Egypt’s Booming Stocks are Symptoms of Runaway Inflation

In the understanding that most of Emerging Markets are suppose to have been under pressure, I was surprised to read of a sizzling boom in Egyptian stocks.

From the Bloomberg:

Egyptian stocks are showing all the signs that investors favor a return to a military-backed rule to end three years of political turmoil and revive an economy stuck in its worst slump in two decades.

Share volume is up 159 percent this year over 2013’s daily average, according to data compiled by Bloomberg, coinciding with voters’ approval of a new constitution and the military’s endorsement of Defense Minister Abdel-Fattah al-Seesi’s possible presidential bid. The benchmark EGX 30 Index rose 18 percent in 2014 as of 10:39 a.m. in Cairo, the fifth-best performance of more than 90 gauges tracked by Bloomberg, with all but one of its members in a rising trend as of yesterday, the data show.

Three years after protesters ended President Hosni Mubarak’s 29-year rule in a popular revolt that left hundreds dead and led to the slowest economic growth since 1992, local investors are piling back into Egyptian stocks amid speculation another military-backed ruler can restore order. The EGX 30 is trading near the highest since 2008, while volatility of the index fell last week to the lowest since before the start of the 2011 uprising.

That’s the so-called turbocharged Egyptian stocks as seen via the equity benchmark, the CASE, which has been trading at a 5 year record high

But has it been true that investors have been favoring “a return to a military-backed rule” that has boosted the stock market?  

Let’s us check on the currency first.

The USD-Egyptian dollar has made a significant upside move even prior to the 2013 Fed's 'taper'. This can be attributed to political troubles which led to the ouster of the Morsi government. Said differently, the Egyptian dollar has had some serious devaluation in 2013.

Devaluation is a symptom of monetary abuse. But we will tackle this later.

Now let us check on Egypt’s interest rates…

Oooh, we find that, like anywhere else, the Egyptian government has adapted zero bound last year

The result has been to lure Egyptians into a credit fueled spending binge as revealed by record loans to the private sector.

Unfortunately soaring stocks pumped up by record loans has hardly translated to (statistical) economic growth as growth has been in a steady decline since 2012. This means that many of such loans may have likely been funneled into the stock market speculation.

Yet the massive loan growth can be seen expressed via an exploding M2. For 2013, Egypt’s M2 grew at a rate of 19.1% (!) according to Reuters. Such fantastic monetary growth rate has been way way way out of the league with the rate of economic growth.

So why the Zero bound rates?

The answer is because of financial repression. Negative real rates has been adapted to finance an increasingly spendthrift government as revealed by the swelling budget deficits.

And part of the symptom has been that Net Consolidated General Government of Domestic Debt has ballooned by 2.5x from 475,895 (LE millions) in June 2009 to 1,190,608 as of June 2013, according to data from the Ministry of Finance.

And it’s not just local debt, external debt has astoundingly exploded to the upside in 2013. Just think of how more devaluation in the face of slowing growth will impact her intractable external debt conditions.

In addition, Egypt has drained about 30% of her forex currency reserve reserves from the high of 2011. So Egypt's government will most probably deplete more of her reserves to keep her currency from sinking further...just to maintain zero bound rates.

And Egypt’s balance of trade and current account has been in huge deficits since 2008. These deficits are consequences of the credit spending spree by both the government and the private sector.

For the last quarter official inflation rates have ranged from a high of 12.97% to a low of 11.4%.

I believe that such figures may be understated. Why? 

Because of the recent widening of the variance between the black market and the official currency rates.

Steve Hanke’s Cato’s troubled currencies project sees an alignment between implied and official inflation rates. But for me, since the chasm between the black markets and the official rates have gone to the distance similar to January 2013, where inflation rates hovered over 20%, I believe that Egypt’s inflation has reached the same levels or even more.

The bottom line is that media seems confused in interpreting  booming Egyptian stocks as a return of investor confidence based on current political developments.

What they didn’t say is that booming Egyptian stocks have been a product of runaway inflation and has become a bubble that is ripe for being pricked. 

Egypt's very fragile position makes her extremely senstive to a Black Swan event.