Remain Cautious on Egypt and Nigeria

new egyptNigeria and Egypt look more inviting to foreign investors as dollar reserves rise.  Egypt just got a tranche of IMF aid, whilst Nigeria issued $3 bln of 10- and 30-year foreign currency debt.  While investors clearly feel more comfortable, we believe caution is still warranted. 

EGYPT OUTLOOK

Egypt and the IMF just signed off on the next $2 bln tranche of aid.   Officials expect the money by year-end or early 2018.  Of the 3-year $12 bln program, $4 bln has already been disbursed.

Foreign reserves have risen to all-time highs after falling over the course of 2015 and 2016.  This is due to a combination of IMF aid, debt issuance, and foreign investment inflows.  At $36.7 bln in October, they cover nearly 5 months of import and are nearly 3 times larger than the stock of short-term external debt.

Foreign holdings of Egyptian T-bills reached $17.5 bln at the end of September, according to central bank data.  This is up from $5.2 bln in April and a mere $30 mln (yes, mln) at the end of 2016.  External debt has also been climbing, rising to $79 bln this year vs. $56 bln last year.  While the external debt/GDP ratio remains relatively low at around 40%, it is up sharply from below 20% in 2015.

The economy is recovering.  The IMF recently noted that “Egypt’s economy continues to perform strongly.  Reforms that have already been implemented are beginning to pay off in terms of macroeconomic stabilization and the return of confidence.”  GDP growth is forecast by the IMF to decelerate modestly to 3.5% in 2017 from 4.3% in 2016, before picking up to 4.4% in 2018.

Price pressures remain elevated, though CPI decelerated to 30.8% y/y in October from 31.6% in September.  Much of this year’s spike was caused by the pound’s weakness after being floated, though we note inflation was elevated beforehand.  Inflation remains stubbornly high, just below the peak of 33% in July.  12-month local currency T-bills are currently yielding around 17.8%.

This situation supports the case for tight monetary policy.  The central bank has hiked three times over the past year:  by 300 bp last November, followed by 200 bp in May and 200 bp in July.  Real rates remain deeply negative, but it appears that the bank does not want to hike any more.

It’s been just over a year since the pound was floated.  In 2016, EGP fell -57% vs. USD and was by far the worst EM performer.  To show just how bad this was, the next worst were ARS (-18%) and TRY (-17%).  So far in 2017, EGP is up 2.5% YTD and is in the middle of the EM pack.  With strong foreign inflows, the central bank has basically put a floor under USD/EGP.

Our own sovereign ratings model shows Egypt’s implied rating steady at B+/B1/B+ after rising a notch last quarter.  Actual ratings of B-/B3/B are thus enjoying some upgrade potential.

Political risks are building.  One risk is a regional dispute with Ethiopia.  Ethiopia is constructing a controversial dam on the Nile River, which Egypt fears will cut into its water supply.  The Nile supplies over 90% of Egypt’s water, and President el-Sisi called the dispute one of “life or death.”

The weekend attack on a Sufi mosque in northern Sinai is a grim reminder that the security situation remains tenuous.  ISIS is believed to have been behind the deadly attack.  The government raised its security alert to its highest level, and launched airstrikes on targets believed to have taken part in the attack.

Egypt scores poorly in the World Bank’s Ease of Doing Business rankings (128 out of 190).  The best components are dealing with construction permits and protecting minority investors, while the worst are trading across borders and paying taxes.  Egypt also does poorly in Transparency International’s Corruption Perceptions Index (108 out of 176 and tied with Algeria, Cote d’Ivoire, Ethiopia, and Guyana).

 

NIGERIA OUTLOOK

Nigerian officials recently completed a global roadshow ahead of its issuance of 10- and 30-year foreign currency debt.  With $11 bln in bids, a total of $3 bln was raised, split evenly between the two tranches.  The longest dated dollar debt previously was a 15-year issued this February.

Foreign reserves have risen this year after falling over the course of 2015 and 2016.  At $33.8 bln in October, reserves are the highest since January 2015.  They cover more than 6 months of import and are nearly 3 times larger than the stock of short-term external debt.

The economy is still sluggish despite higher oil prices.  The IMF recently noted that “The economic backdrop remains challenging, despite some signs of relief in the first half of 2017.”  GDP growth is forecast by the IMF at 1.1% in 2017 vs. -1.6% in 2016, and picking up to 2.6% in 2018.

Price pressures are easing somewhat but remain stubbornly high.  CPI decelerated to 15.9% y/y in October from 16% y/y in both September and October.  Inflation peaked at 18.7% y/y in January.  12-month local currency T-bills are currently yielding around 15.6%.

This supports the case for keeping rates high, and we believe the central bank is nowhere near easing.  The last move was a 200 bp hike to 14.0% back in July 2016.  Real rates moved into negative territory recently, but this was due largely to nominal borrowing rates falling faster than inflation.

The central bank introduced the special I&E window back in April to help deal with dollar shortages.  So far, it’s working.  Most FX trading now takes place via the I&E window, and Fitch recently acknowledged that this rate “should now be considered the relevant exchange rate.”  With strong foreign inflows, the central bank has basically put a floor under USD/NGN.  In 2016, NGN was -37% vs. USD and was ahead of only the worst performer EGP (-57%).  So far in 2017, NGN is -12% YTD but basically flat near 360 since August.

Our own sovereign ratings model shows Nigeria’s implied rating steady at B+/B1/B+, keeping it mostly in line with its actual ratings of B/B1/B+.  We see little risk of movement in either direction.

Political risks remain high as violence persists.  Last week, an attack by suspected Boko Haram terrorists killed over 50 people in northern Nigeria.  In addition, the health of President Buhari remains an ongoing issue and the likely succession path remains unclear.

Nigeria scores poorly in the World Bank’s Ease of Doing Business rankings (145 out of 190).  The best components are protecting minority investors and getting credit, while the worst are trading across borders and registering property.  Nigeria also does poorly in Transparency International’s Corruption Perceptions Index (136 out of 176 and tied with Guatemala, Kyrgyzstan, Lebanon, Myanmar, and Papua New Guinea).

 

INVESTMENT OUTLOOK

We remain very cautious on investing in both countries.  While the potential returns to investing in local currency T-bills are high (especially risk-adjusted returns, since EGP and NGN vols are very low), there remain inherent risks.  Political risk remains high in both, whilst dollar liquidity is always at risk of drying up.  External debt ratios are rising for both countries.

If overall risk sentiment were to turn against EM, then the exit from these two countries would likely be very messy.  Foreign holdings of Egyptian government T-bills are over 30% of the total, accounting for nearly half of the nation’s foreign reserves.  For Nigeria, foreigners are estimated to hold a little under 30% of local currency government debt, accounting for over three quarters of Nigeria’s foreign reserves.