;
  • Investors and analysts cheered the news, with the EGX 30 gaining 4.9% at the closing bell and a top foreign investor in Egyptian equities saying this morning’s moves were “fantastic”;
  • Certificates of deposit offering 18% are back at state-owned banks including the National Bank of Egypt and Banque Misr — but only at 12-month tenors;
  • Overcorrection is possible — the EGP could regain ground in the coming days or weeks, as it did after the float in late 2016;
  • Expect an accelerated offering of high-quality state-owned assets to desirable foreign investors, with an emphasis on GCC sovereign wealth funds and private-sector actors, as the state looks to build FX reserves in view of current global macro conditions.

It’s really unlikely there will be a second interest rate hike this week: The central bank said just before dispatch time that it has canceled Thursday’s regularly scheduled Monetary Policy Committee meeting (pdf).

WHAT’S THE CBE SAYING?

It’s all about inflation: “Rising international commodity prices resulting from further supply chain disruptions in addition to increased risk-off sentiment have added to domestic inflationary pressures as well as external imbalances,” the CBE wrote in the statement. Exchange rate flexibility acts as an important “shock absorber” to maintain economic stability and competitiveness, the CBE added.

“Achieving low and stable inflation over the medium term supports real incomes and sustains the achieved competitiveness gains of the Egyptian economy,” the CBE wrote. “The MPC reiterates that the objective of raising policy rates is to anchor inflation expectations and contain second round effects of supply shocks stemming from exogenous factors outside the scope of monetary policy.”

Headline inflation reached a 31-month high in February as rising global prices caused local food price inflation to hit its highest level since 2018. Annual urban inflation rose to 8.8% last month from 7.3% in January — its highest level since July 2019 — while monthly inflation hit a 16-month high of 1.6%.

Still within the target range though: The headline rate remains within the central bank’s 7% (±2%) target range, but analysts were concerned that the rate could leap to 10% or more for March on the back of Russia’s war in Ukraine.

WHY NOW?

Analysts and bankers we spoke with today say a number of factors prompted the CBE to act before Thursday’s regularly scheduled meeting, including (a) the imperative to tamp- down inflation, (b) the need to keep Egypt attractive to the global carry trade, and (c) wiping away the perception that had emerged in some quarters that the EGP was overvalued against the greenback.

The central bank’s moves this morning are the latest in a series of on-point policy measures by the Sisi administration as Egypt faces fallout from Russia’s war with Ukraine. The two countries together account for a bit more than 30% of all tourist arrivals in Egypt and sell us just over 85% of our total wheat imports. The war is also driving a global risk-off, has sent the price of oil far above the figure penciled into Egypt’s 2021-2022 national budget, and comes at the same time as the US Federal Reserve hiked interest rates for the first time since 2018, providing more generous returns to risk-averse investors.

MARKET REAX-

The speed with which the central bank acted has impressed bankers, analysts, and investors alike — and the fact that the CBE moved without Egypt having signed up for an IMF assistance package speaks to substantial policymaking maturity, putting us in a better position when (or if?) Egypt approaches the lender.

“It’s a bold move rather than hoping to ride out a storm when nobody, anywhere in the world, knows when that storm will end,” said a senior private-sector banker.

“It’s fantastic,” said a top foreign investor in Egyptian public and private equities when asked this morning to comment on the central bank’s moves. “The process of anticipating a devaluation like this creates uncertainty — and uncertainty makes it hard for buyers and sellers to agree on prices. As an investor, I need to agree on valuation with sellers or with people raising capital. Periods of uncertainty make it difficult for transactions to close, and today’s moves create a new reality that allows businesses to plan and transactions to happen.”

The EGX30 rose 4.9% at today’s close on turnover of EGP 2.2 bn (57.6% above the 90-day average). Local investors were net buyers. The index is down 3.7% YTD.

“The CBE took fast and bold action,” making a strong first move to hit the problem on the head, says Al Ahly Pharos’ Radwa Elswaify. HC Securities’ Monette Doss agrees, saying the combination of EGP devaluation along with higher interest rates will result in a rebound in Egypt’s carry trade and help finance Egypt’s external funding needs. “We believe the carry trade could rebound at a yield of 14.2%-14.5% for 12-month T-bills, implying a real return of around c.1% on our calculations,” she added.

THE “NEW NORMAL” FOR THE EGP?

Is today’s closing price of 18.27 the “new normal” for the EGP-USD exchange rate? That’s a 16% devaluation from the rate at which greenbacks were changing hands yesterday — and it’s within range of analyst expectations. JPMorgan analysts said about two weeks ago that the EGP was perhaps 15% overvalued, setting a target price of 17.25 to the USD. Arqaam said in a research note (pdf) earlier this month that “EGP forwards have spiked to … 14% vs. spot,” implying there was room for a correction.

We’ve already hit the worst of the depreciation: “EGP 17.50 to the USD is the fair value,” Al Ahly Pharos’ Radwa Elswaify tells us. “Even if the rate overshoots, it will revert back to those levels,” she noted. “This was widely expected and should not go far away from this given all fundamentals,” she added. Naeem Holdings’ Allen Sandeep concurs, adding that they’ve priced the FX rate at EGP 17.50 for the USD. “Considering the basket of other EM currencies and their depreciation, we expect a 10-12% devaluation from the USD 15.70 mark,” he says.

Until this morning, the EGP had been changing hands at c. 15.70 to the USD since November 2020, after opening 2020 at EGP 16.11 per USD just before the covid-19 pandemic kicked off. The pound strengthened to as much as 15.71 on 8 March 2020, the day Egypt announced its first death from covid-19.

