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On November 3, 2016, the Central Bank of Egypt (CBE) announced a devaluation of the Egyptian Pound (EGP), stating that from now on free market forces will set the exchange rate. This move doesn’t impact our global emerging markets portfolios and has only limited impact on the African equities strategy.
The CBE supplied US dollars to the market in a very big auction at an exchange rate of 13, which is a devaluation of 32%. In the foreign exchange market the EGP weakened a bit further and at the moment of writing traded 36% lower than the old pegged rate.
The exact timing of a devaluation is always unexpected, but all Egyptians and foreign investors knew a devaluation would be coming before the end of the year. In August it had already become clear that a devaluation would happen in 2016 as the Egyptian government had reached a preliminary agreement with the International Monetary Fund (IMF) on a USD 12 billion funding program. The IMF had clearly stated it would only provide financial support if Egypt moved to a flexible exchange rate regime. Furthermore the central bank governor and president Sisi made statements hinting at a devaluation and a move towards a flexible exchange rate.
It still took Egypt a long time to execute on its plan to devalue and move to a freely floating exchange rate. One important reason is that the government wanted to mitigate the impact on inflation as that would hurt its popularity among poor Egyptians. Hence the government has prepared targeted measures that soften the pain of higher prices for food and other basic items.
Another reason for the delay was that the CBE wanted to build a war chest of hard currency reserves which it can use in case speculators are pushing the EGP too far down. In the last few months Egypt has received funding from Saudi Arabia, China, Germany and many other countries.
The lack of US dollars in Egypt has hindered many Egyptian companies and has hurt economic growth. A significant devaluation of the EGP was long overdue, but it is still a positive development. Better late than never. We expect the availability of US dollars to improve significantly and this should remove bottlenecks for Egyptian traders and companies.
Importantly, we also expect the IMF to announce very soon that it will provide a big support package for Egypt. This should then trigger international development banks, aid donors and foreign corporates to provide funding for big infrastructure projects that have not yet been executed due to a lack of funding. Many foreign parties were reluctant to inject money into Egypt as a devaluation appeared highly likely and the foreign exchange market was not functioning properly. With the devaluation out of the way and an IMF deal to be announced soon, we expect economic growth in Egypt to sharply increase in 2017. That is because of the start of many big infrastructure projects, but also because manufacturers and trading companies can operate more smoothly as US dollars will become available to them.
In addition to the devaluation the CBE is also sending other positive signals. It clearly stated that banks and other market participants are free to quote and trade at any exchange rate. The CBE will monitor market activity and hold auctions when deemed necessary. The purpose of the auctions is to prevent extreme market volatility in the first days after the devaluation.
The CBE also states that the devaluation and the liberalization of the exchange rate are part of a broader package that will ensure macroeconomic stability. Other measures include a reduction of government spending (partly through cutting inefficient subsidies of fuel and other items) and an increase of the key policy interest rate by 3%.
The local share prices of most (but not all) Egyptian stocks went up on November 3, as the measures are expected to lead to higher economic growth and higher profits for companies. We understand from brokers that the rise was mostly because of local investors buying. Most foreign investors had stopped buying Egyptian stocks because of the foreign exchange difficulties. The devaluation makes it likely that at least some investors will return as buyers on the market.
As mentioned earlier, the devaluation did not come as a surprise to us. As the foreign exchange market in Egypt had stopped functioning normally and a devaluation appeared almost certain to us, we already started to make fair value adjustments to our EGP-quoted positions in August.
In addition to locally listed Egyptian stocks Robeco Afrika also holds USD-quoted depositary receipts of two Egyptian companies for which we never had to take an impairment as the USD share prices already incorporated a discount to the local listings. On November 3, the EGP devalued by 36%, while our EGP-quoted stocks (representing around 5% of the portfolio value before the devaluation but adjusted for our impairments) rose by around 4%. The total value decline measured in EUR is quite close to what we had already impaired. Hence the impact of the devaluation on the net asset value of Robeco Afrika is small.
Robeco Emerging Markets Equities, Robeco Emerging Stars Equities, Robeco Emerging Markets Smaller Companies Equities and other funds and mandates managed by Robeco’s fundamental Emerging Markets Equities team have no locally listed Egyptian stocks in their portfolios and are hence not impacted by the devaluation.