Foreign Portfolio Equity Investment in Egypt: An Analytical
Overview
This paper evaluates the recent history of foreign portfolio equity
investment in Egypt, its advantages and disadvantages, and the required
institutional changes to take full advantage of its potential positive
contribution to the Egyptian economy. The paper suggests ways of
maximizing the benefits and minimizing the costs of the foreign equity
portfolio investments through policies and market friendly regulations
which (i) provide macroeconomic stability, (ii) generate incentives to use
the least volatile of the existing portfolio investment instruments, (iii)
promote the use of institutional investors instead of individual investors
and (iv) strengthen the existing market infrastructure.
I-Introduction:
Egypt has enjoyed a relatively high economic growth rate over the last decade, in spite
of its dismal saving rates, supported by credit granted under concessional conditions, and
foreign investment. However, the expected reduction in concessional credits for Egypt
means that, if the country wants to continue to grow at rates exceeding 5 per cent, it will
either have to raise its savings rate or receive more foreign investment or, most likely,
both. This paper evaluates the recent history of foreign portfolio equity investment in
Egypt, its advantages and disadvantages, and the required institutional changes to take full
advantage of its potential positive contribution to the Egyptian economy.
Since the early 1990s, equity markets have become significantly more globalized.
Governments, including that of Egypt, have been opening domestic stock markets to
foreign investors and issuers. Institutional investors have been rapidly increasing their
holdings of foreign equities. Financial innovations, specially equity-related derivatives,
have offered more opportunities for borrowers to raise capital in foreign markets and for
investors to make cross-border investments. Technological advances have increased
efficiency in gathering and disseminating information and in processing transactions.
Between 1986 and 1997, emerging stock markets’ capitalization grew, from $171
billion to $2.2 trillion, and their share of world stock market capitalization increased from
nearly 4 per cent as of end-1986, to nearly 9 per cent as of end-1997. By the end of 1998,
over 17,163 companies were listed and traded in emerging capital markets. [International
Finance Corporation, (IFC), 1999]. However, of the total foreign portfolio equity flows
(FPEFs) into the developing countries, the share of the Middle East and North Africa
region only reached 1.21% in 1996, while Latin America and East Asia and the Pacific
have been taking the lion shares. Moreover, between 1997/98 and 1998/99, Egypt has had
an outflow of resources on this account, averaging over US$ 200 million per year, after
relatively heavy inflows during the 1995/6-1996/7 period, averaging about US$ 850
million per year [ see, figure (1) and Table (1) in the text].
1
Figure (1)
Net portfolio investment to emerging markets ( 1990-1997) (%)
150%
100%
50%
0%
1990
-50%
1991
Asia
1992
1993
1994
Middle East & Europ
1995
1996
1997
Latin America
Source: Own calculations, from IMF, 1998a.
It is well known that, on the one hand, FPEFs expand investors’ opportunities for
portfolio diversification and provide a potential for achieving higher risk-adjusted rates of
return for foreign investors. In addition, from the perspective of the recipient country,
foreign portfolio equity investment (FPEI) contributes to the financing of domestic
enterprises and it allows risk sharing between foreign and domestic investors, as
repayments depend mainly on the performance of the firms concerned. (United Nations,
1997). Increased foreign investment activity may also improve the depth and increase the
liquidity of the local stock exchange, bringing benefits to other segments of the capital
market, such as the bond market. Foreign participation in the domestic capital market may
induce improvements in accounting, information, and reporting systems, as well as
increase the analytical sophistication of the domestic securities industry. Also, as foreign
practices are adopted by domestic shareholders, domestic companies may improve
corporate governance.
However, despite the above-mentioned benefits, FPEI, has particular features which
raise serious concerns. FPEI usually has a short investment horizon, just a few weeks or
months, although this horizon can extend to ten years or more under appropriate
conditions. It is easy for portfolio equity investors to liquidate their investments by selling
their equity positions in the secondary securities market. This may lead to an increase in
the volatility of domestic asset prices and returns, greater exchange rate volatility or greater
interest rate volatility, or both. Furthermore, if the stock of international reserves is at a low
level, it may cause a balance of payments crisis. All this can create considerable
uncertainty, discourage domestic and foreign investment, and can ultimately be very
damaging to the economy as a whole. (Corbo et.al.,1994a and Corbo1996).
These potential risks of flow-reversal may be very harmful, if this reversal is driven by
the most volatile types of investors and instruments, in a recipient stock market that is not
sufficiently prepared with a reliable infrastructure and effective regulatory framework.
No doubt, portfolio flows to the emerging markets during the 1990s have been volatile.
The sharp fluctuations of net inflows into Egypt referred to above are evidence of that. At
the global level, from a peak of $104 billion in 1993. they fell to less than one-fourth of
this level in 1995, in the aftermath of the Mexican peso crisis, then nearly doubled to $50
billion in 1996. After the Asian financial crisis and the severe financial difficulties of
2
Russia and Brazil, portfolio equity flows to developing countries fell again, from US$ 30
billion in 1997, to an estimated US$ 14 billion in 1998. (World Bank, 1999a and 1999b).
Other concerns about FPEI are related to the implications of a potential increase in
foreign ownership of domestic firms and the increase in systemic risk, since failure of a
financial intermediary in another country could have an impact on domestic markets. In
addition, it might reduce the effectiveness of monitoring and supervising financial
intermediaries, because of difficulties in assessing the financial status of firms that are
active in many markets.
In summary, foreign portfolio equity investments represent an important opportunity
and a tough challenge for developing countries in general and Egypt in particular. Egypt
needs to encourage the more sustainable, long-term types of foreign portfolio equity
investments and instruments, that contribute to economic growth and reduce the risks of
volatile, unpredictable and speculative types of foreign capital flows.
Thus, the aim of this paper is to identify the most suitable types of foreign portfolio
equity investors and instruments for Egypt according to their degree of volatility and the
stage of development of the Egyptian stock market, and how to attract them.
The plan of the paper is as follows: Section II identifies the most common types of FPE
investors and instruments and their likely effects on developing countries in general and on
Egypt in particular. This section includes some statistical work to determine the causal
relation between foreign investors trading in the Egyptian stock market and the change in
the market price index. Section III reviews the literature on the determinants of FPEI
flows to developing countries and examines Egypt’s recent economic performance, as well
as the characteristics of the Egyptian stock market, to enable us to identify the main factors
affecting FPE flows to Egypt. This section includes a statistical description of the stock
return in the country. Section IV proposes a set of economic policies to allow Egypt to
attract sustainable and long-term types of foreign portfolio equity investments, which
should contribute to economic growth and reduce the risks of volatility, unpredictability
and speculation. Finally, the main conclusions of this study are presented.
II-The types of foreign portfolio equity investment investors and instruments :
The aim of this part, is to identify the most common types of FPE investors and
instruments and their likely effects in developing countries in general and in Egypt
particularly.
A.Types of investors and instruments of FPEI in developing countries:
Foreign portfolio equity investors in emerging markets, may be institutional or retail
investors.
Institutional investors, such as mutual funds, pension funds, and insurance companies
manage money for individuals and firms. These investors are particularly important for
emerging markets, and offer fundamental advantages. They are often prepared to accept
less liquidity than retail investors, and demand high standards of management. They
3
provide a potential source of large and more stable funds. Their investments are mostly in
longer-term assets.
Institutional investors provide individual investors with a low-cost method of realizing
higher returns from a more diversified international portfolio than they could get by
themselves, without having detailed knowledge of the countries and individual companies
issuing the securities. (Chuhan, P. 1994).
The process of internationalization of equity markets, has been driven by institutional
investors. In seven major industrial countries, institutional investors had assets close to $17
trillion in 1994, compared with $5.3 trillion in 1985. The growth in the asset base of
institutional investors and the growing internationalization of these assets has led to a
rising volume of international investments. For example, total international investments by
pension funds increased from $302 billion in 1989 to $790 billion in 1994, with the growth
in asset base contributing to around 40% of the increase in international investments and
greater international diversification contributing around 60% of the increase. (World Bank,
1997c and 1997 d).
Private foreign investors or retail investors, tend to invest directly and more
speculatively than institutional investors, in emerging stock markets. They usually chase
high short-term returns arising from market anomalies, such as delays in price adjustment.
However, they may also invest in international or domestic mutual funds that buy traded
securities. (Chuhan, P. 1994).
