Egyptian Equities are Approaching a Bottom
Egyptian equities are beginning to enter a bottoming-out phase, although there is likely more economic pain this year and no near-term stock market catalysts are present. However, with MSCI Egypt trading at circa six times forward earnings, a near 50% discount to MSCI Emerging Markets, Egypt appears to be positioned very well in terms of relative value. Some of the major headwinds approaching include food/energy inflation, declining tourism, and Egypt’s entry into another IMF program this year. All of these factors do not bode well for Egypt as it is attempting to bring its public debt, at 91% of GDP, down to a reasonable level. Food and energy inflation is also a major risk for consumer confidence in Egypt, especially since it is heavily dependent on Russia and Ukraine for agriculture imports. Egypt, despite its attractive economic profile and low stock market valuation, does seem vulnerable to another pullback either due to country-specific or external factors such as Fed rate hikes or general emerging market turmoil in other markets such as Turkey, Argentina, or Peru for example. Food and energy inflation will increase political risk in all of these already vulnerable markets.
The MSCI emerging markets index has not witnessed an annual decline exceeding 20% since 2008 when MSCI Emerging Markets declined by 53%. Egypt, on the other hand, has been much more vulnerable, especially during 2011, when the market also declined by nearly 50%.
Political and economic turmoil this year could create a new bear market in emerging market equities, in which Egypt may decline in line with other emerging markets in the short term, as it did in 2008. However, Egypt still appears to be one of the best long-term holds in this space from a risk-reward perspective, especially since IMF programs have a history of success in terms of improving the economy and driving increased inflows into the stock market.
New Risks Emerging
In March 2022, the Egyptian government officially requested support from the IMF to help mitigate some of the economic risks that were further exacerbated by Covid and most recently the Russia-Ukraine war. This program follows the country’s 2016 IMF program, which notably liberalized the Egyptian pound, introduced VATs, and helped to boost Egypt’s macro profile and image to foreign investors. The economy, which was already under pressure prior to 2022, was in need of relief in multiple areas, most notably inflation.
Food inflation in Egypt recently reached 19% and is approaching previous highs, which will put notable pressure on at least one-third of the population that is already in poverty.
Inflationary pressure is beginning to build up in Egypt, most recently reaching 10.%, compared to 8.8% in the previous month. Although energy and food prices are not major components of the CPI index in Egypt it is crucial to note that these will drastically impact the country’s poor population, who spend a significant portion of their income on food and electricity. Food inflation is approaching 20%, and significant political risks may kick in if this approaches its previous decade’s high of around 40%.
Egypt is the world’s largest importer of wheat, with 85% of this coming from Russia and Ukraine. Egypt’s food subsidy program, which costs the government around $5.5 billion, has only slightly helped to offset this issue, as consumers are still feeling the pain of soaring wheat prices. Furthermore, rising prices have also caused the government to have to increase this budget, putting further strain on its also high debt to GDP ratio. The government has also been gradually implementing a plan to reduce energy subsidies. An Economist article from 2019 noted that one-third of Egypt’s population was living in poverty, which was defined as $45/month. The addition of economic destruction from Covid and rising energy and food prices will put a massive strain on a large % of the population.
Lessons from 2016-2019 and Current Implications
Egypt’s macro investment narrative following its 2016 program had a lot of credibility to it, and the equity markets lagged at multi-year low valuations despite the clear improvement of key macroeconomic indicators. This low-hanging fruit in the equity markets became more clear during 2018 and 2019, and the combination of the improved macro profile and an exciting pipeline of privatizations brought increased investment inflows into Egypt. However, Egypt was one of the more vulnerable markets during covid, given that its economic growth largely hinges upon tourism. Some of the success stories from before, such as rising foreign exchange reserves, improved tourism, and lower inflation, began to lose steam in 2020, and are all still under stress.
