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Egypt's Uncertainty Leads to Investor Angst

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Frontier market investors like Paul Herber, manager of the Forward Frontier Strategy Fund, are monitoring the situation in Egypt very closely.

Thus far, the mayhem in Egypt that began with the ouster of its first democratically elected president has stayed within Egypt, but Herber is nevertheless concerned that there could be a spill-over into other countries in the region that he is invested in—countries that, like Egypt, are in the very initial and vulnerable stages of the slow and painful transition toward democracy.

“Next door to Egypt, you have Libya, which is also trying hard to determine the right path forward,” Herber said. “Then there’s Tunisia, which is in more or less the same position, and, of course, Syria, which needs no further explanation, and Lebanon, which is already flooded with Syrian refugees.” All these countries are struggling with newfound democracy and the biggest risk—for them as well as for the foreign investment community—is that they turn away from that course, Herber said, and that they turn away “not through the ballot box but by other ways.”

These are also nations where there’s also a high probability that religious factions may take the upper hand and where long-term military rule is not to be discounted. That said, the Egyptian market actually regained some stability on the news that the military had taken over in Egypt, but this, Herber said, was largely due to the fact that the government of ousted premier Mohamed Morsi had not done enough to tackle Egypt’s endemic macroeconomic problems. Another factor was the hope that whoever comes into power next will take the necessary steps to effect much-needed changes in Egypt.

Egypt, which was downgraded to single B-minus with a negative outlook by Fitch Ratings in the aftermath of the military coup, is facing a gaping budget deficit of 13.5% of GDP, the highest of all Fitch’s rated sovereigns, and its debt-to-GDP ratio is forecast to rise by a staggering 85% this year. The serious shortages of foreign exchange reserves in the country have impeded private sector activity, tourism revenues have been more or less non-existent, an unofficial currency market has emerged and arrears to oil companies have accumulated. Although the ad hoc bilateral cash flows that have been propping up the Egyptian economy should continue (some of the Arab nations immediately pledged their financial support to the interim Egyptian leaders announced on July 9), there’s nevertheless a lack of clarity as to the size and the frequency of these.

“Egypt has also gone from being a net exporter of oil to a net importer of oil,” Herber said. “It also has a huge unemployed population. The previous government really didn’t do much with respect to creating jobs, which is what the average person cares about more than anything else.”

But with the situation changing every day, it’s still unclear whether a more efficient government will come to power in Egypt to tackle the many challenges the country faces, or whether the unrest is going to continue, worsen and cause the nation to spiral further away from democracy.

And although Egypt itself may not be a focal point for many foreign investors, the events there nevertheless have a worldwide impact, particularly when it comes to oil prices, which rose in the days following the onset of the crisis on fears that it could escalate into a more widespread civil war situation that would then threaten the Suez Canal (which Egypt controls) and the passage of oil from the Middle East to Europe and the United States.

“We are all much more linked to what’s happening in Egypt than we may think, particularly if the situation there worsens and oil prices continue to rise, because then the weaker economies that have been struggling to get back on track will be greatly affected. I am worried about that,” said Brian Frank of Frank Capital in New York. “Investors are also likely to pull back further from the markets if the situation worsens.”

Last week, Egypt’s interim government issued a timetable for a quick path toward new elections, indicating that a return to democracy is still the most favored option for the country. Hopefully, the country will not move away from that course, since a functioning democracy that will continue to gain strength would ultimately benefit Egypt, the nations that surround it and the rest of the world, Frank said. But with the situation so tense and fragile and changing every day, there’s no guarantee yet that democracy will indeed be the final outcome.