Paid for the risk? Egypt’s tempting pound

May 23, 2013

Surprising as it may seem, the Egyptian pound has got some fans.  The currency has languished for months at record lows against the dollar and the headlines are alarming — the lack of an IMF aid programme, meagre hard currency reserves, political upheaval. So what’s to like ?

Analysts at Societe Generale say that just looking at the spot exchange rate of the pound is missing the bigger picture. Instead, they advise buying 12-month non-deliverable forwards on the pound — essentially a way of locking into a fixed rate for pound against the dollar in a year’s time depending on where you think it may actually trade. They write:

The implicit yield at this point is 21 percent for the 12m NDF, which we think is quite attractive. The way to think about Egypt NDFs is to approach them as a distressed asset. The risk/reward is quite attractive, and a lot of the bad news has been priced in. Yes, there have been serious delays in the programme negotiations with the IMF and that has clearly been a negative for the overall country view, but I would like to point out that the actual 12m NDF level has hardly budged in the process. This to me suggests that the valuation looks particularly good.


One year  forwards are typically calculated by assuming the currency will depreciate over 12 months by an amount equivalent to the currency’s deposit rate over that period. However, the non-deliverable forward on dollar/pound, a cash-settled FX forward calculated from open market pricing, implied a pound exchange rate at 8.5 pounds per dollar in a year’s time – more than 20 percent weaker than today’s spot price of 6.9 per dollar. This means that there is more than 10 percent pure currency depreciation (i.e. outside of the deposit rate) priced on the NDF. Given that this is well in excess of what many assume will be the actual pound decline, the trade starts to look attractive despite all the economic and political pessimism. In other words, the NDF rate is assumed to have priced in excessive gloom.


Graham Stock, an investment strategist at frontier fund Insparo, also likes the pound. He says a maxi devaluation does not appear on the cards as wealthier neighbours such as Qatar, Libya and Turkey have stepped up with multi-billion dollar loans. The currency collapse that looked imminent at the end of 2012 hasn’t happened as the central bank has managed to stabilise the pound by rationing dollars. Moreover analysts now reckon that Egypt will muddle through without IMF aid this year — instead it may tap the IMF after elections (due later this year) when measures such as scrapping subsidies can be more easily implemented. Meanwhile (Stock says):

You get compensated for taking the risk and you earn good carry. They may not be able to do an IMF deal but they are getting a lot of support from neighbours, there is general willingness to support them. You want the yield which is 15-20 percent.

Not everyone is into the trade though. The implied yield of 18-21 percent — well above what one can earn in other high-yield markets such as India or Brazil — is alluring but risks too are big given Egypt’s balance of payments problem and ugly politics. Luis Costa, head of CEEMEA currency and debt strategy at Citi, first wants to see Egypt cutting energy subsidies which currently eat up a third of government spending. Once  that happens, Costa says, he will take another look at the pound.

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