The market swerved south. Sherine Abdel-Razek investigates the reasons Recent decisions to eliminate tax breaks and diminish fuel subsidies resulted in unprecedented increases in the price of all local commodities and services. Well, almost all, with the exception of locally traded shares. The stock market's reaction to the new policies was unfavourable, with the share value of most traded companies nose-diving amid a selling frenzy by both local and foreign investors. Overall market capitalisation lost eight per cent of its value in the week ending 15 May. The CASE30, the index tracking the performance of the market's 30 most heavily traded shares, lost almost 15 per cent of its value since the day the decisions were announced. It was stripped of most of the gains it had accumulated in 2008 so far. "The decisions took investors by surprise," stated Angus Blair, head of research at the local investment bank Beltone Financial. "Some were justified, but others were read as a retreat in the government's commitment to reform. The market reflected this sentiment." Blair explained that the package might be seen as a means to fund an increase in social spending, such as the increase in salaries and ration card beneficiaries. However, fears of resulting inflationary pressures and the sudden change in government policies -- especially related to the elimination of tax breaks in free zones -- resulted in a heavy selling spree, or what he called "a wide-ranged correction" . Authors of a research note issued by EFG- Hermes on the effect of the decision agree with Blair, saying that recent government announcements have had a populist element but, similar to previous major reforms, the timing and presentation of the changes could have been better. The document added that the sell-off has been driven by perceptions that policy changes will have a severe impact on individual companies, particularly on energy-intensive industries, as well as on the broader economy. Companies with exposure to natural gas prices and those located in free zones, such as Orascom Construction Industries, witnessed a real change of heart among investors who quickly abandoned shares which previously were considered good catches. OCI lost 15 per cent of its value in one week. In fact, all the sectors of the market were hard-hit, with some like banking, food and beverages, chemical industries and construction sectors recording double digit losses. Market observers also believe that a decision to levy a 20 per cent tax on profits from treasury bills and bonds fed rumours that the government might soon introduce a similar tax on the capital gains of trading shares and corporate bonds. This added more pressure on the market, with investors rushing to liquidate their portfolios to reap the still-tax-free profits. Counter statements by the prime minister as well as ministers of finance and investments last week stressed that such a move is not an option, because its negative effect on the investment appeal of the local market is not compensated by the estimated yield of the tax. Out of the 25 emerging markets which Morgan Stanley Emerging Market Index covers worldwide, Egypt is one of the 13 countries which do not impose taxes on capital gains. Another four exempt altogether the gains incurred by foreign investors in their markets from taxes. These statements helped calm investor fears, a fact which was reflected in their return to net buying on Sunday and Monday. However, Arab and local investors are still on the selling side. "Being dominated by individual investors who lack the needed investment background, has intensified the reaction as they panic and sell out with the first signs of a market decline," noted Blair. "This pushes it further south." He insists that such retailers would have seen it differently had they been investing through professional investment funds. "Markets can fall and rise, and the local market's fundamentals are really good," he asserted. "Look at the positive results posted through the week by traded companies, and the jump in value of transactions." EFG-Hermes' note described the reaction as overdone, and goes further by saying that the decisions are consistent with medium-term policy goals. These include the reduction of fuel subsidies, the better targeting of food subsidies, and the establishment of a level playing field for investment. "We recognise that several of the changes will add further fuel to surging inflation, to reach 18.1 per cent in 2008," stated EFG-Hermes. "But we believe that the government is maintaining momentum on economic reform during a difficult period, in contrast to government policy during the economic slowdown nearly a decade earlier." Meanwhile, market experts agree that the decline has put most traded shares at very attractive levels since it was overpriced. As for the expected medium-term effect of the changes on traded stocks, it differs from one sector to among same-sector. Contrary to expectations, the banking sector will not be adversely affected by the new 20 per cent tax on T-bills, since most banks have been reducing their holdings of the bills due to a decline in their yields through 2007. By law, Egyptian banks have to invest a percentage of their liquidity in treasury bills and bonds. EFG sees a limited impact on the telecom sector, as inflation might limit usage of mobiles, affecting MobiNil and Telecom Egypt which has a majority share in Vodafone. Companies in energy-intensive industries and free zones will have their share of losses, albeit still bearable ones, it stated. "OCI's fertiliser business in Egypt will be affected by the increase in natural gas prices, and by the abolition of its tax holidays in the free zones. This will affect margins in the fertiliser business," noted EFG. "However, profits in its construction line of business will improve in 2008, as OCI executes more infrastructure projects." Companies in the construction and real estate sectors will have to deal with the increase in building material prices. But according to EFG, in general, firms will be able to pass along higher costs to customers given the demand-driven nature of the current boom in the sector.