Foreign Exchange Reserves: Egypt took massive strides to increase the country’s foreign exchange reserves in 2016 and beyond. However, stress from the Russia-Ukraine War and Covid has caused the country to begin depleting foreign exchange reserves, although Egypt’s foreign exchange reserves are still far above the lows of 2016. Most recently, foreign exchange reserves fell by $4 billion, which put pressure on Egypt’s Central Bank to devalue the currency by 14%.
CA Deficit Under Pressure Again: Egypt’s current account deficit also improved from 6.0% of GDP in 2016 to 3% of GDP in 2019 under the previous IMF program. Egypt most recently reported a current account deficit equivalent to 4.6% of GDP in 2021, as issues related to tourism, exports, and other areas of the economy have put a strain on the country.
Post-Covid Tourism Boom: Another major driving factor was the return of tourism in Egypt, as international tourist numbers rose and the government began investing heavily in tourism. However, Egypt’s tourism revenue declined by 70% during 2020, as tourist arrivals fell from 13.1 million in 2019 to 3.5 million in 2020. 2019 was a game-changing year for Egypt’s tourism industry, as international tourist arrivals nearly exceeded the 2010 pre-revolution high of 14.7 million tourists. Overall, Egypt’s stock market is well-positioned to return to levels experienced in 2019, as much of the hesitation due to perceived safety and political risks have abated and global travel restrictions are declining.
Delayed Response of Equities: Investors took a wait-and-see attitude with Egyptian equities during 2017 and 2018, largely to ensure that the improvements under the IMF program would be long-term. MSCI Egypt returned a whopping 42% during 2019, a far cry from the 18.9% return in MSCI Emerging Markets. This displays that there was a delayed response to the clear economic recovery signals that began following 2016. Egypt appears positioned for a rerating and potential bull market after 2022, once there is more clarity regarding the outcome of the country’s new IMF program. The equity market may be slower to respond though, as it previously was, so 2022 and even 2023 will not likely be salient years for equities. In fact, a pullback seems more likely during these years.
Debt Remains a Burden: The high level of public debt is one of the key risks of investing in Egypt, as Egypt’s public debt exceeds that of other high-risk frontier and emerging markets such as Pakistan (87%), Kenya ( 79%) and Vietnam ( 58%), As of 2021, the country’s public debt as a % of GDP reached 91% compared to 107% in 2017, which is a significant improvement. However, interest payments as a % of government revenue have also been on a steep rise, more than doubling from the 2009 low of 15%.
Privatization Delayed, but Back on Track: Egypt’s plan to aggressively move forward with privatization prior to 2020 would have been a key driver of an accelerated bull market, as this would both help improve the country’s macro profile by reducing the debt burden and drive further interest in the stock market, which had already finished a stellar 2019. Egypt still plans to move forward with new privatizations, gradually each month, albeit at a relatively slower pace. As seen with other frontier and emerging markets, such as Vietnam, there is much more incentive for governments to privatize during market upcycles rather than during the market lows experienced in 2020-2021.
Future Outlook and Rerating Potential
Egypt’s new IMF program, coupled with a heightened privatization program through 2025, could help bring recovery to the economy, and eventually produce a bull market akin to 2019. The IMF expects Egypt to grow by 5.6% during 2022, ahead of many of its MENA peers. Egypt remains vulnerable as an oil and agriculture-importing country but has made up for this in other parts of the economy, particularly in tourism. Banks and stocks with tourism exposure could bode well in this economic environment, as tourism is likely to sustain growth and Egypt’s Central Bank will not likely be able to cut interest rates with inflation out of control in Egypt and many countries.
Relative Value: One of the clear and most intriguing characteristics of Egypt is the market’s current discount to MSCI Emerging Markets. Egypt trades at a discount to its MENA peers, and other cheaper options, such as Romania and Pakistan, are smaller MSCI Frontier Markets constituents. Furthermore, half of Egypt’s MSCI IMI Index used in this chart is from Commercial International Bank, a large-cap bank with a US ADR listing that has traded well above 2x book historically. There is ample room for a rerating of Egyptian equities in 2024 once there is more macroeconomic and political clarity, as low valuations alone are not enough, as compelling as they are at the moment.