Foreign portfolio equity investment instruments in developing countries, take two main
forms:
-Equity instruments, such as: direct equity purchases in domestic stock markets, venture
capital funds, country funds, American depositary receipts and Global depositary receipts.
-Quasi-equity instruments, including: convertible bonds, and bonds with equity
warrants.
Following is a detailed analysis of the above-mentioned instruments:
A.1. Equity instruments:
A.1.1. Direct equity purchases by foreign investors in the domestic stock markets:
The acquisition of securities by foreigners, directly in the local equity market has both
its advantages and disadvantages. This type of flow contributes directly to the finance of
domestic firms, in the market of primary issues and indirectly when shares are traded in the
local secondary market, by pushing up equity prices and thus lowering the cost of raising
capital. This encourages new equity issues. Also, these foreign direct equity purchases
increase the liquidity of the local stock exchange, and enhance its efficiency, by providing
high standards of regulations and information, required by foreigners, especially
institutional investors. In addition to high quality services such as brokerage, custody and
settlement. (United Nations, 1997).
The above-mentioned benefits encouraged the progressive dismantling of barriers to
capital account mobility in developing countries. During 1991-1993, eleven developing
countries undertook full or extensive liberalization of their exchange restrictions, 23
liberalized controls on foreign direct investment, 15 eased controls on portfolio inflows,
4
and 5 eased restrictions on portfolio outflows. By 1998, 30 emerging markets were
classified as free, 15 markets as relatively free, and only one market was closed to foreign
investment. (IFC, 1999; and IMF, 1994).
The following figure summarizes the investment regulations for entering and exiting the
emerging markets:
Figure (2)- Entry and Exit restrictions for foreign investors in emerging stock
markets (1991-1998)
Entry restriction for foreign investors in emerging stock markets (
percentage %
70
60
48,57
50
40
30
20
10
0
91 - 98 )
57,69
48,15
28,57
28,85
20
14,82
11,54
3,7
11,11
2,86
Free Entry
Feb-91
Relatively
Restricted
End 1994
1,92
Closed
End 1998
Source: IFC, 1996, p.7 and IFC, 1998, p.343.
Foreign direct equity purchases in developing stock markets increased rapidly, from
$3.1 billion in 1990 to $34 billion in 1993. Then, they declined to $14.2 billion and $23
billion in 1994 and 1995 respectively, partly in response to the Mexican financial crisis. In
the second half of 1997, this type of flow witnessed another decline due to the East Asian
crisis. For example, in 1997, due to the Thai baht crisis and its contagion effects, five
Asian countries- Indonesia, Malaysia, the Philippines, South Korea, and Thailandrecorded an outflow of $12 billion, which was equivalent to about 10% of their combined
GDP. (World Bank, 1997, 1999 a, and 1999b).
These figures show that direct equity purchases by foreign investors in local stock
exchanges are extremely volatile. Any loss of foreign investors’ confidence, may result in quick
liquidation of domestic security holdings, conversion of the proceeds into foreign currencies , and
their repatriation. This is particularly true, when they are managed by retail investors who do
not have access to the sophisticated investment methods or the extensive information and
resources for research typically available to large institutional investors. (Frankel, 1997).
Moreover, information asymmetries between domestic and foreign investors, may lead
to an increase in the volatility of domestic asset prices and returns. For example, a
defensive reaction by local investors to the sale of domestic securities by foreigners who in
turn are responding to events overseas, may magnify the impact of foreign stock market
spillover effects on the domestic market. Since local investors generally do not know why
foreigners are changing their holdings of domestic securities, they may react to such
changes even though the fundamentals of the domestic market have not changed. (World
Bank, 1997d).
These disadvantages made many emerging markets, such as Korea , Indonesia, and
Chile impose some restrictions on this type of foreign investment, and encourage other less
volatile types, particularly in their first stages of financial integration, until their domestic
stock markets were more prepared to receive direct foreign portfolio equity investments.
5
A.1.2. Venture capital funds:
Foreign investors may provide financing and management guidance to new unquoted
companies or high risk ventures with prospects for high growth and profitability, to
participate in the high potential returns, particularly in the form of capital gains. Following
is a discussion of the mechanisms and structure of venture capital funds.
i-Mechanisms of venture capital funds:
The venture capital industry passes through three main stages: entry, operations and
divestment.
i-a-The entry phase: venture capital investors cannot sell out their investments (in
unlisted shares) if performance is poor. Thus, these foreign investors, must assess the
expected return and when it might be realized, the investment size (because very small
investments are expensive to manage), and the investee company’s share in its relevant
sector. Thus, venture capital needs a highly qualified fund manager.
The finance provided by a venture capital fund may be of various types:
-Start-up financing: for the setting-up of a new business, and involves investment in
fixed assets and working capital.
-Seed capital: for the research and development of new products or production
technologies before the setting up of commercial scale production.
-Expansion financing: to enter new markets, develop new products or introduce
improved technological processes.
-Replacement financing: for entrepreneurs who wish to purchase shares of their
associates in the venture, and do not want a stock market listing.
-Special situations financing: for mature companies that can yield attractive returns,
and need financing to control an existing business by a new management team,
either from within or from outside the company.
i-b-The operating phase: during this phase, the venture capital fund adds value to the
investee company by contributing its experience and contacts to business strategy,
management organization and processes, and raising additional capital from other
financial institutions.
i-c-The divestment phase: the final and critical phase of the venture capital fund, is to
manage the divestment or exit from the investee firm, once a substantial capital gain and
high investment returns are achieved. Exit strategies are: an initial public offering, an
acquisition of the investee company by another firm, or the repurchase of the venture
capital funds’ shares by the investee firm. (IFC, 1996 and U.N.,1997).
ii-The structure of venture capital funds:
A venture capital fund may be either a single-tiered or a two-tiered fund. In the
former structure, the fund and its manager are incorporated in one entity, while in the
latter, each of them is separately incorporated. A two- tiered fund, enables investors to
control the managers’ performance and the fund’s strategy. It may also lower
management costs. (Sahlman, A., 1990).
6
iii.Trends for venture capital funds:
Since the late 1980s, venture capital institutions have been established in many
countries, including several least developed countries. These funds have expanded fastest
in the newly industrializing economies of Asia and in Central and Eastern Europe. By
1996, the International Finance Corporation, had invested $196 million in 49 venture
capital funds. Asian and Latin American countries received 59% of these funds. In recent
years, venture capital funds were established in Morocco, Tunisia and Egypt. (IFC, 1996).
In general, venture capital portfolio investment horizon tends to be somewhat longer
than for other types of FPEI instruments, and less volatile. Thus, it seems more suitable for
developing countries, that need finance and managerial expertise for small and medium
enterprises, that are applying privatization programs, and that are encouraging domestic
companies to go public. (Barry, et.al.,1990).
A.1.3. International equity investment funds: “Country funds”.
International equity investment funds are financial structures for pooling and managing
the money of multiple investors. These funds can invest on a global, regional, sub-regional
or individual country basis. (IFC,1996; United Nations, 1997).
The characteristics of country funds vary according to the structure of the fund, and the
investor placement.
i-The structure of the fund: country funds usually fall into two types: closed-end funds
and open-end funds.
i-a-A closed-end fund is an investment fund, which issues a finite number of shares at
the time of its initial public offering, and is not required to meet redemption requests. Thus,
they take a longer-term view, are able to invest in less liquid instruments and in less
developed equity markets. Closed-end funds, are less likely to contribute to market
volatility. (IFC, 1996; and IFC, 1998).
If the investment portfolio of the closed-end fund is concentrated relatively heavily in
less liquid instruments in which trading activity is light, then the prices of the fund’s shares
may vary independently of the value of the underlying portfolio of securities in which the
fund invests. This, diminishes the diversification benefits from the investor’s point of view,
but offers the emerging market, an insulating property when the local market in which the
fund is invested is illiquid.
Closed-end funds may be either diversified or non-diversified. Diversified funds face
limits on the percentage of total assets which can be invested in a single security, whereas
non-diversified funds face no such restriction. Diversified closed-end country funds
usually pose no threat to the control of domestically owned private firms, because most of
them limit their holdings to no more than 10 percent of a single firm’s equity. Nondiversified funds are relatively more risky, because of the potentially higher degree of
concentration in their investment portfolio.
i-b-An open-end fund is an investment fund in which new shares can frequently be
issued and in which existing shares can be redeemed on demand. These funds grow or
shrink as investors invest or divest. Open-end funds, when selling a portion of their
7
portfolio of securities in order to meet redemption requests, can create downward pressure
on securities prices in the market, and therefore, contribute to equity price volatility.
