Limited damage from bond exclusion

Sherine Abdel-Razek , Tuesday 16 Jan 2024

How will the exclusion of Egyptian government bonds from the JP Morgan emerging market bond indices affect the country, asks Sherine Abdel-Razek

Limited damage from bond exclusion


Effective the end of January, Egypt’s LE-denominated government bonds will no longer be included in the US investment bank JP Morgan’s GBI-EM emerging market government bond index series, which is a group of indices that track the performance of local-currency denominated government bonds in emerging markets.  

The importance of being part of such an index emerges from the fact that funds investing in it will allocate a percentage of their investments in listed treasury bonds equivalent to the country’s weight on the index.

The US financial services firm Bloomberg puts the amount of money managed by the funds tracking the index at $200 billion. Egypt’s overall weight in the index as of 29 December was 0.61 per cent.

There are 13 Egyptian pound bonds in JP’s emerging markets indices, with maturities ranging from 2024 to 2030. However, “FX convertibility issues” reported by investors prompted the exclusion decision, according to the investment bank, pointing to the fact that investors who make profits in pounds cannot easily change them to dollars to send back home.

The investment bank also noted that Egypt has been on the Index Watch since 21 September 2023, which means it has been under study for being taken off the index.

The foreign-exchange (FX) convertibility issues, according to Nourhan Al-Toor, CEO at Gateway Financials, a financial advisory company, are due to the fact that “the country’s dollar revenues are directed to debt repayments neglecting other important aspects in the economy.”

According to Amr Hussein Elalfy, chief equity strategist at the Thndr Securities Brokerage, the JP Morgan decision should not have negative effects on the Egyptian economy.

Egypt’s weight on the index (at 0.6 per cent) is minimal, and most foreign investors have already exited the market so this should not instigate bond outflows, he said.

Successive moves by the US central bank the Federal Reserve to raise interest rates on the dollar since the start of the Russia-Ukraine conflict have seen portfolio investors withdrawing investments worth more than $20 billion from Egypt’s treasury bills and bonds in pursuit of the higher rates payable on the dollar, exacerbating the country’s foreign-currency crunch.

The shortage of dollars emerging from the reduction in Egypt’s hard-currency sources on the back of the war has led to an increase in the dollar exchange rate in the parallel market to hover around LE55 to LE56 per dollar compared to the official rate of LE30.8.

Investment bank Jefferies International’s MENA analyst Alia Moubayed explained to the CNBC Al-Arabiya business news channel that JP Morgan’s decision is partly a result of the existence of more than one exchange rate in Egypt, making it hard for investors to invest in the bonds as they cannot know the real value of the pound.

In addition, according to Moubayed, the ambiguity of the Egyptian government’s plans to deal with the foreign-exchange problem is another dissuasive factor.

Moubayed agreed with Elalfy that the effect of the exclusion from the JP Morgan index would be limited for the Egyptian economy, as for the last year-and-a-half there have been hardly any inflows in pound-denominated bonds due to the lack of clarity on exchange-rate policies.

Citing Ministry of Finance figures in September, she noted that the overall value of bonds owned by foreigners in the Egyptian market stood at only $12.7 billion.

While Elalfy ruled out the move affecting the demand for Egypt’s sovereign bonds denominated in other currencies, he noted that the JP Morgan decision would deter foreign investors from considering Egypt’s pound-denominated bonds as part of their emerging markets portfolio in the future.

Other countries in the index include Brazil, Turkey, and South Africa. India is to be included in June.

As the move implies that the bonds carry a risk, according to Al-Toor, selling them in the future would necessitate compensating investors for such a risk by hiking their yields and thus increasing the cost of borrowing for Egypt.

Moubayed highlighted the fact that re-inclusion in the index cannot happen soon as the due diligence work before this happens takes at least two years. Egypt was included in the index in January 2022, 10 years after it was excluded on the back of the economic turmoil following the January 2011 Revolution.

It was revealed at the time that the country had tried for two years to be re-included in the index. JP Morgan analysts said that when included in the index, local currency bond markets would benefit to the tune of $1.4 to $2.2 billion.

Dealing with the foreign-currency problem and reducing the budget deficit are inevitable if Egypt is to be able to fix its finances and improve its investment environment and thus be eligible to be re-included in such indices, according to Elalfy.

Egypt is muddling through one of its worst foreign-currency crunches at present, which it hoped last year’s $3 billion deal with the International Monetary Fund (IMF) would resolve.

However, Egypt’s reluctance to adopt a fully flexible exchange-rate regime out of fears of its inflationary pressures on Egyptian households resulted in delays in the IMF review of its economic reform plans and thus limited the value of the loan that has been disbursed so far to the first tranche valued at less than $380 million.

It has been reported in recent weeks that the IMF will expand the value of the loan by at least $2 billion, but the accompanying reforms have yet to be revealed.

A delegation including Finance Minister Mohamed Maait and Central Bank of Egypt Governor Hassan Abdallah held meetings in Washington last week with US Treasury Secretary Janet Yellen and IMF Managing Director Kristalina Georgieva, who said the fund “remains a strong partner to Egypt in these difficult times”.

Egypt is expected to shoulder losses from the war in the neighbouring Gaza Strip, which threatens to negatively affect tourism bookings and natural gas imports, as well as Suez Canal receipts due to recent disruptions in the Red Sea.

* A version of this article appears in print in the 18 January, 2024 edition of Al-Ahram Weekly

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