Bullish, but risky, call on the Egyptian pound
With the IMF back in Cairo for a new round of talks on a stand-by arrangement, a strategist turns bullish on the EGP. But there are huge risks
One strategist entered a long position in the Egyptian pound (EGP), just before the International Monetary Fund delegation landed in Cairo for a two-week visit to talk about a new deal.
A deal agreed at staff level last year later collapsed because of political instability and the government's reluctance to cut energy subsidies, fearing a political backlash.
Investors had been hoping that Egypt which has seen its economy deteriorate since the Arab Spring would clinch a deal with the IMF soon after a visit by the Fund's Managing Director, Christine Lagarde, to the country last year in August.
"The long-awaited IMF loan is very likely to come to a conclusion by the end of this month," said Souheir Asba, frontier markets strategist at Societe Generale.
Asba entered a long EGP position by shorting USD/EGP 12-month non-deliverable forwards (NDFs). NDFs are forward contracts for non-convertible currencies, mostly used by international companies that want to hedge their currency risk.
NDFs are entered into by investors for short periods of time - usually of up to a year -and give a profit or a loss via the difference between the agreed exchange rate and the exchange rate at the time of settlement. The difference is paid in the convertible currency.
In the case of the EGP, Asba believes the forward market "is pricing an implicit depreciation of about 13%," which she believes is "excessive."
"We expect positive developments being triggered by the IMF mission, easing pressure on EGP assets," Asba said. "From a valuation perspective, we now think that the EGP is quite cheap."
EGP DEVALUATION DANGER
She anticipates a firm confirmation for a loan deal with the IMF for three main reasons. The first is the fact that Egypt "is starting to lighten its energy subsidies burden," with the government said to establish a gradual end of the fuel subsidy over five years and raising prices on cooking oil and other subsidies fuels.
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Last month, Moody's cut Egypt's credit rating to Caa1 from B3, placing the country's bonds in the category of assets that are "subject to very high credit risk."
Asba lists as the main risk to the bullish EGP position the fact that the IMF deal "might come at a price that Egypt could not be able to handle, which would potentially cause the breakdown of program negotiations."
Jean-Michael Saliba, an analyst with Bank of America Merrill Lynch, expects "difficult negotiations ahead."
While Saliba does not exclude an agreement being reached, he reckons that "the lack of a credible political commitment to required prior actions and to reforms ahead of elections may yet derail Executive Board approval."
Even if a deal is approved, Saliba warns, the fact that a black market for foreign exchange has developed in Egypt will mean that an IMF deal would probably involve exchange rate unification.