Open-end funds tend to invest more in larger companies and in more mature equity and
liquid markets. (IFC, 1998).
ii-The investor placement: It may be private or public. A country-fund could be
privately placed to a small, perhaps preselected group of investors. It may otherwise be
publicly placed by selling it through underwriters to retail or institutional investors.
Country funds offer significant benefits to investors, firms and host countries. The
following figure (3), summarizes the main benefits of country funds.
Figure (3)- Country-Funds’ Benefits
Improved access to capital,
management, & to marketing
and financial studies.
Firms
Host Government
Fund
Risk
diversification,
professional
management,
and
economies of scale in
investors
Foreign investors often
demand
better
infrastructure
Refor
Prices rise and
liquidity
Supply and liquidity
increase,
and
demand expands
Cost of issuing
More
institutional
More equity is
issued
Recently, there has been an evolution towards specialized funds, such as : debt-equity
conversion funds, and private-equity funds.
*Debt-equity conversion funds: several heavily indebted countries in Latin America and
Asia, swapped external debt obligations into domestic equity. The International Finance
Corporation, advised some of these countries on legal frameworks and helped develop,
8
structure and market debt equity funds. In June 1992, the only fund in the Middle East and
North Africa region was a debt-equity conversion fund for Egypt, investing in tourism
projects. (IFC, 1996).
*Private-equity funds: These funds invest primarily in growing unlisted companies.
They differ from venture capital funds in size and stage of investment. They tend to target
larger more developed projects. The market for these private-equity funds, developed in
response to several factors, such as privatization, increased private provision and financing
in infrastructure, improvements in stock market size and liquidity that have allowed private
equity investors to sell through initial public offerings.
From 1986 to 1996, the total number of emerging markets’ international equity
investment funds, grew from 28 to 1435, while the net value assets of these funds
increased from US$2 billion to US$135 billion. Asian funds, accounted for about 48% of
the total net asset value of emerging markets equity funds. In September 1996, there were
298 global funds, 775 funds dedicated to Asia, 239 to Latin America, 88 to emerging
Europe and 35 to Africa and the Middle East. (U.N., 1997).
A.1.4. American depositary receipts (ADRs) and Global depositary receipts (GDRs):
i-American Depositary Receipts [ADRs] are shares of a non-United States company that
are listed and traded in the United States as well as on their own country’s stock exchange.
When the securities of this foreign corporation, have been deposited with a custodian bank
in the country of incorporation of the issuing company, this custodian bank informs a
commercial bank in the United States known as a depositary, that the ADRs can be issued.
ADRs are United States dollar denominated and are traded in the same way as are the
securities of United States companies. The holder of ADRs is entitled to the same rights
and advantages as owners of the underlying securities in the home country. (IFC, 1998).
ADRs may be unsponsored or sponsored:
i-a-Unsponsored ADRs are issued without any formal agreement between the issuing
company and the depositary. They provide the issuing company a relatively inexpensive
method of accessing the United States capital markets. The investor bears certain costs,
including those associated with the disbursement of dividends.
i-b-Sponsored ADRs are created by a single depositary, which is appointed by the
issuing company under rules provided in a deposit agreement. Sponsored ADRs, may be
restricted or unrestricted:
*Restricted ADRs are privately placed, are not registered with the Securities and
Exchange Commission, and are exempt from its reporting requirements. Rule 144A,
passed by the Securities and Exchange Commission in 1990, eased restrictions on the
resale by qualified institutional buyers of private ADR issues amongst themselves once
these issues were made under this rule.
*Unrestricted ADRs are publicly placed and traded. There are three classes of
unrestricted ADRs, each increasingly demanding in terms of reporting requirements to the
Securities and Exchange Commission, but also allowing higher visibility and making the
facility more attractive to potential investors.
9
It is difficult for small capitalization companies of emerging markets to issue
unrestricted ADRs, because they must meet partial or full reporting requirements of the
Securities and Exchange Commission and other specific minimum requirements with
respect to the size of total assets, earnings and /or shareholders equity. Thus, emerging
market ADR issuers tend to be large domestic companies with considerable financial
resources and high international visibility.
ii-Global Depositary Receipts [GDRs], are shares of a corporation that are publicly
traded in London, Luxembourg, or other international stock exchanges as well as the home
country. The only difference between GDRs and ADRs is that the former can be traded in
more than one currency and within as well as outside the United States. (IFC, 1998).
Depository receipts provide benefits to the issuing company and to foreign investors,
and have become the most popular portfolio equity instruments among emerging markets’
firms, nowadays.
Depository receipts, facilitate the issuing company’s access to international investors in
foreign markets, and enable it to attract the capital of investors who are unwilling to go
directly to the inefficient domestic markets, or are prevented from doing so by legal
restrictions (World Bank, 1997).
Depositary receipts lower the future cost of raising equity capital, by raising the
company’s visibility and international familiarity with it. The decision to issue a depositary
receipt is not necessarily equivalent to raising new equity capital. Firms can choose to list
existing shares in the foreign market, to gain access to a larger shareholder base, which
may increase the value of their equity. At a future date, they may be able to raise new
equity in the foreign markets. However, in countries like Chile, the firms are allowed to go
to the international markets only with new issues of equity while the trading of existing
shares is prohibited.
For foreign investors, depositary receipts lower the cost of trading in foreign
companies’ securities and lower information search cost. The depositary provides both
settlement and clearance services, thus lowering the settlement time and risk. The
depositary provides periodic financial reports on the issuing company to the investor, who
bears certain costs. (Glen and Brian, 1994).
Over the period 1990-1996, the issuance of ADRs and GDRs in international markets,
increased by an average growth rate of 30 per cent. By the end of 1995, ADRs and GDRs
represented 6% of the market capitalization of the IFC Emerging Market Investable Index.
(World Bank, 1997).
In 1996, a total number of 10.7 billion depositary receipts with an overall value
equivalent to US$337 billion were traded on United States securities exchanges, and an
estimated 1.5 billion depositary receipts with a value between $20 and $25 billion were
traded on European exchanges, or on the “over-the-counter” market. Nearly sixty three
countries issued depositary receipts.
A.2. Quasi-equity instruments:
A.2.1. Convertible bonds:
A convertible bond is a bond that its holder may convert into a specified number of
shares of the issuer’s stock, usually at prestated prices and at any time up to and including
the maturity date of the bond. The holder of a convertible bond will exercise the right to
10
convert the bond into stock if the value of the shares for which the bond could be
exchanged exceeds the value of the bond.
Many convertible bonds include a call option, which gives the issuing company the
right to redeem the bond before its maturity date. Once the call is exercised, the bond
holder chooses either to convert the bond into shares or surrender it and receive in return
the call price in cash. (Julian, W., 1997).
A.2.2. Bonds with equity warrants:
An Equity warrant, is a security that offers the owner the right to subscribe for the
ordinary shares of a company for a given period of time [the exercise period], and at a
fixed price. A warrant may sometimes be issued, bought and sold on the stock exchange, as
a separate security.
The holder of a bond with equity warrant, will exercise the warrant if the price of the
shares exceeds the exercise price of the warrant, to realize a net gain. (French, 1989).
Generally, the holder’s rights attached to convertible bonds and bonds with equity
warrants will be exercised in the event that the company is successful and its market value
and share price rises. If growth is not very high, the investor can retain the bond, and
receive a stable relatively safe income flow.
The interest payments on convertible bonds and bonds with equity warrants are lower
than on straight bonds (because of the value of the right to convert and the value of the
warrant, respectively). Thus, the issuing company will be able to apply a larger amount of
financing towards expansion of the company or towards general operating expenses.
Convertible bonds have been issued since 1985. During the past ten years, they
accounted for 93 per cent of total emerging-market issues of equity-related debt
instruments. Bonds with equity warrants were first issued in 1989 in emerging markets.
During the last ten years, a total of US$314 billion of these equity-related bonds were
issued. Only fifteen emerging markets had floated equity-related bonds in the international
markets. Emerging markets, accounted for 4% of the international issues. These issues
have emanated almost exclusively from the relatively large middle-income emerging
markets, that are well known in international capital markets. [ China, India and Pakistan
are notable exceptions]. Asian issues of convertible bonds have, on average, accounted for
81 per cent of all emerging-market convertible bond issues, and for 85 per cent of
emerging-market issues of bonds with equity warrants. In 1995, the share of Africa and the
Middle East in emerging markets’ issues of equity-related bonds, was 16%. (United
Nations, 1997, annex table 21).
