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The Morning After the Night Before

February 23, 2011

What comes next in Egypt?

Watching North Africa shake itself from dictatorship has been nothing short of inspiring. The inerta of the public will was enough to convince the Egyptian Army to get behind a new leadership model, just as a similar exercise in tiny Tunisia beheaded a rapacious regime. In Egypt, the Army is supervising an interim government. Protests linger in both countries. But after the hyperbole quiets down, what will unfold in Cairo?

Within the investment community, there are two dominant schools of thought. The first has the Army upholding a modified constitution, and acting as a safeguard to the new Republic, which leads to free elections, an immediate upswing in growth, followed by  a kind of renaissance for Egyptians everywhere. This view, with its unlikely casting of Egyptian generals as Jedi Knights, is seen as blissfully naive by more pessimistic observers. They note both that the interim government isn’t wildly different from the previous one, and that less savoury players in Egyptian politics have not yet spoken. To the pessimist observer, it is inevitable that the Ikhwan (known in the West as the Muslim Brotherhood) will poll well in the election, and once in power will cease to relinquish it – a time immemorial habit of Egyptian leaders. Since the outside world (and their investors) tend to like beer , shaving and culinary diversity, the theory goes, it is only a matter of time before Egypt sees more, potentially violent upheaval.

Iran is nobody’s model

The pessimist’s view is not without merit. Remove the previous policing of Egyptian politics and you will end up with a less pasteurised debate, in which a broader – and presumed more radical – series of voices will gain bandwidth. The fact that no polarising figure has yet emerged as a credible presidential candidate is less meaningful, since the regime did not tolerate rivals to the Great Hosny before the latter’s ignominy. Several observers have posited the view that Egypt will have an “Iran moment” when the popular movement will collapse on intellectual exhaustion and open the door for a radical religionist voice. These voices tend to be remote to the national experience: No Khomeini will sweep into the country because there is no Egyptian equivalent.The Egyptian revolution was not “about” religion; it was mostly about jobs and a narrow wealth distribution. When the religious began to protest, shouting “God is Great!” among other things, the broader community of protesters responded with “Muslim, Christian, We’re all Egyptian”. This is hardly the sort of thing you would expect to get from a pack of fanatics bent on banning shaving. What the local populace want is equal and fair opportunity, which means the ability to raise your kids sensibly, hoping that their lives are better than your own. This is a universal human value, which the previous leadership failed to sufficiently deliver. Before the revolution, Egyptian elites used to regularly complain about the country’s poverty problem, and the government’s complete failure to do anything meaningful about it.

The Egyptian revolution was more about a desire to participate in benefits of the global economy than it was about a lurch into political isolation. Egyptians are familiar with the Iranian model, and don’t see much appeal in living in a country with high inflation and low international popularity. From their perspective, they already enjoy all of these problems at home; and minus oil revenues, there hasn’t been enough cash to offset the lack of more diverse trade. That means fewer jobs and more poverty. Mainstream Egyptians are frustrated with the difficulties of finding work, and are annoyed that the best jobs are often outside the country. This is a material issue: Foreign remittances are one of the country’s largest FX generators.

At its heart, this is what makes the Egyptian situation rich with opportunity. Everybody knows that Egypt can be as important globally as Malaysia; after all, its population demographics are not wildly different. High concentrations of young people keen to work and get on where their lives are much more interesting to investors than the rarer, more flaccid European offering. And this is before Egypt’s strategic position is taken into consideration.

…But old habits die hard

At a meeting of business leaders in Cairo last night, attended by David Cameron, the Egyptian investment minister spoke about her desire to reduce red tape and create a more welcoming market for foreign direct investment. The local heads nodded and the hands clapped; the international media happily wrote down a few useful soundbites. But deep down, the locals know that every Investment Minister in the last 30 years has called for this to happen. They also know that no progress has been made because the red tape is deliberately protectionist – of the Army’s economic interests, not the nation’s. This is why the populace rallied to demand a better, more responsive leadership, and it is crucially why the Army backed the protesters: because they know that with a new leadership, their primary benefactor will continue to make the payments. For the avoidance of doubt, that primary benefactor is the United States.

