We believe lower interest rates will help stimulate local private investment, consumption: HC securities & investment

We expect coronavirus fears to lead to outflows from Egyptian treasuries

The Central Bank of Egypt's (CBE) Monetary Policy committee (MPC) held an unscheduled meeting yesterday where it was decided to cut overnight deposit and lending rates by 300bps to 9.25% and 10.25% respectively and the discount rate and the rate of its main operations to 9.75%, according to an MPC release.
The decision aims to support domestic economic activity given a challenging external environment, the release added.
Economist and banking analyst at HC Securities and Investment Monette Doss said the 300 bps interest rate cut announced by the CBE comes higher than its estimate of a 200 bps rate cut in the first half of 2020 (1H20), and comes after the US Federal Reserve and the Bank of England cut rates by 50 bps to 0.5% and 0.25%, respectively, and following an announcement by the Fed of another possible rate cut to 0%, in light of the coronavirus outbreak.
"We believe the lower interest rates will help stimulate local private investment and local consumption, which we see as the main economic driver going forward. We also believe that the decision will lower the Egyptian government's debt servicing cost, easing the pressure on the budget deficit. The MPC decision will have a positive effect on the resumption of CAPEX lending, in our view, partially offsetting coronavirus fears," Doss said.
February inflation came in at 5.3% year-on-year (YoY) better than our expected 5.9% YoY and well below the CBE inflation target of 9% (+/- 3%) for the fourth quarter of 2020 (4Q20).
HC Securities expects an increase in demand for consumer staples resulting from the coronavirus to reflect in inflation, picking up to an average 9.0% over 2020 up from our earlier estimate of 7.7%.
"We believe that current Brent price at USD34/barrel could allow the government to reduce gasoline prices by the maximum allowed band of 10% quarterly," Doss said.
Applying Bloomberg consensus for Brent at USD39 per barrel in 2021, could allow the government to gradually reduce 92-Octane gasoline and diesel prices further, which would reflect positively on containing inflationary pressures.
"Applying our new inflation forecast into our real effective exchange rate (REER) model, we expect the Egyptian pound to devalue by 4% from current level by December, up from our previous estimate of 3% devaluation," HC Securities reported.
Assuming 12-month treasury bills (T-Bills) rate declines by 3% to 11.7%, applying 15% tax rate on T-bills for foreigners, and given HC Securities' inflation forecast, it expects Egypt to offer 0.95% positive real interest rate compared to 0% for Turkey (Egypt 5-year CDS at 521 base points vs. 471 for Turkey), which suggests that Egyptian yields still look relatively attractive.
Despite this, HC Securities expect coronavirus fears to lead to outflows from Egyptian treasuries and to be financed by the Egyptian interbank market, similar to what happened during emerging markets massive outflows in 2H18.
Accordingly, it's expected that Egyptian banks will move into a net foreign liability position, which could be reversed later with foreign portfolio inflows as coronavirus fears subside.
Doss believes that Egyptian banks will fill in the domestic funding gap, especially after the Egyptian government announced that it is not planning to issue additional Eurobonds in Fiscal Year (FY) 19/20 beyond the issued $2bn in November 2019.
In HC Securities' Navigating Egypt report published in 20 February, entitled Good Stories with Limited Downside Risk, the company had accounted for a 200 bps rate cut in 1H20 in its equity valuations, so the additional 100 bps rate cut can act as an upside risk to its valuations, that might partially offset the negative effects of the coronavirus outbreak.