B-Types of foreign portfolio equity investment mechanisms in the Egyptian stock
market:
Since the Capital Markets Law no. 95 of 1992, which came into force on April 7th 1993,
foreigners have been enjoying free access to the Egyptian stock exchange, which was
registered by the International Finance Corporation as a free market for foreign investors.
(IFC, 1998).
Over the period 1991/92-1995/96, capital inflows to Egypt have been about $6 billion
or over $1 billion per annum. (Subramanian, 1997).
11
In 1993/94, Egypt started receiving portfolio flows by small amounts. In 1996/97, Egypt
witnessed a surge in foreign portfolio investment, reaching their peak level of around $1.5
billion. (Central Bank of Egypt, Annual Report, 1996/97, and Monthly Statistical Bulletin,
vol.39, no. 3, 1998/99).
The following table shows the value of net foreign portfolio investment flows to Egypt,
during the last six years.
Table (1)- Net Foreign Portfolio Investment in Egypt [1993/94-1998/99]
In US$ million
Fiscal Year
Net value of FPI
FPI as a % of market capitalization.
1993/94
1.3
0.03
1994/95
4.1
0.06
1995/96
257.6
2.30
1996/97
1462.9
8.30
-248.0
-1.10
-197.2
-0.70
1997/98
1998/99
*
* first quarter of 1999.
Sources: 1-Central Bank of Egypt, Monthly Bulletin, various issues.
2- Egyptian Ministry of Economy, Monthly Bulletin, various issues.
In 1997/98, portfolio investment witnessed a net outflow of $248 million, as the
Egyptian stock market trended downwards. This was mainly a result of eight major
negative events that damaged local and foreign investors’ confidence. Seven of these
events were mainly domestic factors.
-The government of Egypt announced that it would rescind the tax breaks allowed on
the revenue generated from treasury bills, and subsequently delayed in issuing the
executive regulations of the new income tax law 5/1998.
-The privatization process slowed pace such that only three companies were privatized
in 1998.
-Investors feared that new public offerings of public-sector companies would probably
be very highly evaluated.
-Investors faced difficulties in tracking companies’ performance, as very few companies
provided quarterly financial reports.
-The Commercial International Bank planned to distribute its shares among its
employees and management.
-Cases of insider trading were reported.
-Transparency issues and the poorly executed sale of Egypt’s two mobile phone
companies, had a negative impact.
-Global market conditions were unfavorable, due to the ongoing financial crisis in Asia.
(IBTCI, June 1998).
12
Foreign portfolio investment flows to Egypt seem to be very volatile, and merit an
investigation of their main types in the Egyptian stock market and their likely effects.
The main instruments of foreign portfolio equity investment in Egypt are, direct equity
purchases by foreign investors in the Egyptian stock markets, international equity
investment funds (country funds), and global depositary receipts. (see figure (4)).
Source: own calculations.
Types of foreign portfolio equity investment instruments in egypt in
1996
country funds
13 %
foreignres
value traded
67 %
GDRs
20 %
foreignres value traded
GDRs
country funds
B.1. Direct FPEI in the Egyptian Stock Exchange:
In the Egyptian stock market, there are no restrictions on foreign trading. There is no
ceiling on foreign ownership for companies established under Law no. 159 for 1981 as
amended by Law no.3 for 1998. In addition, it is no longer required that the majority of
board members be Egyptians.
Capital gains taxes and taxes on dividends, were eliminated. There are no taxes on the
repatriation of profits and foreigners are allowed to repatriate profits at any time. (Egyptian
Ministry of Economy, 1998).
Foreign securities companies are allowed to operate in Egypt and face the same
licensing procedures as domestic firms. Branch offices of fund management firms that are
not incorporated in Egypt are allowed to operate without any special license. Foreign
brokerages are not required to use local brokerages for the buying and selling of shares.
(EFG- Hermes, 1999).
According to the Egyptian Capital Market Authority (CMA) published data, direct
foreign trading was not registered before 1996.
Although the highest share of foreign investors in the capitalization of Egypt’s stock
market, was about 8% only in 1996/97, their share in the number of transactions, in traded
shares, and in the value traded was very large, and increasing. [see table (2)]. In other
emerging markets, foreigners’ shares in market capitalization and in trading, are relatively
proportionate. For example, in 1995, these shares in Korea, were 13%, and 6%,
respectively, and in Thailand they were 21% and 26%. (World Bank, 1997d).
13
Table (2)- The share of foreigners, trading in the Egyptian stock market during the
period from 1996- September 1999. [%]
Year
Share in the
number
of
transactions
Share in the
number
of
traded shares
Share in
the
value
traded
1996*
7.3
19.7
22.4
1997*
8.5
23.6
23.5
1998**
18.2
40.2
44.5
9/ 99**
24.16
45.5
41.1
Sources: [*] - IBTCI, 1998, June, p. 91-95. [**]- Cairo and Alexandria Stock
Exchange Monthly Bulletin, vol. 1, no. 3, October 1989, p. 13.
-Capital Market Authority, unpublished data for 1999.
Since foreigners’ share in capitalization is low compared to their share in value traded,
then foreign investments’ turnover is very high. This means that foreigners are mainly
interested in short-term transactions, which may encourage destabilizing price
speculations, and adversely affect the market price level. For example, in July 1998,
foreigners’ share in the value traded reached nearly 64%, selling transactions represented
44.6% of it. This caused a further decline in prices. (IBTCI, June, 1998).
Foreign investors are usually more experienced than local investors, and may play an
important role in directing the market price. A foreign investor trades an average of 564
shares per transaction, while the average number of shares in a transaction by an Egyptian
investor is 117. Thus, the average number of traded shares in a transaction by a foreign
investor, is 4.8 times higher than that of an Egyptian investor. The average value per traded
share by a foreigner is L.E. 85, while that of an Egyptian is L.E. 56. (IBTCI, June 1998).
These speculative transactions, induced Hendi et.al., 1999, to investigate the relation
between foreign trading and changes in the stock market price index using regression
analysis. They found a significant relation between the size of foreign investors’
transactions and the index of the Egyptian market. The coefficient of determination was
0.38, and therefore they concluded that foreign investors play an effective role in
determining the market price.
However, a significant regression coefficient between the size of foreign investors’
transactions and the index of the Egyptian market, does not help in identifying the
direction of the relation between these two variables.
In order to investigate whether there is a causal relationship between the value of shares
traded by foreigners and the change in the price index, and the direction of this relation, we
employed Granger causality test. (Granger, 1969).
The value of shares traded by foreigners was used as an indicator of foreigners’ size in
the Egyptian stock market. (VSTF). Changes in two indexes for the Egyptian stock market
price, were employed. First, the publicly traded securities index (PTSI), because foreigners
trade in publicly listed companies, only. Second, the IFCG index (IFCG), as it includes the
most active companies, which foreigners are very much aware of. (about 60 companies).
Monthly data was used for the period 1996- third quarter of 1999. Statistical
14
tests for the stationarity and cointegration of the series, were run. Our series (VSTF),
(PTSI) and (IFCG), are not co-integrated. [The series (VSTF) is stationary at difference
one with 99% confidence level. Changes in the two market price indexes are stationary at
the level, with 99% level of confidence].
The results summarized in table (3), show that trading by foreigners in the Egyptian
stock market (VSTF), causes changes in each of the two market price indexes, (PTSI), and
(IFCG).
Thus, foreign investors’ direct trading has an effect on the Egyptian stock market price
indexes. This result seems consistent with our previous analysis of this type of flows which
emphasized its potential negative effect on the volatility of domestic asset prices and returns.
Table ( 3)- Results of Granger causality test: (1996- 9/1999)
Null hypothesis
IFCG
VSTF
F-statistic
Probability
0.771
0.385
3.4
0.07
2.4
0.12
3.01
0.09
VSTF
IFCG
PTSI
VSTF
VSTF
PTSI
Notes: * (
), means no causal relationship.
*(A change in an index is calculated as Log Pt/P t-1, where Pt and
P t-1 represent the index in time t and t-1, respectively).
B.2. Egypt’s country funds:
Egypt has seven offshore funds, that are listed in London, Dublin, Luxembourg and
Saudi Arabia. Five of these funds are closed-ended. Their aggregate issue value is
approximately $ 414.3 million. These are few funds, if compared with other emerging
markets, and considering their potential advantages that were previously mentioned. In
1996, international funds for China, Korea, and Brazil, were 108, 94, and 53 respectively,
with total net assets $6680, $5150 and $1497 million. [United Nations, 1997, p. 284].
