Tuesday,25 September, 2018
Current issue | Issue 1260, (27 August - 2 September 2015 )
Tuesday,25 September, 2018
Issue 1260, (27 August - 2 September 2015 )

Ahram Weekly

Catching the contagion

Red has been the colour dominating the screens of stock and commodity traders worldwide over the past week, reports Sherine Abdel-Razek

Al-Ahram Weekly

It is so like 1997 or 2008. A new financial crisis is in the making, with headlines referring to losses transferring in a domino effect across the globe, breaking news stories showing emerging markets currencies and listed securities hitting new lows, and front page stories with photographs of traders and investors glued to their monitors and holding their breath while billions of dollars of investments drain away.

It all started with China, which, worried by its slower growth rate of seven per cent compared to double digits less than a year ago, decided to let the yuan devalue on 11 August.

This triggered a currency war between countries competing with China, the world’s second-largest economy, with almost ten countries leaving their currencies to head south. That added to the woes of emerging markets already suffering from falling commodity prices and expectations of a US interest-rate increase that would give more strength to the dollar.

Global equities lost more than $5 trillion in value in the two weeks following the yuan devaluation. Morgan Stanley’s (MSCI) Emerging Markets Index last week showed a bear market scenario, dropping 20 per cent from its peak to head for the worst month of August since 1998.

The scenario was not any different in Egypt. By the end of Monday, the ninth consecutive session for the EGX30 to end in the red, the index had fallen 1.9 per cent to its lowest level since December 2013. It has lost 18 per cent of its value since China devalued its currency.

The local market has not been faring well since the beginning of the year due to the introduction of a capital gains tax, scrapped in May, and problems in repatriating foreign funds and the absence of a parliament.

“Signs of slippage on economic reforms coupled with the passing of a new controversial anti-terror law have caused investors to take fright. Notably foreigners have been net sellers of equities so far in August,” noted Jason Tuvey, a macroeconomic analyst at Capital Economics, in a note on Monday.

This added to a set of imported downers. The relatively slow growth in Europe, Egypt’s main trading partner, has negatively affected Egyptian companies’ exports to European countries and thus limited profits and weakened shares. It has also suppressed European investors’ appetites, according to Hani Tewfik, chairman of the Arab Private Equity Association.

The currency wars between emerging economies have resulted in a relative increase in asset values, including shares, and thus have limited their appeal as an investment haven, weighing down on equities markets worldwide, Egypt included.

The panic selling tide was strong enough to offset the effect of decrees freezing the controversial capital gains tax on market transactions and lowering the rates on high-income tax brackets, both announced on Sunday and aimed at appeasing investors.

Another piece of good news that was unaccounted for was a stock exchange release showing that the net profits of listed firms had increased by 17 per cent in the first half of the year compared to the same period last year.  

Fears of slower growth rates on the back of stocks and currencies losses fuelled worries of lower demand for oil and pushed Brent to its lowest level in more than six-and-a-half years to break the $45 per barrel threshold on Friday.

This factor took its toll on shares trading, as it left Arab Gulf investors and sovereign funds less willing to buy on the market, added Tewfik. The Gulf countries rely on oil income to fund government-fuelled spending, and the six-nation Gulf Cooperation Council (GCC) is home to about 30 per cent of the world’s oil.

Aid from the Gulf countries has been a life line to the Egyptian economy since the 30 June Revolution. The UAE and Saudi Arabia have been trying to replace aid with investments, however, as was seen during the Sharm El-Sheikh Egypt Economic Development Conference in March, where investors from both countries inked multibillion dollar deals.

“Investments from Gulf sovereign funds and private firms will definitely be slashed as the crisis is eating up the surpluses in their economies,” said Ahmed Kamali, an economics professor at the American University in Cairo (AUC).

Total foreign direct investment for this year is forecast to be $7.5 billion, against $4.1 in the previous year.

The already vulnerable Egyptian pound is expected to take the brunt of the losses.

Since the 25 January Revolution, Egypt has been having problems with its foreign reserves due to low foreign investments and weak tourist arrivals. This pushed it to let the pound devalue twice, to settle at LE7.8 to the dollar.

In 2015, which witnessed the pound losing eight per cent of its value against the dollar, the CBE limited access to hard currencies. AUC’s Kamali now expects to see a further devaluation because of the mismatch between dollar supply and demand.

“But it is in our favour as with our high inflation rate, in double digits, compared to our trading partners, the cost of our exports is much higher than that of competing exporters,” he added.

The currency problems stem from a weak balance of payments, as net foreign assets (NFA), showing the difference between international reserves and government liabilities like the $6 billion deposit by the Gulf nations, declined by 56.8 per cent in July, compared to their level at the end of 2014. The NFA’s July figure is the lowest since January 2005.

“In plain English, the plunge in NFA in July means that the CBE only owns a very tiny fraction of foreign reserve assets, whereas the bulk is owned by foreign debtors like Saudi Arabia, Kuwait and the UAE,” Hani Geneina, head of research at Pharos Securities wrote in a note.

This combined with a sustained loss of competitiveness due to currency wars between emerging markets makes the devaluation inevitable. Pharos expects the pound/dollar exchange rate to exceed LE8 over the coming few weeks to reach LE8.5 in the first half of 2016.

     On another front, the decline in oil prices will reduce the value of oil exports that already plunged in the third quarter of 2014/2015 to $388 million compared to $1 billion a year earlier.

However, the decline in oil prices is not all bad as it will deflate the country’s oil-imports bill, which came in at $1.8 billion compared to $2.7 billion a year earlier.

“The spill-over of these savings to foreign reserves will be felt in 2016, given the presence of several short-term drains on foreign currency resources in 2015 including the payment of overdue liabilities to foreign explorers in production-sharing agreements, import of liquefied natural gas for the first time in Egypt’s history, and large-scale imports of coal by cement companies,” Pharos noted.

Meanwhile, the drop in oil prices is good news for the budget deficit, which the government has been working to lower to 8.9 per cent this year compared to 10.8 per cent in 2014/2015.

The decline in oil prices spared the government LE30 billion in fuel subsidies last year.

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