Egyptian stocks have been trading for years at less than their fair value, and with the recent economic repercussions, Egyptian stocks declined more, while investors demanded a risk premium to offset potential risks from the Egyptian pound’s unstable exchange rate against the US dollar.
Egyptian stocks were also affected with the reduction of the country’s credit rating by international agencies, and the reports focused on the problem of ambiguity in the course of exchange rates and the presence of more than one price for the local currency, in addition to the scarcity of dollar liquidity and the decline in foreign exchange inflows, which increases the risk premium and its impact on the decline in stock valuations.
A risk premium is the investment return an asset is expected to yield in excess of the risk-free rate of return. An asset’s risk premium is a form of compensation for investors. It represents payment to investors for tolerating the extra risk in a given investment over that of a risk-free asset.
HSBC Bank said in a report that investors are still concerned about investing in Egypt, as the past four years witnessed a decline in investor interest in Egypt, especially in light of concerns about the exchange rate of the pound against the dollar.
The policy measures agreed upon with the International Monetary Fund to push for economic rebalancing in Egypt are still pending, and the prospects for floating once again seem distant and difficult in obtaining foreign currency.
It added that these challenges make investors in Egyptian stocks demand a premium to compensate for the risks of devaluation of the pound against the dollar.
Mahmoud Nagla, Executive Director of Money and Fixed Income Markets at Al Ahly Financial Investment Management, said that the increase in the risk premium leads to a redirection of investors’ appetite towards safe, risk-free investment, such as treasury bills and bonds, especially due to the high return rates without any risk.
Nagla added that the increase in the risk premium affects the revaluation of stocks and the reduction of their prices for investors to increase the attractiveness of the alternative opportunity from safe investments, pointing to the fact that the returns of government treasury bills have reached a historically high point of 24.5%, expected to increase in the coming period, and thus increase their attractiveness at the expense of stocks despite their low valuation.
He expected that inflation will reach its peak during the current year, near 41%, in addition to a decrease in inflation rates at the beginning of the new year due to its rise in the already existing base year.
Moody’s issued the most threatening rating for Egypt as it expressed doubts about the country’s economic outlook and ability to repay debts.
Mostafa Shafie, head of the research department at Arabeya Online, said that the most important thing is to develop a way for investors, whether foreign or Arab, to exit without losing currency differences, which is the best way to attract investors.
Shafie added: “If you find a way for investors to enter and exit without losses, the problem of risk premium and risks imposed on investors will be solved, which reduces the value of the actual shares to accept entry.”
Shafie explained that debt instruments and raising interest with the entry of a new competitor from emerging markets such as Turkey will greatly affect their attractiveness, especially if the economic conditions and the exchange rate are more secure.
In late April, the credit rating agency, Standard & Poor’s, announced that it had revised its estimate of the degree of Egyptian debt prospects from “stable” to “negative” due to the “large needs for external financing” it expects regarding public finances.
A source in one of the investment banks said that the high risk premium affects stock valuations and leads to further reduction, especially since stocks are basically trading at less than their fair value, and in light of the attractiveness of alternative opportunities of treasury bills and safe investments, the investment law makes investors accept higher risks in exchange for an investment return that covers that risk.
He pointed out that the high risk premium increases the attractiveness of safe investment over investing in stocks such as treasury bills and government bonds, where the investor finds high interest and a strong investment return without the presence of risks, and the current economic repercussions from the exchange rate and others increase the risk premium that requires a reduction in stock prices higher than The value of its decline over its actual fair value until the investment is accepted.
Moody’s extended the deadline for its review of a possible downgrade of Egypt’s second credit rating for the first time ever, if progress is made in government reforms in exchange for clear signs of increasing liquidity weakness and the possibility of further depreciation of the pound.
Moody’s in May began reviewing the country’s credit rating, warning of growing risks to liquidity and debt sustainability.
In February, Moody’s downgraded Egypt’s credit rating for the first time ever, to B3.
The three major international rating institutions have also revised their position on Egyptian debt this year: in May, Fitch Ratings cut the sovereign debt rating to B, while in April Standard & Poor’s downgraded its outlook to negative.
Bassem Elmekkawy, a private equity analyst at Tharwah Capital, said that the increase in the risk premium is mainly due to the large increase in interest rates, which makes interest-based investment a safer alternative opportunity, with the ease of exiting from it making it more profitable, investors are paid to ask for a premium on stock prices to give up the alternative opportunity.
He added that the contraction of the economy and the increase in economic challenges lead to an increase in the investor’s doubts about collecting returns, in conjunction with an increase in the risks incurred, which leads to an increase in the shrinkage of the state’s investment market due to the lack of investors and according to the law of economics: whenever demand decreases, supply decreases.
In addition to the fear of the economic repercussions, which leads to a higher risk premium, and it is possible for the investor to exit the market in general, whether debt instruments or stocks, because he needs a return greater than the existing one to cover any risks to which the state is exposed.
The Monetary Policy Committee of the Central Bank of Egypt decided at the beginning of this month to raise the rates of the return on deposit and lending for one night and the price of the main operation of the Central Bank by 100 basis points, to reach 19.25%, 20.25% and 19.75%, respectively., It also raised the credit and discount rates by 100 basis points to reach 19.75%.
Mohamed Farouk, Chairperson of Global Invest, said that the main reason for the high risk premium for foreign investors and the impact of the economic repercussions on stock valuation is that the foreign investor does not guarantee his exit from the Egyptian market without incurring exchange rate losses and obtaining the full value of his investment.
He pointed out that the market is already attractive for investment because there are many stocks and assets whose market value is less than the fair value of their prices, and solving the exchange rate problem will have a very positive effect on the market.
Standard & Poor’s said that the negative expectations reflect the risk of the need for more measures to be sufficient to stabilize the exchange rate and attract foreign exchange inflows to meet the sovereign’s high external financing needs.
The agency indicated in the report that if the support of bilateral and multilateral funds is more limited than expected, the rating may be downgraded in the next 12 months.