The establishment of more country funds, and other specialized funds such as privateequity funds, should be encouraged. Transparency and improvements in disclosure and
accounting standards will encourage foreigners to invest in Egyptian companies’ equities.
15
Table ( 4 )- Country funds investing primarily in Egyptian securities
Fund
Starting
date
of
operation.
Size
in
US$ million
Nominal value per
certificate L.E.
Egypt Fund
(Dublin)
8/96
43
9.98-10
Egypt
Growth
Inv.
(London)
6/96
46
Egypt
Investment
(London)
1/97
Egypt Trust
(London)
Faisal Fund
(Dublin)
Fund
Type
Fund
Manager
Capital
growth
Hermes
10
Capital
growth
closed-ended
Concord
91
10.25
Capital
growth
closed-ended
Concord
9/96
74
10
Capital
growth
closed-ended
Lazard
3/98
15
10
Capital
growth openended
Hermes
Nile
Growth
(Luxembourg)
6/97
130
10.30
Capital
growth
closed-end
CIIC
Rajhi Egypt
(Saudi Arabia)
5/97
15.3
100
Capital
growth
Hermes
Source: IBTCI, September 1997, p.16. EFG-Hermes, 1999, p. 63.
B.3. Egyptian global depositary receipts:
Since mid-1996, Egypt started to issue global depositary receipts [GDRs]. Issuing
GDRs enables the Egyptian government to offer a large number of public companies’
shares, and attract foreign investors, especially that the size of the local market is relatively
small.
During 1996- July 1999, eight Egyptian companies issued GDRs, as shown in table (5),
below. Egypt’s GDRs issues represent four sectors- financial, industrial, chemical, and
food and beverage-out of 20 sectors classified by the Egyptian Stock Exchange. The eight
issuers represent almost 10% of total market capitalization of the Egyptian Stock Market.
(Ministry of Economy and Foreign Trade, 1999, p. 6).
Global depositary receipts may have a positive effect on the efficiency of the domestic
stock market price. When shares’ price increases in the Egyptian stock market, GDRs may
be converted into local shares. This arbitrage process, may be beneficial to the company
that issues GDRs, by reducing the volatility of its shares’ price in the local market. (see
Hendi et al., 1999).
As shown in the last column of table (5), the GDRs’ outstanding balance for five out of
eight Egyptian GDRs issuing companies, was negative, as of end June 1999. This means
that some of these five companies’ GDRs, were converted into local shares, implying that
16
these companies shares’ price in the Egyptian stock market was higher than their GDRs’
prices.
Table (5)- The Egyptian GDRs issues
Company
Commercial
Investment Bank
[CIB]
Suez Cement
Volume
on offering
date
in
million GDRs
[1]
Volume
in 30/6/99 in
million GDRs
[2]
Net
balance ([2]
- [1] in
30/6/99
Sector
Date of Offering
Financial
July 1996
9.9
7.9
-2.0 *
Cement
July 1996
7.3
5.7
-1.6 *
Al-Ahram
Beverages
Food
beverages
&
February 1997
8.0
7.2
-0.8 *
Al-Ahram
Beverages
Food
beverages
&
January 1999
n.a.
n.a.
n.a.
Chemical
October 1997
6.3
3.0
-3.3 *
Financial
April 1998
6.5
5.3
-1.2 *
Financial
August 1998
4.8
5.4
0.6 **
Al-Ezz Steel
Rebars.
Industrial
June 1999
0.5
0.5
0.0
Lakah Group
Industrial
July 1999
35.0
n.a.
n.a.
Paints
Chemicals
[PACHIN].
and
Misr
International
Bank [MIB].
EFG-Herms.
Notes: N.A. = not available.
* = a negative balance, means converting GDRs into local shares.
** = a positive balance, means converting local shares into GDRs.
Sources: 1-Capital Market Authority, the public department for information.
2- Cairo & Alex. stock exchange monthly bulletin, 31/7/1999.
3- Egyptian Ministry of Economy, 1999.
In July 1998, the Egyptian Ministry of Economy constructed an index, aiming at
providing an overview on Egypt’s GDRs trend and performance, the price changes of
GDRs resulting from various emerging market disturbances and foreign investors’
responses toward information, especially timely local information. The index includes five
GDRs, and its base period is October 1st 1997. (see: Ministry of Economy and Foreign
Trade, 1999).
The Egyptian GDRs index level, fell insignificantly by 2.48% over the year 1999. In
January 1999, the index witnessed an increase of almost 25%, as the US dollar depreciated
against the newly issued Euro currency. However, the index fell by 9.3% in March, due to
the dollar shortage facing the country. It experienced a further decline of 9%, in May and
June as a result of increasing fears in the international markets concerning the possibility
that the Federal Reserve would increase the interest rate.
17
Egyptian companies should be encouraged to issue GDRs, especially that the value of
the Egyptian market international issues in 1996 was $ 233 million only. This value is very
small, compared to other developing countries. {In 1996, the value of international issues
for India was $1.340 billion, for China was $1.3 billion, and for Indonesia was $1.237
billion} (World Bank, 1997).
III- The Determinants of Foreign Portfolio Equity Flows to Egypt:
In this part, the central issue is to identify the main factors that are internal to Egypt, and
affecting foreign portfolio equity investment in the country. The assessment of these
determinants is important because successful domestic policies, are the key to ensuring
sustainable, long-term FPE investors and instruments that contribute to economic growth;
and to discouraging the highly volatile types, even if external conditions turn around.
(Helmy, 1997).
A review of the literature on the determinants of foreign portfolio equity flows to
developing countries, an examination of Egypt’s recent economic performance and of the
characteristics of the Egyptian stock market, will enable us to identify the main factors that
affected these flows to Egypt.
A-Review of the literature on determinants of foreign portfolio equity flows to
developing countries:
The surge in private capital flows to developing countries since the early 1990s has
coincided with a period of low international interest rates and a period of domestic policy
reform in many developing countries. Thus, there has been considerable debate in the
recent literature, on whether this surge was driven in large part by cyclical factors in the
international economy or was a result of longer-term structural changes. (Hernandez and
Rudolph, 1995; Fernandez-Arias, 1996; Fernandez-Arias and Montiel, 1995).
The debate has been about the relative importance of “push” factors (factors in the
global economy, that are external to the economies receiving the flow, such as the decline
in international interest rates, and the slowdown of the economic activity in industrial
countries, in the early 1990s), and “pull’ factors (factors that are internal to the recipient
economies, such as improved domestic policies and sustained high growth performance in
them). (see, for example, Calvo et al., 1993; Claessens, 1995; Claessens, Dooley, and
Warner, 1995; Chuhan, Claessens, and Mamingi, 1993; Fernandez-Arias, 1996; Dooley,
Fernandez-Arias and Kletzer, 1996).
In order to identify the main push and pull factors that have stimulated FPEI flows, to
developing countries in general and Egypt in particular, the available studies on the
determinants of these flows to Latin American and East Asian countries were examined.
(see appendix (1), for the summary findings of these studies).
A survey of the main external “push” factors and internal “pull” factors, will be
presented below.
A.1. External factors:
The major factors behind the increase in FPEI flows to emerging markets are the
liberalization and globalization of financial markets, and the concentration of substantial
financial resources in the hands of institutional investors. Also, the role of foreign interest
18
rates, as a push factor driving capital flows and determining their magnitude is well
established by the empirical work undertaken on this issue.
A.1.1. The regulatory environment:
Financial-market liberalization, the major advances in financial instruments, and the
rapid flow of market information, due to the improvements in communications technology,
facilitated the globalization of financial markets, which implies that financial capital can
move more freely and at lower cost between countries.
Regulatory changes in major creditor countries made it easier for developing countries’
firms to place their equity under more attractive conditions to investors. For example, the
USA Securities and Exchange Commission adopted Rule 144A in 1990, which permits
holders of shares in non-USA firms purchased in private placement, to sell them freely to
qualified institutional buyers under certain conditions without being subject to a two-year
holding period. Also, Regulation S in the USA, eliminated settlement delays, and
facilitated registration and the payment of dividends. [El-Erian,1992; Goldstein, 1995).
A.1.2. International diversification of investments:
International investors, who are willing to reduce their risks and diversify their
portfolios, consider investing in emerging markets because the correlation between equity
returns from different countries is lower than that between equity returns in the same
country. This is especially true for investments in developing countries, because their stock
returns tend to have a low correlation with those of industrial countries (Bekaert, 1995).
