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Egypt’s Bondholders Show Skepticism Post-IMF in Lesson for EM

(Bloomberg) -- Egypt’s IMF-led strategy to overcome its debt distress sounds like a perfect recipe for a rally in the nation’s debt -- except that money managers are skeptical about the plan’s execution.

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In quick succession last month, the North African nation won a rescue package from the International Monetary Fund, tied up billions more in bilateral funding, embraced a more flexible currency regime and raised interest rates. But any expectation the tide of good news would spark market euphoria quickly faded: Egypt’s bonds began retreating and the cost to insure the country’s debt against default soared.

Bondholders’ response to Egypt’s breakthrough announcements may hold a lesson for countries with similar fiscal vulnerabilities such as Pakistan, Argentina and Ghana. Mere promises aren’t cutting it any longer and investors are demanding evidence the nations are taking the tough steps necessary to bridge funding gaps and reduce debt. Besides, the Federal Reserve’s latest hawkish lurch has reduced the appetite for risky turnaround themes in the emerging world.

“A resolutely hawkish Fed is dampening enthusiasm for investing in risk assets, particularly frontier markets like Egypt,” said Todd Schubert, the head of fixed-income research at Bank of Singapore. A rebound in Egyptian bonds will need “improvement in the global climate for risk assets and a more concrete plan on how the country will deal with its not inconsiderable financing needs.”

Egypt’s bonds handed investors the seventh-best returns in October among the 72 developing nations tracked by Bloomberg as its negotiations with the IMF neared a climax. But this month, they are trailing most of their peers with marginal losses. Meanwhile, five-year credit default swaps surged 210 basis points in five days to 1,245 on Thursday. While the spread retreated to 1,150 basis points on Monday, it remains well above the 1,000-basis-point level that analysts like Gordon Bowers of Columbia Threadneedle Investments consider to be the distress threshold.

“Egypt remains a ‘show me’ story,” said Bowers. “The IMF involvement is a nice policy anchor but does not by itself fix any of the external funding issues as program success is very much contingent on execution of the privatization and foreign-direct-investment agenda, of which investors remain skeptical given previous disappointments.”

It’s a wake-up call to other emerging-market governments with distressed debt and unfinished agenda of reforms. The IMF has warned Argentina against unconventional currency measures. In Ghana, the lender has said authorities must take restructure liabilities to qualify for assistance should the state’s debt be deemed unsustainable.

Time for Action

The size of the loan that Egypt will be getting from the IMF -- $3 billion -- came in at the lower end of expectations. Goldman Sachs Group Inc. and Bank of America Corp. had estimated that Egypt may need to secure $15 billion.

The country requires $28 billion through end-2023 to refinance its maturing debt, pay interest and fund its current-account deficit, according to Deutsche Bank Research, with an additional $20 billion required the following year. Egypt’s net international reserves, at just over $33 billion, can hardly handle the burden. That has fueled concerns that Egypt will continue to turn to debt markets.

Egypt Clinches IMF Deal, Set to Get $5 Billion From International Partners

Investors need clarity on the external financing outlook for the nation beyond the next 12 months and see foreign direct investments from Egypt’s Gulf allies materialize, said Alia Moubayed, managing director of EMEA economics & strategy, at Jefferies International.

But money managers fishing for cheaply valued distressed debt haven’t abandoned Egypt altogether. Its bonds due 2029 and 2030 are attractive after investors snapped up the shorter and longer maturities in recent weeks, according to Deutsche Bank.

“IMF-led reforms and a more flexible exchange rate should underpin the macro story and help attract foreign inflows,” Deutsche Bank analysts including Samira Kalla and Anthony Wong wrote in a report.

This is Egypt’s second major program with the Washington-based lender since 2016. Yet, progress on reforms has been slow in some areas, Callee Davis, an economist at Oxford Economics Africa, wrote in a report. The state -- in particular the military -- maintains a large degree of control over the economy, and the successes of the government’s initial public offering program have been limited so far, she said.

A major food importer, Egypt turned to international lenders for support after struggling with elevated commodity prices as a result of Russia’s invasion of Ukraine. Tourism revenue may also take a hit on fewer visitors from Russia, a key market.

Under the latest deal, the IMF has asked Egypt for fiscal reforms aimed at reducing debt and improving tax collection. It also wants the nation to boost private sector growth by “reducing the state footprint.”

“Some of the inputs and forecasts that underpin the IMF program that the authorities have shared seem very ambitious,” said Adriaan du Toit, London-based director of emerging market economic research at AllianceBernstein. “There are, therefore, significant risks and with market positioning in the credit space remaining relatively heavy, the bonds could tread water for the foreseeable future.”

What to watch this week:

  • World leaders gather at the Egyptian Red Sea resort city of Sharm El-Sheikh for the UN-sponsored COP27 climate talks that run through Nov. 18

  • China’s exports and imports both unexpectedly fell for the first time in more than two years, with rising risks of a recession causing overseas consumers to buy less and the nation’s Covid Zero controls and a housing slump hitting demand at home

    • Data due Wednesday will probably show factory prices dropped for the first time since late 2020

  • Poland and Mexico are expected to raise interest rates to tame inflation

  • Indonesia’s economy expanded faster than expected in the third quarter, giving the central bank room to tighten policy further

    • The Philippines and Malaysia will also report on gross domestic product in the coming days

  • Thailand’s headline inflation eased for a second consecutive month in line

    • Chile and Taiwan are also set to publish inflation numbers

(Updates prices in fifth paragraph)

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