A Problem For The Egypt ETF

Over 500 exchange-traded funds, nearly a third of the entire U.S. ETF universe, hit 52-week lows on Wednesday, and plenty of emerging markets ETFs were part of that dubious group. The Market Vectors Egypt Index ETF (NYSE:EGPT), the lone ETF dedicated to North Africa's largest economy, was part of that group.

Egypt: North Africa's Largest Economy

EGPT is off nearly 30 percent over the past six months. As if that is not bad enough, there is another issue facing the flailing Egyptian economy: weakness in the banking sector.

That is of particular concern to EGPT, because, like so many single-country ETFs tracking developing economies, the Egypt ETF is heavily allocated to the financial services sector. To be precise, EGPT devotes 53.2 percent of its weight to the financial services sector.

Regulations to boost SME lending, issued by the Central Bank of Egypt earlier this month, could weaken the quality of loans extended by Egyptian banks in the medium term, said Fitch Ratings.

The Egyptian government's aim is to increase bank lending to the SME sector over four years to end-2020 by EGP200 billion, or USD25 billion, equivalent to 26 percent of end-3Q15 total banking sector loans. In our view, the drive to stimulate the domestic economy is ambitious and could if implemented force banks to lend to weaker borrowers to fulfill the lending quotas.

Is A Demotion On The Horizon?

Weakness in Egypt's banking sector could have another impact: Egypt, in the eyes of some global investors, should be in line for possible demotion to frontier market status, a classification that other index providers have already slapped on Africa's third-largest economy. However, it should be noted that MSCI does not currently have Egypt on its list for possible demotion to frontier status.

If there is a source of allure with EGPT, it is that Egyptian stocks are inexpensive. EGPT trades at just 11 times with a scant correlation to the S&P 500, according to Market Vectors data.

The strong correlation between sovereign and bank risks effectively caps the banks' standalone Viability Ratings (VR) at the level of the sovereign rating. A drastic reduction in government debt exposure, which we do not expect in the short or medium term, could weaken this correlation and lead us to assign VRs above the sovereign rating, added Fitch.

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