A.1.3. Low interest rates and recession in many developed countries:
Available empirical studies suggest that foreign investors initially turned to emerging
markets largely because of the decline in global interest rates and the slow down in
economic activity in industrial countries, in the early 1990s.
The period 1989-1993, was a slow-growth period in the industrial world as a whole.
The rate of growth of real GDP for the G-7 countries, as a group averaged 2.8% in 19891990 and 1.1% in 1991-1993. USA’s real GDP grew by only 1.2% in 1990 and declined by
0.6% in 1991 (Fernandez-Arias and Montiel, 1995).
Taking the industrial countries as a group, the weighted aggregate short-term interest
rate, fell from over 9% in 1990 to a little over 5% in 1993. Long-term interest rates in the
G-10 countries, declined (on a weighted average basis) from about 9.5 percent in 1990 to
6.5 percent in 1993. In the USA, short-term nominal interest rates peaked at 9.1% in 1989,
and had fallen to 3.2 % by 1993. Long-term rates also fell dramatically, by roughly half
(Fernandez-Arias and Montiel, 1995, Goldstein, 1995; Calvo, 1993).
Other things equal, lower interest rates in creditor countries, make investing in them less
attractive at the margin than investing abroad, (the asset substitution effect/channel); and
appear to have improved the creditworthiness of heavily indebted countries that borrow at
these rates, (the creditworthiness effect). (Goldstein, 1995).
FPEI flows in emerging markets were found to exhibit a strong negative association
with interest rates in developed countries. On an annual basis over the period 1986-1995,
the correlation coefficients between United States interest rates on Treasury bills and FPEI
flows: to all emerging markets, to Asia, and to Latin America were, respectively -0.7, -0.6
and –0.8. These coefficients were statistically significant and indicated that FPEI flows to
19
emerging markets were heavily influenced by developments in United States financial
markets. (Burki, et al., 1997; Schadler, 1994).
A.2. Internal Factors:
Some studies observed that the timing of the external factors, did not coincide with the
surge of private capital inflows in each recipient country. For example, Thailand and
Malaysia, started receiving inflows as early as 1988 or 1989, respectively, while the
Philippines and Peru, received them in 1992 or 1993, respectively. Furthermore, between
1989-1994, over 80% of private capital inflows went to a score of countries. This uneven
geographical distribution of private capital flows, among regions and between developing
countries within those regions, suggests that country-specific factors have played an
important role in determining the size and composition of private capital flows to
developing countries.
Thus, the “pull” view holds that, inflows are attracted to the recipient countries mainly
because of the fundamental economic reforms they have taken immediately preceding the
inflow episode including the restructuring of their external debts and privatization efforts.
(Schadler et.al., (1993); Schadler (1994); Gooptu, S., (1994); (1994); Bekaert, (1995);
Fernandez-Arias, and Montiel, (1995).
A.2.1. Policy performance in the host countries:
Since the mid-1980s, several developing countries have embarked on stabilization and
structural reform programs. For example, Bolivia, Chile and Mexico, implemented major
disinflation programs prior to the surge in capital inflows.
In several cases, fiscal adjustment (reductions in the share of government expenditure in
output as well as lower budget deficits) played a key stabilizing role and was instrumental
in attracting capital flows. Improved fiscal balances helped to lower inflationary
expectations and conveyed a signal regarding the policymakers’ commitment to achieve
and maintain macroeconomic stability. In countries like Argentina, Thailand, Mexico and
Chile, significant reductions in fiscal deficits preceded the surge in capital inflows. (Corbo
and Hernandez, 1996; Fernandez-Arias and Montiel, 1995).
The rate of economic growth; as well as the potential rate of growth of the host country
is an important influence on decisions on where to invest. The distribution of FPEI is
skewed towards upper-middle income and large low-income countries with a high growth
potential.
Foreign portfolio investments are extremely sensitive to a country’s openness. The right
to repatriate dividends and capital may be the most important factor in attracting
significant foreign equity flows. In Korea, the surge coincided mostly with faster financial
liberalization, particularly a shift to allowing foreigners to acquire domestic stocks and
bonds. (Goldstein, Mathieson, and Lane, 1991; Schadler, 1994; Lee, 1997).
Many developing countries increased openness of their markets, through the lowering
of barriers to trade and foreign investment, the liberalization of domestic financial markets
and removal of restrictions on capital movements.
Foreign investor involvement in developing countries, [Argentina, Chile, Hungary,
Indonesia, Malaysia, Mexico, and the Philippines], has been further boosted by the
privatization of state-owned enterprises. Of the $112 billion of privatization proceeds that
20
developing countries received during 1988-1994, almost 42% were from foreign investors.
Thus, privatization programs offered foreign investors an opportunity to gain a stake in
some of the host countries’ firms (World Bank, 1977).
A.2.2. Improved relations between heavily indebted countries and external creditors:
Credit ratings and secondary-market prices of sovereign debt, reflect the opportunities
and risks of investing in the country, and are important in determining capital flows as
well.
Capital flowed initially to the rapidly growing countries in East Asia that never suffered
a debt crisis.
Many heavily indebted countries in Latin America, made significant progress towards
improving relations with external creditors and restoring their creditworthiness. The
restructuring of the commercial bank debt of these countries in the context of officiallysupported “Brady-type” initiatives, improved their debt indicators, and secondary market
prices of bank debt, over the 1989-1993 period. (Cline,1995); and Dooley et.al., 1994).
By 1994, eleven developing countries had established an investment grade credit rating
from one of the two major international credit-rating agencies (Moody’s and Standard and
Poors). (Mathieson and Rojas-Suarez, (1992); Chuhan, Claessens, and Mamingi, (1993);
World Bank, 1994, and 1997; Bekaert, 1995].
A.2.3. The growing maturity of the market for developing countries’ securities:
Flows of FPEI are intimately linked to the development of stock markets in recipient
countries, and to the range of instruments available to foreign investors who wish to
purchase developing countries’ equities. For example, many venture-capital fund
investments in unquoted companies are made with the expectation of reaping capital gains
subsequent to the listing of such companies on the stock market once they become mature.
Also some country funds are set up in anticipation of the establishment of a local stock
market.
The broadening and deepening of developing countries’ securities, and the increase in
their market accessibility, have offered investors significant opportunities for risk
diversification (World Bank, 1997).
During 1988-93, foreign investors were attracted to emerging equity markets whose
returns tended to be higher than those in industrial countries. For example, during that
period, the annual U.S. dollar rate of return according to the IFC composite index for Latin
America was 38.8 percent, while the U.S. Standards and Poor was 14.4 percent.
(Claessens, 1995).
However, over the period 1992-97, U.S. mutual funds investing in developing country
stock markets have earned average annual returns of 8 percent while funds investing in the
United States and Europe have earned 19 percent. Risks were also relatively high in
emerging markets. The standard deviation of the return on funds was 22 percent for
emerging markets and 13 percent for U.S. and European funds. The risk-adjusted return as
measured by the Sharpe ratio was 0.2 for funds investing in emerging markets, much lower
than the 1.1 ratio for funds investing in the United States. (World Bank, 1998).
Despite the lower returns and higher risk of emerging markets over these five years,
foreign investors will probably continue to be attracted to these markets. Returns in those
21
emerging markets may exceed returns in industrial countries over the medium term as
output in developing countries is expected to rise significantly faster than in industrial
countries, and as differences in patterns of population growth are likely to widen the
differential in expected rates of return on capital between industrial and developing
countries. Moreover these returns are not highly correlated. (World Bank, 1998).
The degree of market liquidity is also a crucial element in the decision to invest in
emerging markets. In this respect, an adequate market infrastructure and the availability of
exit mechanisms through stock exchanges, contribute to greater liquidity. Liquidity has
increased in emerging markets as total trading values in the secondary market for
developing countries’ instruments exceeded $790 billion, and $1 trillion in 1992 and 1993,
respectively (Goldstein et.al.,1994; and Goldestein, 1995).
Improving accounting and disclosure standards in host countries and greater availability
of market research on emerging markets has made foreign investors less reluctant than they
used to be to send capital to developing countries, when the opportunities are viewed as
favorable.
A.2.4. Contagion effects:
Contagion effect, may arise because investors decide to temporarily withdraw from a
country (or a group of countries) in order to re-evaluate risks and returns following a crisis
in a neighboring country. (Goldstein, 1995, Calvo et al., 1996).