Another area of old school Egyptian reticence is the desire to keep the local stockmarket closed. A variety of arguments are used to defend the near month long shuttering of the exchange. Initially, the central bank closed the market due to the closure of the banking system, which in turn was the result of the regime trying to hammer down the economy as a last ploy at remaining in power. But now that the banks have largely re opened – minus a small hangover – the excuses to keep the market shut get thinner and thinner. The head of the Egyptian Financial Services Authority (EFSA), Dr Ziad Bahaa, recently cancelled an investor call at short notice – he claimed to be meeting the Prime Minister. Harry sees no reason to doubt his intentions, but notes that Dr Ziad just closed his market for another week. This has lead to sharp criticism internally.

The regulator invariably responds to such criticism by suggesting that the exchange’s infrastructure might fail, leading to chaos locally. Harry finds this difficult to believe; instead, evidence suggests that the market’s stewards are worried about what might happen were they to turn the machines back on. Sources close to the CMA reported rumors of trade cancellation, which brought terror to the already glum Egyptian brokerage community. To market veterans, this feels more ominous than it perhaps will prove to be. But the equity market remains closed, brokers remain disconsolate and investors frustrated.

This is a tragedy because it is under selling the country, not least by convincing large international investors to keep clear. Egyptian risk has rarely been as appealing, and yet the cronies left at the helm of the local Exchange are keeping it closed. Like Panodora, you cannot retrieve what you have released; and like friendship, you make a stock market grow by staying open in the bad times. Someone clearly isn’t getting the memo.

Everywhere else in Egyptian finance is suggesting that opening the market wouldn’t be that bad. The currency has been more stable than people might have projected before the revolution, hovering around LE 6 to the dollar. Forex reserves dipped by around $1 billion, leaving the country with around $35 billion left – hardly a reason to panic. Extra cash provided to local banks- in some cases emergency liquidity borrowed from overseas – sat mostly unused in Cairo’s bank vaults as the forecast run on the Pound failed to materialise. In New York, the only Egyptian ETF is trading at a 15% premium to the underlying local market. Enterprising hedgies looking to pay the resulting convergence trade (by shorting the ETF) have been frustrated by the 40% cost of borrowing the fund – which suggests that everyone already invested is buckled in for the launch sequence when the EFSA finally clears the market for takeoff.

Today’s Dog Is Tomorrow’s Turkey

Emerging market equity investors see the situation as an opportunity because they are not heavily invested in the country. The benchmark index, which reflects investor interest, has the company at a paltry 0.5% weighting – making Egypt bigger than Nigeria but far less interesting than Turkey and Poland. Turkey, also a moderate Islamic country, has around 4x the per capita GDP (and far more market capitalisation) than Egypt, despite having many of the same issues as Egypt. This suggests that more credible policy formation will result in a more attractive destination for capital – and job growth will surely follow. Since jobs are the best tools to fight poverty and penury, (and thus terror), there isn’t a policy maker on earth not pulling for this outcome.

This is why Harry believes that the outcome of the Egyptian revolution at least initially looks like the Turkish model. The Army will be a political player as the new system beds down, while in the place of a monolithic single party, we will now have a wide variety of smaller parties angling for seats and influence. Like Turkey, we can expect coalition governments, and also like Turkey, we can expect fiscal indiscipline as populist governments attempt to transition from the old system to the new. Not everybody benefits from democracy, particularly those that were overly rewarded in the previous system – typically those promoted for loyalty over ability.

Egypt’s position astride the canal will make it a logical destination for re imports, and acting as a logistics center for access into both North Africa and European markets. The banking system will run rampant, again as in Turkey, as ordinary Egyptians seek to upgrade their lives with improved housing and better cars. Ultimately, what equity investors know (again, because of the Asian example) is that political change often reaps rewards for the local population; and that means better, more interesting businesses and institutions to participate in.

It is difficult to not be bullish on the outlook, even when that view is tempered by the understanding that delivering such a result will take time. The region is waking up, lead by the country that will show the way to a better distributed wealthy region.

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