* Hedge funds, some banks showing interest in Egypt debt
* High-risk bet on successful transition to elections
* Transition could mean further yield fall of at least 200
* Little motive for Egypt to default despite reserve
* Egypt bonds look attractively priced versus Lebanon
By Rachna Uppal
DUBAI, July 11 Some foreign buyers are returning
cautiously to Egypt's international bonds, betting the country
may succeed in stabilising its economy and engineering a tricky
transition back to civilian rule in coming months.
Yields on the bonds have plunged by more than 2 percentage
points over the past two weeks. Flows of money have not been
large; in many cases, prices are being quoted higher without
much actual trading.
Huge uncertainties remain over Egypt's ability to form a
stable interim government that would govern until elections, the
risk that street violence could develop into a campaign of
industrial unrest and militant attacks, and prospects for fiscal
reforms to curb the state's soaring budget deficit.
But this week's naming of an interim prime minister
acceptable to many Islamists, and pledges of $12 billion in
financial aid to Egypt from wealthy Gulf governments, have at
least raised the chances of overcoming these obstacles.
And if Egypt does stabilise, the steep drop in its debt
prices during the first half of this year means there is plenty
of room for them to snap back further. So for some investors, a
high-risk bet makes sense.
"Currently we can finally say the market is back...Cautious
buying, but there is buying interest at the moment," said Khalil
El Bawab, managing director for asset management at investment
bank EFG Hermes in Cairo. "Yes, asset managers are willing to
increase exposure now."
The yield on Egypt's $1 billion sovereign bond maturing in
2020 soared to a peak of 11.07 percent on June 27
from 5.84 percent at the end of last year, as political tensions
worsened and the economy ran deeper into trouble during the last
months of president Mohamed Mursi.
The bond began recovering well before Mursi was ousted last
week, as it became clear that the army was likely to intervene
to remove him - suggesting the market viewed the performance of
his government as more of a threat than the tumult created by a
"The risks attached to Egyptian currency, fixed income and
equities are actually lower than 10 days ago because, from an
investor's perspective, anything is better than the prior
stalemate between the Muslim Brotherhood and old-regime
loyalists," said Hasnain Malik, who heads economic research firm
Frontier Alpha in Dubai.
Trading in Egyptian bonds is being limited by several
factors. Much of the debt is believed to be owned by Egyptian
banks who aim to hold it for the long term, viewing it as a
hedge against depreciation of the Egyptian pound ; they
have been unwilling to sell.
Also, European banks which might have bought the bonds a few
years ago are now reluctant to take on fresh risk because the
euro zone debt crisis has weakened their balance sheets.
But a trader in London said he had detected some buying by
foreign banks, while hedge funds, scenting an opportunity for
quick profits, had been bidding up the bonds.
The yield on the 2020 bond has now dropped to 8.64 percent.
History suggests that if Egypt's economy and politics do
stabilise, the yield may fall much further; it is still more
than 300 basis points above its levels late last year, before
the political and economic outlook darkened.
Since last year, yields on emerging market bonds have risen
around the world, often by more than 100 bps, because of
climbing U.S. Treasury yields. But even including this factor,
Egyptian yields could still have at least 200 bps to fall.
Last week, when the Egyptian 2020 bond yield was around 10
percent, frontier markets-focused investment bank Exotix
switched to a buy recommendation on Egypt's 2020 and 2040
"If and when an Egyptian government demonstrates it is
capable of delivering economic adjustment and structural
reforms, we see ratings increasing and yields declining rapidly.
We think there is 400-500 bps upside in such a scenario," Exotix
economist Gabriel Sterne wrote in a report.
The risk that a peaceful transition to elections could be
derailed by violence and inter-party squabbling is the main
factor deterring many foreign investors in Egypt.
Fitch Ratings cited this factor when it cut Egypt's
long-term foreign and local currency issuer default ratings last
week to B-minus from B; the outlooks are negative, meaning Fitch
could cut again in coming months.
But since the downgrade, the credit default swaps market has
shown a reduction in perceived risk in Egypt; five-year CDS
are down to 705 bps, their early June level,
from last week's peak of 891 bps.
Investors who are optimistic about Egyptian bonds argue the
market may not yet have fully digested the positive impact of
this week's massive pledges of aid by Saudi Arabia, the United
Arab Emirates and Kuwait.
The $12 billion may be enough to prevent balance of payments
and state budget crises for the next six months - the period
leading up to parliamentary elections, if all goes according to
plan. The money may allow the interim government to try to buy
social peace by improving fuel and food supplies.
The speed with which the aid was announced suggests the Gulf
nations view supporting post-Mursi governments as a geopolitical
priority - so if Egypt turns out to need yet more aid, it may be
Other factors argue in favour of Egypt's international
bonds. The country's foreign debt is small relative to its
economy at under $35 billion at the end of 2012, according to
Standard Chartered research, or about 15 percent of gross
The maturities of Egypt's two big dollar bonds are far in
the future; until then it only has to find money for coupon
payments. Fitch estimated its external debt servicing payments
were 6 percent of its current account receipts.
So despite pressure on Egypt's foreign reserves, a default
may never make sense for Cairo - it would simply freeze the
country out of international markets, blocking a sukuk issue
which it hopes to make next year, without saving much money.
Meanwhile Egypt is arguably priced attractively in
comparison with some other countries hit by political and
economic instability, including sectarian divisions and armed
conflict among opposing groups.
The yield on Lebanon's $650 million 2019 bond
is at 6.24 percent; the sovereign is rated by Fitch just one
notch higher than Egypt at B.