Lessons from history as Egypt again awaits GBI inclusion

MEDIA RELEASE

29 MARCH 2021

Lessons from history as Egypt again awaits GBI inclusion

Against a favourable macroeconomic environment, investors are taking note of Egypt’s likely inclusion in the JP Morgan Government Bond Index with expectations that its addition could attract US$4.8bn of inflows.

History suggests that bonds compress by 130bp in the six months leading up to index inclusion and widen by 80bp 12 months after.

An 80bp widening in the bonds would cause a 5% depreciation in the USD/EGP.

“We recommend going long on EGYGB 14.35% July 2025 (FX unhedged), in the lead up to inclusion and reassessing thereafter” says Neville Mandimika, RMB Economist and Fixed Income Strategist.

Egypt’s re-entry in the GBI is expected in the second half of 2021, with sizeable inflows into the local bond market also anticipated.

Since its exclusion from the GBI index in 2011, Egypt has done unusually well in improving its macroeconomic fundamentals: it successfully exited the IMF programme in 2019, and was subsequently granted exceptional access status.

A consistent primary budget surplus has paved the way for its debt-to-GDP profile to compress in the coming years. Meanwhile, the current account balance has steadily improved, allowing the currency and foreign exchange reserves to remain stable.

“Investors are continuing to favour the local currency carry trade opportunity, says Mandimika. “They are noticing the favourable macroeconomic backdrop, with holdings of US$29bn by offshore investors, which is above pre-pandemic levels.”

Adding to the appeal is the expectation that local securities will easily qualify for Euroclear, thus simplifying the administrative aspect of transactions.

So, how much inflow is expected from the GBI inclusion? The widely-tracked GBI-EM Global Diversified Index only includes bonds with an amount of at least US$1bn outstanding and a minimum time to maturity of 2.5 years. RMB’s estimation is that there are currently 18 Egyptian bonds that meet these criteria, with a combined nominal amount of US$28.2bn and an average time to maturity of 4.2 years.

If included, this will result in Egypt having about a 2% weight in the index, resulting in inflows of close to US$5bn, assuming US$240bn of AUM (Assets Under Management).

With foreign capital still searching for a pickup in yield, our estimates could prove conservative given that Egyptian bonds are nominally higher (albeit riskier) than EM peers, making the carry trade comparatively appealing.

Implications for yields

The nature of index inclusion is that it is widely publicised beforehand to allow active managers to adjust their portfolios accordingly.

On average, yields tend to compress naturally by 130bp in the lead up to inclusion, but will start to trend higher soon after inclusion as investors presumably take some profits after the rally. We expect to see the same evolutionary yield path for Egypt in the lead-up to inclusion - this was certainly the case in October 2007, ahead of Egypt’s inclusion in the GBI. It was excluded on liquidity grounds in 2011 in the wake of the Arab Spring uprisings.

Assuming that inclusion happens in July 2021, history would suggest that the 10-year bond could potentially compress to around 13.4%, before retracing higher over the next 12 months to 14.2%.

“As speculation around the timing of the inclusion picks up momentum, it is likely to garner some strength in the currency, which is already outperforming most EM currencies on a year-on-year basis,” says Mandimika. “If Egyptian bonds weaken in the 12 months after inclusion, this could cause some trepidations in the FX market.”

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Contact:

Joandra Griesel l joandra.griesel@rmb.co.za l +27 (0)82 462 6741