Egypt’s bankers hope the political crisis will result in a more open economy. Published in MEED, 11 February 2011
Egypt’s banks passed their first major test of the country’s political crisis on 6 February, when they reopened their doors after a week of enforced closure.
There had been concerns it would mark the start of a run on the banks as skittish investors emptied their accounts. In the event, the reduced opening hours and cash withdrawal limits of E£50,000 ($8,400) imposed by the central bank helped to ensure the long queues remained orderly and confidence held.
“Things are way better than we expected,” says Hisham Ezz al-Arab, chairman of Commercial International Bank, one of the country’s largest. “We thought of the worst case scenario: a run on the banks, a massive number of people finishing transactions. That did not happen.
“Things were extremely busy on the first day and busy for the first couple of hours on the second day and now there are no queues outside. What we did on the first day was the backlog from the week before and now things are getting back to normal.”
Future threats to Egypt’s banking sector
The smooth reopening of the banks does not disguise the fact that they continue to be damaged by the crisis. Profits will be lower for this quarter and bad debt levels could rise. The relative health of the banking sector means it has been able to withstand the shocks to date, but whether banks can maintain the confidence of investors and depositors in the coming weeks depends to a large extent on how the political environment develops.
“The duration of the crisis in the economy will be the single most important determinant for the amount of bank profitability you will see in this quarter and the next one,” says John Sfakianakis, chief economist at Banque Saudi Fransi, part owned by France’s Credit Agricole Group, which has a large presence in Egypt. “If this is a long, drawn-out event, which takes many months to resolve and demonstrations go on this is going to have a severe impact.”
Prior to the crisis, banks in Egypt were generally viewed as solid prospects, with high liquidity and good capital adequacy ratios. But they now face two key risks, which could undermine those strengths: investors pulling out of the country and reduced domestic economic activity which could lead to far more non-performing loans.
“The main risk for banks is liquidity,” says Nondas Nicolaide, senior analyst at credit ratings agency Moody’s Investors Service. “If withdrawals and capital flight continue to significant levels then this is a threat. The other possibility is rising levels of bad debts.”
In any political crisis, investors are likely to move money out and signs of nervousness have not been hard to spot over the past few weeks across the stock, bond and currency markets.
International investors were net sellers on the Egyptian Exchange through January, cutting their portfolios by E£647m over the course of the month, with most of that coming in the last three days of trading before the market shut on 27 January. Since then, the Egyptian government sold E£13bn in a planned E£15bn auction of treasury bills on 7 February, paying an average interest rate of 10.97 per cent on 91-day notes, the highest rate since 2009.
The cost of credit default swaps on Egyptian government bonds, which are used by investors to insure against the risk of default, are also far higher than at the start of the year. On 3 January, the cost was 237 basis points and rose as high as 430 basis points by 28 January, although the figure subsequently fell back to 347 basis points by 7 February.
The Egyptian pound has been just as volatile. The currency fell in value in the wake of the Tunisian revolution and lost even more ground on 7 February, as investors withdrew money from the country and others moved their deposits into international currencies.
All these issues around investor confidence will harm the position of Egypt’s banks. The second major problem they face – the slow-down in economic activity – is also under way, although its full impact is hard to gauge.
Trade levels dropped by 6 per cent in January compared to the previous month, according to Trade & Industry Minister Samiha Fawzi Ibrahim. Given that the demonstrations only started in the final seven days of the month that is a significant fall. In addition, the tourism industry, a mainstay of the economy, has suffered a sharp slowdown as visitors left early and others stayed away.
Any company involved in international trade or tourism will obviously be feeling the pinch, but companies in other areas have also been finding it hard or impossible to operate normally because of the curfews and other indirect effects of the protests. If this pattern of economic inactivity continues, there could be a large rise in bad debts, as firms struggle to repay loans.
“If there is a continuous decline of economic output due to demonstrations and protests, SMEs [small and medium-sized enterprises] will be the first to suffer,” says Sfakianakis. “If the private sector sees a decline in activity and output that will reflect on non-performing loans increasing.”
It will take several months for data to emerge on just how big a problem this will be, however, as loans are usually only classified as non-performing if they have not been serviced for three months.
All this has lead to credit ratings agencies queuing up to downgrade the country’s sovereign debt and its largest banks. To date, there have been 16 downgrades affecting nine banks, with Commercial International Bank and National Bank of Egypt the most widely hit.
Further downgrades will follow if the political and economic instability continues. Even once these problems are resolved, it could take a year or more for tourists and foreign investors to regain confidence, although domestic economic activity is likely to recover faster.
“Local economic activity could get back on track relatively quickly, [but] it’s going to take some time for tourists and foreign investors to regain confidence,” says Nicolaides. “They’ll have to feel the situation has normalised. It might take a year or so, provided there is a smooth political transition.”
Egypt remains a promising market for some companies, however, not least because of its large population and well diversified economy. Indeed, some investors are apparently still intent on entering the market despite the current crisis. Alchemy Investments, a local investment bank, says a deal it is working on, involving the sale of an Egyptian food firm worth more than $100m, is still going ahead. “We received investor offers from the US and Europe in mid-January and were supposed to initiate the due diligence phase in early February,” says Ahmed Samir, managing partner of the bank. “We thought things would stop but the investors say they are still interested in pursuing the acquisition and would be ready to close as soon as we think the time is right.”
Long-term private equity opportunities for investors
Others in the market seem just as determined to be optimistic and to look beyond the current instability. “In the coming period, we see very compelling opportunities for long-term private equity investors in Egypt and beyond,” said Cairo-based Citadel Capital in a statement released on 3 February, citing the large, young workforce and low labour and energy costs, among other things.
“Economic activity will come back,” says Al-Arab. “When you’re talking about a country of 82 million people, a week or two of the 52 weeks of the year is not really a big issue.
“Egypt has changed forever and for the better. Every single investor we spoke to over the past two years said their main issue was the transition of power [once Mubarak leaves]. This is now out of the way. Now I have a smile on my face, but we have to be patient because we have an interim government until September.”
The current expectation is that elections due in September will usher in a new government intent on reform. Between now and then, however, the political situation will remain fragile and banks will continue to be affected by wary investors and lower domestic economic activity.
At the time of writing, President Hosni Mubarak appeared determined to stay in office until his term officially ends, while protestors in Tahrir Square were equally adamant they would continue until he stepped down. But even as that standoff continues, the successes which the protest movement have already achieved has engendered a sense of optimism for the long-term prospects of the country.
“A democratic state and an uncorrupted regime is better for the economy and better for society,” says Samir.