Egyptian bond market inertia a missed opportunity

An active secondary market would attract more investors, who would be far more willing to buy Egyptian bonds if they knew they could sell them later should they need the cash. Khalil Hamra / AP Photo

Soon after it came to power in July 2004, the government of Ahmed Nazif did something very helpful to reform Egypt’s bond market. The current government should now complete the reforms.

Back in the old days, Egypt’s finance ministry had been selling short-term Egyptian pound treasury bills at a fixed price through the central bank, mainly to the country’s dinosaur state banks. The yields on the bills were exceptionally low, with the price, of course, having more to do with politics than supply and demand.

Mr Nazif’s government opened up the trading, introducing a totally new system where 13 “primary” banks could bid for bills and bonds at yields they proposed, with the central bank and finance ministry deciding which prices to accept. If outsiders wanted bonds, they would have to go through one of the primary banks.

Towards the end of 2004, the finance ministry broke new ground by issuing long-term bonds with maturities of four, seven and 10 years and, in January 2005, a 20-year bond, creating a yield curve. It set up a secondary bond market on the stock exchange where investors could buy and resell these bonds.

Corporations followed the government’s lead and began issuing bonds of their own that could also be traded on the new secondary market.

The problem was that the government didn’t carry out part two of the programme. It had promised to require the primary banks, whose number was later increased to 15, to act as market makers. This meant that when asked, these banks would have to quote buying and selling prices for any bonds in the market, then actually buy or sell these bonds at the price quoted should a buyer or seller want them.

It never happened and the secondary market is all but moribund. One Egyptian investor says that when you ask primary banks to quote a rate, they often simply ignore you. Or if they do quote a price, they then refuse to buy or sell.

Part of the problem is that primary banks prefer to sit on their bonds once they buy them. Another problem is that the government is not issuing many, despite strong appetite from investors.

This hurts Egypt. An active secondary market would attract more investors, who would be far more willing to buy bonds if they knew they could sell them later should they need the cash.

Greater investor demand would push down yields, lowering the cost of government borrowing, no small matter in a country where servicing interest on its debt now accounts for around a quarter of all government spending.

A more liquid bond market would also make it easier for corporations to raise finance. Only a handful of Egyptian corporations have issued bonds since the market was liberalised in 2004. On other stock exchanges around the world, bonds generally account for more than three-quarters of the trade. On the Istanbul exchange, for example, the average daily volume of equity trades in 2012 was only $1.4 billion, compared to $15bn for fixed income.

In Egypt, total daily trade in equity has only been about $50 million in recent months, with fixed income making up just a tiny fraction of this.

Egyptian investors have been lobbying the government to reform the system for years, but to little avail.

Reform has been hobbled by the wide range of government agencies involved in the secondary market’s operation: the actual trading is on the stock exchange, the Egyptian Financial Supervisory Authority sets the rules, the finance ministry is the major bond issuer and the central bank regulates the 15 or so banks that act as primary dealers.

The main stumbling block seems to be the central bank, which investors say perhaps is afraid that trading could get out of control. The bank also believes interest rates have been unnaturally high since the 2011 uprising and has been loath to commit to long-term obligations when it believes interest rates may soon come down.

Part of the problem is also the government’s low salary structure, which was a problem even before a law was passed last year setting a maximum wage for civil servants of less than $6,000 a month. The central bank needs experts in fixed income to develop and regulate the market, but good luck finding any that are qualified at such a salary when they can make multiples of that at private banks abroad, or even in Egypt.

The certificates that the government issued last year to help finance the upgrade of the Suez Canal could have been a golden opportunity to develop the market. But under the rules of sale, foreigners were not allowed to buy them, nor are Egyptians allowed to resell the ones they bought.

If Egypt could get its act together the well managed and relatively sophisticated Egyptian stock exchange would be in an excellent position to capture a portion of the region’s financial transactions.

Maybe Egypt could even capture some of its former glory: in the first half of the 20th century its stock market is said to have ranked fifth in size in the entire world.

Patrick Werr has worked as a financial writer in Egypt for 25 years.

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