Thus, a great shift in capital flows to one or two large countries in a region, may
generate externalities for the smaller neighboring countries.
Some studies have found that correlation of equity price movements across countries, is
greater during times of turbulence than in normal times. (Goldstein, 1994).
The conclusion to draw from existing evidence in the literature surveyed above, is that,
both external (push) and internal (pull) factors that influence private capital flows in a
country may be interrelated, and both play a role in attracting capital inflows. However,
their relative importance is still unclear. [1-g, Fernandez-Arias, (1994)].
The previous review of the literature, enabled us to determine both the push and pull
factors. Following is an investigation of the Egyptian country specific factors that affect
foreign portfolio equity investment.
B. Egypt’s recent economic performance:
Since 1991, Egypt has embarked on an economic reform and structural adjustment
program. The aim was to restore macroeconomic stability, restructure the economy and
enable it to face the challenge of global integration of production, trade and financial
markets.
Egypt’s stabilization policies have been highly successful. Inflation declined from an
average of 20 percent over 1989-92 to 3.8 percent in 1997/98. Real output growth, rose to
5.7 percent in 1997 /98, up from 0.3 and 0.5 percent in the first two years of the
stabilization. Fiscal deficit was brought down from over 15 percent in 1990/91 to 1.3
percent of GDP in 1998/99. The current account’s deficit improved from about 5 percent
of GDP to 1.9 percent in 1998/99.
Egypt has implemented various other reforms that will be discussed below:
B.1. Financial liberalization:
22
In January 1991, interest rates on pound deposits and loans were liberalized, and
treasury bill auctions were introduced. In October 1992 and July 1993, lending limits to the
private and public sectors were eliminated, respectively. Financial liberalization was
supported by a series of other reforms to strengthen the solvency and efficiency of the
banking and securities markets. (for details see: World Bank, 1996; and Central Bank of
Egypt).
B.2. Exchange rate policy and free capital mobility:
In October 1991, Egypt unified the exchange rate system and its’ exchange rate has
become fully convertible. Since then, the nominal exchange rate of the Egyptian pound
with respect to the American dollar has been roughly constant, as a result of heavy
intervention by the central bank. This, in turn, eliminated foreign-exchange risk. In 1994,
capital transactions in the balance of payments were also liberalized with the Foreign
Exchange Law no. 38. Most banks were authorized to deal in foreign currency and foreign
banks were allowed to deal in local currency. Currency transfers across borders by
authorized banks were no longer restricted, thereby allowing complete international capital
mobility. (Central Bank of Egypt, Annual Reports; IMF, 1997; and World Bank, 1996).
Thus, free capital mobility, nominal exchange-rate anchor, together with financial
liberalization, led to large capital inflows, and the accumulation of foreign exchange
reserves. Also, the deceleration of inflation, the fiscal adjustment, the stable nominal
exchange rate, the large capital inflows and foreign exchange reserves, have encouraged
the rapid pace of dedollarization from almost 50 percent of the broad money supply in
1990/91 to about 18 percent in 1998.
B.3. The privatization program:
In 1991, the government adopted Public Sector Law no. 203, for the privatization of 314
state owned enterprises. Over the period 1993-1997, Egypt has been rated as the fourth
most successful privatization program in the world. Proceeds from the privatization
program as of 1998 amounted to LE 7.8 billion. (IMF, 1998, and Egyptian Ministry of
Economy, 1999).
From April to September 1996, the privatization program progressed quickly. The
majority share of nineteen companies was sold, with eighteen of them through the stock
exchange. In 1997, another thirteen companies were sold. (IBTCI, 1999). Out of the
original portfolio of 314 public sector companies, by the end of 1998, the government had
sold controlling interests in 99 of these companies and minority interests in another 20. Of
the total, 31 companies were offered for sale between July-December 1998 with a total
value of LE 4.6 billion. (EFG- Hermes, 1999).
Banking Laws no. 37 of 1992, and no. 101 of 1993, and their amendments adopted in
1996 and 1998, allowed joint venture banks to be 100% foreign-owned, and state-owned
banks to be privatized.
B.4. Trade liberalization:
The government has removed almost all non-tariff barriers. It has reduced the range of
import tariffs to 5 to 40 percent, while tariff preferences and exceptions to the maximum
tariff have largely been eliminated. Tariffs on nearly all capital goods have been removed.
The remaining few restrictions on exports have been abolished. (EIU, 1997).
23
B.5. Improvements in Egypt’s creditworthiness:
After the Gulf War, Egypt received $7 billion in debt forgiveness from Gulf Arab
States. The Paris Club agreed to reschedule $27 billion in official and government
guaranteed debt. As a result of this debt forgiveness and restructuring, and the tight fiscal
policies, the gross external debt amounted to slightly less than $ 30 billion or 36% of GDP
at the end of December 1998. Debt service currently averages $1.7 billion per year or 11%
of exports of goods and services. Total public and private short-term debt, amounting to
$1.8 billion is only 6% of the overall debt and 2% of GDP. Medium and long-term private
sector debt remains negligible at less than $ 300 million. The Ministry of the Economy
calculated the net present value of the gross debt to be $18.7 billion as of 1997. At this
level, Egypt’s external obligations are substantially inferior to its total foreign reserves and
the net foreign assets of the banking system. Consequently, in present value terms, Egypt is
a net creditor to the world (EFG- Hermes, 1999; and Subramanian, 1997).
All of the above-mentioned reforms have led to improvements in Egypt’s
creditworthiness risks, declines in investment risk, and increases in expected rates of
return.
The following table reflects the sovereign rating for Egypt, according to some
international rating agencies (Standard and Poors, and Fitch IBCA).
Table (6)- Sovereign rating for Egypt
Local Currency
Longterm
rating.
Outlook
Foreign currency
Shortterm rating
Long-term
rating.
Outlook
Shortterm
rating
Standard
& Poor.
A-
Stable
A-1
BBB-
Stable
A-3
Fitch
IBCA.
A-
Stable
n.a.
BBB-
Stable
F3*
Notes: 1- F3*: fair credit quality. The capacity for timely payment of financial commitments is
adequate; however, near-term adverse changes could result in a reduction to non-investment grade. 2n.a.: not available.
Source: Egyptian Ministry of Economy and Foreign Trade, unpublished data.
C. Characteristics of the Egyptian stock market:
International investors’ decision to invest in an emerging market is affected by some
important albeit, indirect factors that may limit foreigners’ access to the local stock market
(Bekaert, G., 1995). The Egyptian stock market’s infrastructure, size and liquidity, and
return characteristics will be analyzed, and the main indirect barriers confronting foreign
investors will be investigated.
The Egyptian government has been fostering the revitalization and development of its
capital markets over the past decade. The Capital Markets Law no. 95 of 1992, which came
into force on April 7th 1993, restructured the securities and bond markets. It provided the
framework for the establishment of capital market service companies including securities
24
brokerages, mutual funds, portfolio managers, underwriting institutions and venture capital
companies. The legislation facilitated the issuing of corporate bonds, and encouraged the
formation of a debt market. (Capital Market Authority, 1996 and EFG-Hermes, 1999).
The share of financial assets accounted for by the banking system declined from 67
percent in 1992 to 58 percent in 1996. This may reflect the growing importance of capital
markets. (Subramanian, 1997; EFG-Hermes, 1999).
C.1. Market infrastructure:
Foreign investors- especially those who decide to invest directly in the local stock
exchange- are very much concerned about the market’s operational framework.
The most important processes that affect the liquidity and efficiency of the market, are:
the listing requirements, the trading, clearance and settlement, and central depositary
systems, the financial disclosure and accounting standards, and the availability of
protection for investors.
C.1.1. Listing requirements:
Securities of joint stock companies must be registered in Cairo or Alexandria stock
exchanges, either in the official or unofficial register. The official register includes
companies with no less than 150 shareholders and in which at least 30% of the nominal
capital has been floated publicly. It also includes Law 203 companies, which have
undergone a public issue of shares regardless of the free-float percentage. Also, a company
must be publishing its balance sheets for at least twelve months, before being listed in the
official register.
Securities, which do not fulfill the above criteria, and newly established firms are
included in the unofficial register, as are foreign securities. [Egyptian Ministry of
Economy, 1998, The Law of Business].
Table (7)- Companies listed in both the official and unofficial registers,
at 13/7/‫‏‬1999.
