It occurred to me that some Angry Bear readers may be interested in a short analysis of the Egyptian bond market. Professionally, I’m a macroeconomic analyst and portfolio manager on a global fixed income team. Since we do trade emerging market debt, of which Egyptian debt is categorized, I’ll be happy to comment.
The gist of the article is this: markets are pricing the probability of default in Portugal and Egypt similarly – I’d sell protection on the Egyptian debt. At this point, I should state the following disclaimer: this is not a trade recommendation, nor does this represent my firm’s views on Egypt or Portugal.
Some bond market developments of late:
- Egypt holds a BBB- rating on its local currency debt by Fitch and S&P (BB+ on its foreign currency debt). The local currency debt in Egypt is at the lowest of the investment-grade ratings, while on January 20, 2011, Fitch put Egypt on credit-watch negative.
- The Egyptian pound is heavily managed. Over the last week, the USD gained just 0.9% against the pound. Maintaining a stronger nominal currency is common in developing economies to temper the effects of import prices (in this case, food).
- The 5.75% 10-yr Egyptian international bond, which is denominated in USD, sold off 7% over the last week. According to JP Morgan, Egypt is well underperforming the index (Egpyt is roughly 0.5% of the index): the year to date total return on the Egyptian international bonds is -10%, while that of the JP Morgan Emerging Market Bond Index Global (EMBIG) is -0.7%.
- Credit default swap spreads jumped 50% over the last week to 454 basis points (bps), according to one Bloomberg source (no link, subscription required). CDS are bilateral contracts between two parties, so pricing varies somewhat – but the trend is the same among all sources: up. This means that it’s becoming increasingly expensive to buy protection against Egyptian sovereign default.
If you want to know more about CDS, please see a helpful 2009 publication by Deutsche Bank.
And this is where it gets interesting: it currently costs the same to buy 5-yr protection on Egyptian bonds (454 bps) as on Portuguese bonds (456 bps). And Portugal is rated A- (negative outlook).
(more after the jump)
The chart above illustrates a panel of CDS data for countries with similar market risk, where S&P’s local currency rating is listed in the legend. The CDS quoted above are priced in USD, rather than the local currency; but the spreads do quantify the market’s assigned probability of default : 29.3% for Egypt vs. 29% for Portugal (with a 30% recovery rate on both).
Generally the decision to default comes in two flavors: the ‘willingness’ and ‘ability’ to pay. Also, default can take many forms, like missed coupon payments, terming out debt liabilities, or bankruptcy (corporate).
Willingess. A quick analysis of ‘governance’ indicators at the World Bank says that on the face of it, Portugal is probably more willing to pay its debts. The governance measures are corruption, government effectiveness, political stability, regulatory quality, rule of law, and voice and accountability. Read about the methodology of the governance indicators here and get the data here.
In sum, Portugal ranks much higher on the total of the World Bank governance indicators, 6.4, compared to -2.6 for Egypt (I use a strict sum of the 6 components).
Ability. According to the IMF’s most recent World Economic Outlook (October 2010 database), Egypt is expected to grow an average 13.9% per year in nominal terms over the next three years (2010-2013). In contrast, Portugal is expected to grow just 1.7% on average for the next three years.
According to Bloomberg, on January 27, 2011, the yield on a Portuguese 1-year local bond is 3.42%, while that for a local Egyptian bond is 10.99%. I’ll take odds of payment on the one with nominal growth that exceeds the payment – Egypt.
A quick look at the WEI shows the following statistics for 2011:
|Egypt||General government net lending/borrowing||-7.622|
|Portugal||General government net lending/borrowing||-5.232|
|Egypt||General government net debt||60.993|
|Portugal||General government net debt||82.864|
|Egypt||General government gross debt||71.725|
|Portugal||General government gross debt||87.086|
|Egypt||Current account balance||-1.605|
|Portugal||Current account balance||-9.171|
|International Monetary Fund, World Economic Outlook Database, October 2010|
The 2011 outlook demonstrates the following: government deficits are similar in Portugal and Egypt; government debt is higher in Portugal, a country that has no monetary sovereignty; Portugal has relatively fewer reserves (comparing gross debt to net debt); and the current account deficit in Portugal dwarfs that of Egypt.
If I was an investment bank, I’d rather sell protection on Egypt than Portugal at these prices.