NO SIGN OF CAPITAL CONTROLS-

Importantly, three bankers we spoke with today said the CBE has not imposed capital controls. “We’ve received absolutely no instructions on that front, formally or otherwise,” one said. A senior banker added: “Daily covid limits on withdrawals are still in place, but there are zero technical capital controls. Clients can transfer any amount, anytime, in any currency. I don’t see [controls] coming.”

And why should there be, when we’ve probably already reached peak outflows, a number of analysts have told us. Whoever wanted to exit the market has already left, Sandeep tells us. CI Capital’s Sarah Saada agrees, noting that outflows peaked at the end of February and early March with the beginning of Russia’s invasion of Ukraine. “Over the past week or so prior to today’s decision, the momentum of outflows had slowed significantly,” she notes.

If anything, Egypt should now start to see net inflows whenever global appetite allows, both Sandeep and Saada said. “Monday's weakening of the EGP could catalyze inflows of FX, while investors who already had money in Egyptian treasuries would be unlikely to sell now,” Farouk Soussa, senior economist at Goldman Sachs, told Reuters.

WE’RE NOT LOOKING FOR DEPOSITS THIS TIME AROUND

Don’t expect the Madbouly government to go looking for new deposits from our friends in the GCC, two sources with knowledge of the government’s thinking told us, although there’s certainly a desire among policymakers to see our partners in the Gulf roll over existing deposits at the Central Bank of Egypt that are thought to total some USD 15 bn.

Instead, policymakers will accelerate the process of offering attractive state assets for sale to Gulf buyers. The Madbouly government has previously signaled it will bring new assets to market, including fresh IPOs; sales of additional stakes in already-listed, government-controlled companies; and shares in military-owned companies. Think: Banque du Caire’s long-awaited IPO as well as the sale to strategic investors of stakes in military-affiliated bottled-water maker Safi and filling station operator Wataniya. In early February, Prime Minister Moustafa Madbouly announced that his government planned to list “as many state companies as possible” before the end of this year. Misr Life and an additional stake in Heliopolis Housing are both up for sale this year.

But capital markets are a bit choppy right now given what’s happening in Ukraine, with emerging markets in general under pressure and the EGX30 down 3.7% year-to-date after a less-than-stellar 2021. That could present headwinds to potential IPOs, despite the very welcome 50% cut to the tax on capital gains made on initial public offerings. Maait announced the tax break earlier today as part of his stimulus package.

You can expect the state to start with sale offerings other than the usual suspects. A source with knowledge of the government’s plans says state organizations expect in the coming days to sell down parts of their positions in both a high-profile finance industry player and a major infrastructure provider.

Policymakers will also put on the regulatory fast-track any sale of a private-sector company to a desirable, high-quality foreign investor. Think: Aldar and ADQ’s purchase of upmarket real estate developer SODIC, FAB’s bid this year for a majority stake in EFG Hermes, UAE-based Gulf Capital saying it will invest some USD 250 mn here, and Alpha Dhabi Holding saying it was looking to make Egypt a priority market.

WHAT’S UP WITH INTEREST RATES?

The overnight deposit rate now stands at 9.25%, and the lending rate is 10.25%, while the main operation and disc. rates are at 9.75%. The decision comes after the CBE had kept rates on hold for over a year.

Where do analysts see interest rates heading? Al Ahly Pharos’ Radwa Elswaify and Naeem Holdings’ Allen Sandeep both see another 100 bps rise in interest rates this year, depending on the inflation rate and global markets. Both agree that there would likely not be another hike in the short term. HC Securities’ Monette Doss sees another gradual increase of 150 bps throughout 2022.

Banque Misr + NBE offer one-year, high-yield CDs: State-owned Banque Misr and the National Bank of Egypt brought to market one-year 18% certificates of deposit today after the CBE’s decision to raise interest rates. Banque du Caire has yet to follow suit, so far as we could tell at dispatch time.

NBE and Banque Misr’s stance suggest they think high interest rates may be transient. The state-owned banks (Egypt’s largest) are only offering 12-month certificates of deposit, suggesting they think this may be a short-term engagement — unlike in the wake of the 2016 float of the EGP, in which they offered multi-year, high-interest-rate CDs to pull liquidity out of the market.

Analysts believe the move will pull EGP out of the market. “The high-yielding CDs absorbed the shock and frontloaded what could be expected from the MPC if the situation remains stable,” CI Capital’s Sarah Saada tells us. HC Securities’ Monette Doss sees the move as having a positive impact on containing inflation and supporting household savings.

Will private-sector banks have to offer higher rates in response? Some will, most won’t. NBE and Banque Misr just took the lead in the banking industry’s competition for deposits, but it’s not likely that most private-sector banks will follow suit. While there will be some pressure on current and savings accounts in the retail segment, banks that have a high proportion of SMEs in that segment will be relatively insulated. Faced with lumpy cashflows and comparatively high cash needs, most SMEs tend not to lock money up for more than three months, a senior private-sector banker suggested.

WHAT TO WATCH FOR NEXT-

  • Will we soon announce we’re in talks with the International Monetary Fund on an assistance package? Egyptian politicians are yet to confirm talks have started, but Bloomberg reported earlier this week that “Egyptian officials are still in talks with the Washington-based lender over what may be the best option given the challenging global environment.” A precautionary and liquidity line (think: money on tap in case we need it) or a non-financial policy coordination instrument could be on the table, the business information service suggested.
  • Major capex spending could be on hold at some companies given a high-inflation environment, the dip in the EGP, and the rise in interest rates.
  • Shares of EGX-listed companies will likely be net gainers — their valuation in USD terms just became a lot more attractive, and the debt market just got a bit more expensive for companies looking for finance.

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