Egypt violence threatens plans to revive economy

Supporters of ousted president Mohamed Mursi block the road following clashes with police forces, near the tomb of former president Anwar al-Sadat, in Cairo yesterday. The violence may undermine efforts by the interim administration to lift the economy out of its worst slowdown in two decades, even after Gulf Arab countries pledged to support Egypt with $12bn in aid.

Bloomberg/Dubai

The rally in Egypt’s dollar bonds has come to a halt as deadly violence after the ouster of president Mohamed Mursi threatens to derail a plan by his army-backed successors to revive the economy and hold elections.

The yield on the benchmark $1bn notes due 2020, which plunged more than 200 basis points in the weeks after Mursi’s July 3 removal by the military, climbed 10 basis points this week to 8.55% at 12.57pm in Cairo on Thursday, data compiled by Bloomberg show. The average yield on regional sovereign securities increased by the same to 5.05% on Wednesday, according to HSBC/Nasdaq Dubai indexes.

Daily protests and clashes have killed dozens, mostly supporters of Mursi, in the past three weeks. The violence may undermine efforts by the interim administration to lift the economy out of its worst slowdown in two decades, even after Gulf Arab countries pledged to support Egypt with $12bn in aid.

“As long as political clashes persist, nothing, really nothing will happen on the economic front,” Sergey Dergachev, who helps oversee about $10bn at Union Investment Privatfonds in Frankfurt, said in an e-mailed answer to questions on Tuesday. “I am still very cautious and not invested there.”

The cost of insuring Egypt’s dollar debt against default for five years have soared 119 basis points, or 1.19 percentage points, to 775 on Wednesday since reaching a seven-week low of 655 on July 12, according to CMA data. The contracts, known as credit default swaps, are still down 125 basis points since the army toppled Mursi on July 3. They fell to 763 on Thursday.

The military, supported by a coalition of youth groups and secular-leaning political parties, removed Egypt’s first democratically elected civilian president after days of mass rallies against his one-year rule. The army suspended the Islamist-backed constitution, and named constitutional court chief Adly Mansour as interim president to prepare for parliamentary and presidential elections.

Mansour and his premier, former Finance Minister Hazem el-Beblawi, inherited record unemployment and a budget deficit that may widen to 12% of economic output this year, according to the estimates of 11 analysts compiled by Bloomberg. Economic growth may slow to 2%, while inflation, at 9.8% in June, is the highest in two years.

Egypt has a “mix of very poor credit fundamentals, that are still on a deteriorating path, coupled with extremely tense political infighting with no peace in sight,” said Dergachev. “This combination is very worrisome.”

Investors in local-currency debt may be less concerned. The average yield on one-year Treasury bills tumbled about 140 basis points since the military intervention to 14%, fuelled by steps to amend the constitution and aid pledges.

Financial support pledged from the Gulf countries, of which $5bn from Saudi Arabia and the UAE has already been transferred, covers this year’s estimated current-account deficit and almost half of the budget shortfall, according to HSBC Holdings.

“Because the aid is unconditional, there is a danger that the difficult reforms could be postponed until the elected government” takes office, John Sfakianakis, chief investment strategist at MASIC, a Riyadh-based investment company, said by phone. “If it was IMF money, it would have to be conditional on reforms.”

Egypt has struggled to conclude a $4.8bn loan accord with the International Monetary Fund amid reluctance by Mursi’s government to impose unpopular economic measures such as a reduction in energy subsidies.

It’s the IMF money that will be a “significant trigger for investors in Egypt, not the Gulf aid,” said Dergachev. The IMF “will bring some discipline and more visibility of how to tackle economic problems.”

The Gulf aid package, in addition to $8bn that Qatar had extended to Mursi’s government, also adds 7.5% to Egypt’s ratio of public debt to economic output, taking it closer to 90%, said Raza Agha, London-based chief Middle East and Africa economist at VTB Capital.

While the funds will help stem the decline in Egypt’s foreign reserves, they are not “a substitute for Egypt doing what Egypt needs,” Finance Minister Ahmed Galal said by phone on July 20. “The situation is likely to stabilise. There is a road map. There will be inclusion, at least there will be an attempt to include everybody.”

There is no guarantee the attempt will succeed. The Muslim Brotherhood has rejected offers for talks or to join the government, instead vowing to continue protests until the Islamist leader is released from military custody and reinstated.

“If the Muslim Brotherhood were a small party, this would not be a problem,” Agha said. “But even at their lows, before the change in government, the former president was polling around 30% to 40% support, which is significant.”