Egypt has come almost full circle in winning back and then losing the confidence of bond investors just over two months after sealing a deal with the International Monetary Fund.
Credit-default swaps, used to insure against non-payment, have risen by the most worldwide after Ecuador in the past month and signs of distress are flashing in the bond market again. Derivatives are showing the risk of another currency devaluation ahead.
It’s a throwback for the $470 billion economy that was starting to find its footing after the IMF agreement in December by partly clearing a backlog of imports and attracting foreign-exchange
But doubts over Egypt’s progress in pursuing asset sales and its commitment to a more flexible exchange rate have pushed spreads on some of the government’s longer-maturity bonds back to around 1,000 basis points above US Treasuries — the threshold for debt to be considered distressed.
Adding to evidence of investor anxiety, the cost to insure the country’s debt against default is around 1,185 basis points, up from a nine-month low of around 720 reached in January.
Underscoring the urgency of the moment, Gordon Bowers, a London-based analyst at Columbia Threadneedle Investments, said Egypt needs to deliver on asset sales and embrace a flexible exchange rate within the next two years to plug its external financing gap and avoid default.
“Failure to implement these reforms significantly increases the medium-term risk that some form of debt relief will be required,” said Bowers. “We think near-term default risk is limited; the medium-term is more uncertain.”
The IMF estimates Egypt’s external financing gap at around $17 billion throughout the 46-month program, and the deal is expected to unlock about $14 billion more from international and regional partners.
Ahead of the first review of the IMF’s $3 billion program that’s due this month, the non-deliverable forwards market is signaling a deeper slide in the Egyptian pound. The one-month contract on the currency has slumped about 4% since the end of February to 32.7 per dollar, while the 12-month contract is at around 38.
The pound has lost almost half of its value following three devaluations in the past year and was trading near 30.9 versus the dollar on Wednesday.
Egypt’s “current status quo is tenuous” and any slippage in reforms tied to its IMF bailout would likely raise its credit risk — even if a debt restructuring isn’t imminent, Bank of America Corp. economist Jean-Michel Saliba said in a report.
The next pivot point for Egyptian bonds will center around asset sales, and any delay there is set to deepen the crisis and cast doubt on authorities’ willingness to execute reforms, Bowers said.
Gulf countries are waiting for more certainty on the pound and proof Egypt is following through on commitments to revamp the economy before making good on promises to provide billions of dollars in crucial investment.
The Federal Reserve’s latest hawkish lurch has also reduced the appetite for riskier issuers in the emerging world, and Egypt’s bonds have been among the hardest hit in the past month. Higher interest rates would make it harder for fragile sovereigns to refinance their debt in the future.
“The market feels that progress on IMF commitments is not at the threshold it needs to be,” said Mohieddine Kronfol, the Dubai-based chief investment officer for Middle Eastern and North African fixed income at Franklin Templeton. “In weak markets, weaker credits suffer more.”
Egypt raised $1.5 billion last month through the sale of its first Islamic debt instrument. The yield on the three-year sukuk has risen to 11.7%. It was priced to yield 11%, about 400 basis points higher than similar-maturity debt from Turkey, which has the same credit rating.
The Z-spreads on Egypt’s dollar bonds maturing in 2047, 2049, 2050 and 2051 are above 1,000 basis points. The metric measures the additional compensation that an investor will receive over the entire Treasury spot rate curve.
“Maybe in five to 10 years, yes, there may be restructuring worries but not for a short or medium-term investment horizon,” said Carlos de Sousa, an investor at Vontobel Asset Management in Zurich that owns Egypt’s debt. “They need to prove to the market that the privatization process is really going to happen in a macro-economically significant manner.”