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Egypt - Monetary framework monitor | CBE to keep rates on hold; Preserve carry trade position; Portfolio flows to pick up 1Q21

CBE tightens liquidity for faster restoration of FCY coverage; Expect CBE maintain rates in upcoming MPC meeting. M2 grew by 1.5% m-o-m in Dec-20, accelerating from the Nov-20 0.8% m-o-m growth figure, and 2H20 average monthly 1.4%, in line with our expectation. Dec-20 to date, the CBE has been absorbing liquidity (on a net basis) through its main OMO tool, the CLD, despite cutting policy rates by two consecutive 50bps in Sep-20 and Nov-20. This comes in line with our forecast of a balanced M2 growth, to maintain a sustainable FCY cash cover ratio. The tighter liquidity, along with the hike in Dec-20 NIR and deposits outside reserves, by a total of USD2bn (mainly on IMF SBA loan tranche of USD1.6bn), puts the FCY cash cover ratio at 1.1, as per our calculations, indicating easing pressure on Egypt’s FCY position. We expect the CBE’s conservative liquidity policy in Dec-20 and Jan-21 to be complemented by keeping rates on hold in the upcoming MPC meeting on 4 February.

Yields to gradually reflect current level of policy rate cuts, supporting policy rate stabilisation. Average T-bill yields currently stand at 12.77%, as of 19 January, down 2.05% y-o-y (14.82% as of Jan-20), and 12bps 2021 y-t-d. Meanwhile, average T-bond yields (three-year and seven-year) currently stand at 14.06%, stable 2021 y-t-d, and +34bps y-o-y. This compares to the 400bps rate cut witnessed in 2020. Dec-20 headline inflation dropped to 5.4% y-o-y vs. 5.7% in Nov-20, in line with the CBE’s new lower target of 7%+/-2%. We anticipate inflation to further accelerate to 6.5% in 2021, on gradual restoration of activity, and with the resumption of money supply growth momentum.

EGP carry trade remains favourable relative to EM. Egypt continues to outperform EM peers, offering a real yield of 7.36%, compared to 1.46% and 6.50% for Turkey and Ukraine, respectively. In contrast to Egypt, the Central Bank of the Republic of Turkey (CBRT) opted for a policy pivot, to tighten monetary policy and contain inflation, lifting the main interest rate by 475bps in 10 Nov-20, followed by a 200bps increase in 24 Dec-20, bringing it to 17% in Dec-20 from 12% in Jan-20. Meanwhile, Egypt’s CDS stands at 321bps, recording a significant drop of 329bps since the height of the COVID-19 shock in Mar-20.The downward trend across EM CDS comes on a global economic recovery, fuelled by a COVID-19 vaccine rollout in 1Q21, with Turkey’s at 326bps and Ukraine’s 326bps, recording a 317bps and 776bps drop, respectively, from peak levels of 2020.

Foreign portfolio flows show signs of pick-up in Jan-21, largely restoring FCY buffers. Dec-20 NIR increased to USD40.06bn vs. USD39.2bn in Nov-20, reflecting a recovery of over 90% of total outflows, initially triggered by the pandemic. As of the latest disclosure by the Ministry of Finance, foreign holdings in EGP bonds stand at USD26bn, bringing total holdings near the pre-COVID peak of USD27.8bn in Feb-20. We look for inflows momentum to pick up in 1Q21, after stable flows in Dec-20, on the year-end effect, as well as a more favourable outlook on EM debt market. Foreign currency buffers currently stand at USD49bn (8.6x import coverage), providing a safety net against adverse outflows.