Egypt’s banking sector will benefit significantly from continued improvements in the country’s economic and political situation. In line with a positive macroeconomic backdrop, we expect loan growth to the private sector to pick up over the coming quarters as the attractiveness of government debt starts to wane. For the first time since 2011, we believe risks of dollarization in the banking sector have all but faded.

We are positive on the outlook for Egypt’s banking sector and believe it is facing the most benign operating environment since the onset of the Arab Spring in 2011. The positive outlook is mostly predicated on our expectation for political risks to lessen further combined with a concomitant uptick in economic activity (see ‘Acceleration In Growth On The Back Of Political Stability‘, October 27). In addition, low base effects provide room for relatively substantial gains. We forecast deposit and loan growth to come in at 23.0% and 9.0% respectively in 2014, before a convergence at 14.2% and 10.5% in 2015 – figures which are notably higher than trend growth. The rapid growth in deposits comes on the back of higher interest rates and increased confidence in the Egyptian pound.

Political Stability To Bolster Loan Growth

Egypt – Loan & Deposit Growth (Nominal)

In line with our optimistic outlook on the domestic banking sector heading into 2015, sentiment towards the industry appears to be turning. Egyptian banking stocks have clearly outperformed since the start of 2014. Whilst the broader EGX30 equity index has been among the best performing stock markets in the world in 2014, having risen 34.2% since the start of January, the EGX30 Banking Index has jumped 45.2% in the same period.  Indeed, profitability has increased substantially over the past year, with National Bank of Egyptseeing a 16.6% y-o-y rise in net profit in FY2014 (fiscal year running from July 2013 to June 2014). In addition, net profits at Commercial International Bank rose by 31.1% y-o-y to EGP1.74bn in H114.

Crowding Out Risks To Decline

Given our relatively optimistic view on the Egyptian government’s ability to rein in spending through subsidy reform, the industry’s burgeoning bond portfolio is a trend that should reverse in the coming months. Over the past few years, as foreign investors have remained cautious about re-entering the domestic treasury market, the government has been forced to rely on the domestic banking sector to absorb a significant increase in local debt issuance in order to finance its widening budget deficit.

Attractiveness Of Government Debt To Decline

Egypt – Treasury Bills, Yield %

This is clearly evident in the rise in the banking sector’s bond portfolio as a share of total assets, which reached record highs of 41.4% as of July 2014. Indeed, banks’ sovereign exposure is now at its highest level since the beginning of our time series dating back to 2005. As the accompanying chart highlights, yields on t-bills have dropped since mid-September 2013. As rate expectations are gradually reassessed over the coming months and yields fall further, we believe there will be a growing incentive to shift away from treasuries, which could help spur new lending. Credit growth will primarily be driven by the private sector, with the sole, but notable, exception of construction of the Suez Canal. Egyptian banks were one of in buying Suez Canal certificates, which will fund expansion of the trade route. Outside of this project, however, most of Egypt’s large infrastructure and housing plans – which will benefit from political stability – are dominated by the private sector.

While deposit growth will remain elevated as inflation falls from 13.4% in September to 10.0% by the end of 2015, ending the period of negative real interest rates, opportunities in lending will ensure credit growth outpaces that of deposits.

Nearing The Peak

Egypt – Government Securities Held By Banking Sector

Dollarization Risks Have Passed

Egypt’s political instability and currency weakness had manifested themselves in increasing dollarization of the country’s banking sector. However, on the back of the more promising outlook for the economy and aid from the Gulf States, we believe the depreciation of the Egyptian pound has run its course and forecast sideways trade for the currency in the coming months  (see ‘EGP – FDI Inflows To Support Pound‘, August 13) Indeed, the black market for dollars appears to have dwindled significantly since the turn of the year, suggesting that dollarization in the economy and banking sector will remain low.

Dollarization Risks To Diminish Further

Egypt – Private Business Deposits By Currency, % chg y-o-y

Potential For Long-Term Growth

We maintain a bullish outlook on Egypt’s banking sector over the long term. Total loans-to-GDP (which we use as a proxy for the sector’s maturity) stood at only 31.0% in July, well below regional peers across the Middle East and North Africa. Furthermore, the share of mortgages-to-GDP is only 0.5%, whilst outstanding credit to households and small- and medium-sized enterprises is also relatively minimal. Given the country’s rapidly growing population, there will be a significant increase in demand for financial services over the coming years.

One area on which we are less optimistic is Islamic banking, as political opposition remains the key impediment to growth in this sector. Whilst some pressure may come from Egypt’s Gulf backers who may demand more shari’a-compliant assets, it is likely that the Arab world’s most populous nation will lose ground to the rest of the region in tapping this growth market, due to political considerations and the government’s opposition to Islamist elements in the country.