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17-Jul-2018

Egypt Economics - 1Q18 BOP Chartbook: CAD still largely stable on tourism and remittances; focus section on carry trade

Adjustment cycle holds as CAD narrows 38% Y-o-Y

Egypt’s external adjustment maintained its pace in 1Q18, thanks to growing income from tourism and remittances and muted import growth. The current account deficit (CAD) narrowed 38% Y-o-Y in 1Q18 to USD1.9bn (0.7% of GDP), still within a four-year low, thanks to: i) 65% Y-o-Y growth in the services balance (driven by tourism and Suez Canal revenues); ii) 12% growth in transfers; and iii) 1% Y-o-Y contraction in the trade deficit. Tourism maintained its healthy recovery; this year still recording double-digit growth (81% Y-o-Y in revenues and 37% Y-o-Y in arrivals) from last year’s high base. In parallel, remittances maintained their double-digit growth (12% Y-o-Y). On a quarterly basis, CAD widened, for the second consecutive quarter, reflecting seasonality, but also hinting that CAD had bottomed in 3Q17 (at USD1.6bn), especially with the non-oil merchandise trade deficit continuing to widen – albeit still at a low level, of 2% Y-o-Y – as the adjustment in aggregate demand has ended. We maintain our CAD forecasts for FY17/18, of 3.1% of GDP and FY18/19 of 2.5%, in view of: i) continued recovery in tourism, with still further legs when Russian tourists are fully back; ii) sustained remittances; and ii) rising natural gas production, fully replacing imports by end 2018.
 
The carry trade - Looking back at May’s volatility

We devote the focus section to looking back at May’s volatility, triggered by tightening global monetary conditions, in light of the newly released numbers. Data show that Egypt has seen USD4.5bn of carry trade outflows in the past two months – with the bulk taking place in the last three weeks of May; thereby, reducing the share of foreign holdings of T-bills closer to just above a fifth, down from a third. Most of the outflows were funded through the Central Bank of Egypt’s (CBE) repatriation mechanism, though the interbank market has probably funded around a third of total outflows. Interestingly, latest data show that banks’ total net foreign assets base, of USD4bn, was wiped out in May, in a likely reflection of the pressures facing the local FX markets at the time. Yields saw a considerable rise since these outflows (+220bps, on average, since May), driven by liquidity pressures, as well as locals keeping an eye on recent fuel subsidy cuts. On the one hand, the rise in yields is excessive, when considering that inflation outlook remains favourable (yields have gone back to levels last seen in August, when inflation was in the 20s). On the other hand, higher yields are warranted to reflect the interruption of the easing cycle, where we see rates remaining higher for longer, as well as rising risk profile for emerging markets assets - Egypt included - as clearly reflected in the indicative NDF curve (see Fig.10). We see such opposing forces driving some volatility in the market, though we do not expect any major decline in yields in the short term. The carry trade also still remains supported by Egypt’s reforms story, narrowing CAD and existence of repatriation mechanism. 

Mohamed Abu Basha