Downtown Cairo. Image Credit: NYT

Cairo: Foreign investors came to Egypt for what Renaissance Capital said could be the “best reform story” in emerging markets and stayed for this year’s biggest carry-trade return.

Just one cut in interest rates by Egypt in over a year, coupled with a dovish shift by global central banks, has powered gains in the pound that are second only to Russia’s rouble among all currencies tracked by Bloomberg in 2019. With the currency strengthening and yields still attractive, foreign holdings of local debt have surged almost 40% this year through April.

In the months ahead, little is likely to threaten Egypt’s appeal as a carry trade, in which investors borrow in currencies where rates are low and invest in the local assets of countries where they are high.

All but one of the 11 economists surveyed by Bloomberg predict the Monetary Policy Committee will leave its key rate at 15.75% for a second meeting on Thursday. The pause could stretch past the summer, according to investment bank EFG Hermes.

“Egypt will remain attractive for investors compared to other emerging markets because its interest rate should remain relatively high, its currency position is good, and the country’s risk profile is low compared to other emerging peers,” said Mohammad Abu Basha, head of macroeconomic analysis at EFG Hermes.

A reform push has revived investor interest in the most populous Arab nation after it removed currency controls in 2016, floating the pound to ease a crippling dollar shortage and seal a $12 billion International Monetary Fund loan. After surviving about $10 billion in outflows last year during a sell-off in emerging markets, the central bank was confident enough to lift its repatriation mechanism, which guaranteed foreign investors could withdraw their profits in hard currency.

Despite expectations that the shift toward the open market could result in greater price swings for the pound, its one-month historical volatility has instead halved since January. The currency is trading at the strongest in more than two years after gaining almost 6% against the dollar in 2019.

“The appreciation in the exchange rate finally reflects the market forces, which is reassuring for investors, instead of the previous rigidity due to the repatriation mechanism,” said independent economist Reham El Desoki.

Meanwhile, Egypt’s debt is offering some of the biggest returns among developing nations, with the yield on its one-year T-bill around 17%, or more than triple the average for local-currency debt in emerging markets.

Also providing a measure of optimism is a decision by Egypt to approach JPMorgan Chase & Co. for inclusion in its emerging-market bond index. Egypt’s Finance Ministry additionally signed an agreement with Euroclear that may help attract foreign demand for local-currency debt.

Rates may stay elevated as the central bank looks to bring inflation to single digits next year. It defied expectations for a cut in March after a surprise decrease of 100 basis points a month earlier.

Despite an inflation slowdown in March and April, policymakers are on alert before a new round of cuts in energy subsidies in June, alongside an increase in wages the following month.

Still, an eventual easing cycle is likely to take the wind out of the pound’s rally. A strong currency is also a concern for the government because it hurts exports and tourism.

At current policy rates, Goldman Sachs Group Inc. says its inflation projections imply “historically high real rates,” which suggests that as much as 300 basis points of easing could be warranted in the remainder of the year.

Given a possible depreciation in the pound later this year if rates fall, “some investors might adopt a wait-and-see approach,” according to El Desoki.

But the draw of returns on Egyptians assets could keep foreign buyers coming back for more.

“We see continued inflows but at a slower pace during the year, with investors eyeing the prospects of an easing cycle,” EFG Hermes’s Abu Basha said.