Listing Type
Number of companies
Official
137
Unofficial
838
Total
975
Source: Cairo and Alexandria Stock Exchanges
Monthly Bulletin, July 1999.
The listing requirement system in Egypt has two main weaknesses:
i- As can be seen from the previous table, the majority of the companies are being
registered in the unofficial list, mainly because the Capital Market Authority allows closed
companies to be registered in the stock exchange, thus enabling them to affect the liquidity
of the market.
ii- The Egyptian listing requirement system has no restrictions concerning the
profitability and size of the company being listed in the stock exchange. Thus, the system
does not guarantee the financial health of the listed companies and may adversely affect
investors’ confidence.
25
In most other emerging markets, only public offering companies are allowed to be
registered in the stock exchange and they are usually organized in various sections
according to the companies’ profitability [see appendix (2)].
To enhance the efficiency and liquidity of the Egyptian stock market, it should be
organized in more than one section, with each section differing in its listing requirements
such as the percentage of the company’s shares publicly offered, the company’s size,
performance and profitability.
C.1.2. Trading system and the related subsystems:
According to the Egyptian law, shares listed in Cairo and Alexandria stock exchanges
are to be sold only through licensed brokers. The number of brokerage firms has increased
from 2 companies in 1992, to 152 in 1999( CMA, 1999). Brokerage firms must adhere to
the capital adequacy requirements, according to the type of business in which they are
engaged. (CMA, 1996).
As of April 1999, an integrated computerized trading system links Cairo and Alexandria
Stock Exchanges and all independent bookkeeping activities to the Central Depository and
allows for automatic electronic matching of bids and offers. This has resulted in greater
speed and efficiency in the settlement process.
C.1.3. Clearance, Settlement and Central depository system:
Egypt has been able to gradually improve its clearance, settlement, and depository
systems, moving towards international norms. In October 1996, Misr for Clearance,
Settlement and Depositary, [MCSD], was the first company to be established in Egypt to
provide greater efficiency in the settlement of transactions, according to the delivery versus
payment principle.
Egypt uses the rolling settlement system, by which trades are scheduled for settlement a
certain number of days after execution. Settlement is completed at T+4.
This improvement in the clearing and settlement system is a positive indicator for
foreign investors, as it leads to more efficiency, transparency and liquidity of the market,
and helps in eliminating forgeries.
However, the settlement period in Egypt is still relatively long compared to other
emerging markets, as can be seen from the following table.
Table (8)- Clearance and settlement period in selected emerging markets
Country
Egypt*
Kuwait *
Saudi
Arabia*
Bahrain
*
Jordan
*
Lebanon
*
Brazil
**
Chile
**
Argentina
**
Korea
**
Period
T+4
T+0
T+1
T+3
T+3
T+3
T+1
T+3
T+3
T+2
Source: * Data base for Arab Capital Markets, April 1997. ** http.www.emgmkts.com.
The number of companies with immobilized shares listed with [MSCD], increased from
84 in May 1998, to 143 in February 1999. As of April 1999, 158 securities were being
traded through MCSD, including nearly 75% of all actively traded shares. (IBTCI, March
1999; EFG-Hermes, 1999).
A transition period is needed until all companies and securities become listed with
MSCD.
26
C.1.4. Financial Disclosure and Accounting Standards:
The efficiency of the domestic stock market and its integration with international capital
markets, demand transparency to be enhanced and information to be prepared according to
international standards.
All Egyptian listed companies are required to publish audited quarterly financial
statements adhering to internationally accepted accounting practices. Fully audited
financial statements and the report of the board must be produced within three months of
the end of the fiscal year, made available to shareholders, and published in two daily
widely distributed newspapers. Companies are also required to make timely disclosure of
all news that may affect their business and earnings (Egyptian Ministry of Economy,1999)
Companies that do not comply with the disclosure requirements are to be delisted, after
three months notification. (CMA, 1996). However, as the CMA has not executed this legal
right to date, only one tenth of all listed companies do publish their financial statements
regularly and no more than 50 percent of them send their quarterly financial statements to
the Capital Market Authority. (Al Borsa Magazine, August 1999).
It seems that disciplinary measures should be strictly applied against the companies that
fail in making the required disclosure.
C.1.5. Investor protection fund:
Most emerging markets protect investors, by supervising the settlement system to
increase the confidence in the market. Until end of June 1999 there were no procedures
concerning investors’ protection from losses arising from negligence, error or malfeasance.
As of July 1st, 1999, the Capital Market Authority (CMA) established a compensation fund
to protect local and foreign investors against potential settlement risk. All securities service
companies are required to carry insurance for these potential losses and all companies
deposit fidelity guarantee money with the MCSD, to enable it to open an independent
account for a compensation fund, whose resources may be used to help fulfill the
obligations of a member, who is involved in a troublesome transaction but this fund has not
started working yet . (Al Borsa magazine, no. 163, August 1999).
The (CMA), has created an Arbitration Board to address complaints and legal disputes
raised by investors
C.2. The size and liquidity of the Egyptian stock market (ESM):
Foreign investors, especially institutional investors, are attracted to larger and more
liquid stock markets.
C.2.1.The size of the market:
Various indicators, such as market capitalization as a percentage of GDP, and the
number of listed companies usually measure the stock market size.
Although the Egyptian stock market is still relatively very small, in comparison to other
emerging markets, it has been developing in recent years and its share in the international
market has been increasing since the early nineties.
Over 1994-98, the capitalization of the ESM increased rapidly at an annual average
growth rate of nearly 45.6%, and from 8.3 percent of GDP to 29.9 percent of it. In the third
quarter of 1999, market capitalization relative to GDP reached 31.4% and the number of
27
listed companies increased to 1004, and the value of new issues augmented. (Ministry of
Economy, July 1999).
In 1998, the Egyptian market capitalization was nearly 1.3 percent of the total value of
emerging markets’ capitalization, (compared to 0.2 percent only in 1990), and represented
about 20 percent of the capitalization of the Arab emerging markets. (IFC Factbook, 1999;
Arab Monetary Fund, 1999).
The number of listed companies, in the Egyptian stock market represents about 3.2
percent of the total emerging markets’ listed companies, and nearly 60 percent of those
listed in the Arab emerging markets (Arab Monetary Fund, 1999).
Table (9)- Egyptian stock market size indicators (1994-1998). -LE MillionNo. of listed companies.
1994
1995
1996
1997
1998
1999/Q3
100
146
646
650
861
1004
Value of new equity issues.
4879
11251
20478
19485
36300
n.a.
Value of Capitalization.
14480
27420
48086
70873
83140
95799
2
8.3
13.4
21
27.7
29.9
31.4
Capitalization (% GDP)
Sources: 1-Capital Market Authority, annual report. 2- Ministry of Economy, Economic Monthly
Bulletin, July 1999.
Despite this remarkable improvement, the ESM in comparison to the 32 emerging
markets, is still ranked as number twenty-one with respect to market capitalization, and as
the fifteenth according to the number of listed companies.
The ESM size has some negative characteristics:
i- The value of capitalization shows the market value of all listed shares, and therefore,
has to be interpreted cautiously. When listed shares that are not available for trading are
excluded, the value of market capitalization will drop sharply. According to the Capital
Market Authority’s report in 1998, the capitalization of the companies whose shares are
available to the public reached LE. 23.57 billion only and represented about 28 percent of
the total market capitalization. The share of closed companies not available to the public,
in the market capitalization was nearly 71 percent. Thus, by only considering the number
of public offering companies, the Egyptian stock market is actually very thin.
Allowing closed companies, to be listed in the stock exchange– a phenomenon, not
found in other emerging markets- affects the market badly and is considered a restraint on
the value of trade. It is worth mentioning that in 1997, the share of the Egyptian stock
market capitalization in the total emerging markets capitalization was nearly 1 percent,
while its share in the value traded was only 0.2 percent. (IFC Factbook, 1998).
ii- The average size of the listed companies is very small relative to other emerging
countries and to other markets in the rest of the world. As of end 1998, according to the
IFC world ranking, Egypt was number 72 with respect to the average companies’ size.
(IFC Fact book, 1999). Small sized companies cannot compete in the market, are not very
attractive to local and foreign investors, particularly institutional investors, and are unable
to issue shares in the international markets.
C.2.2. Market liquidity:
As shown in table (10), the value traded in the ESM, increased by an average annual
growth rate of about 68.2 percent. During 1994-98, the value traded increased at a rate
28
higher than that of capitalization and consequently the turnover ratio (value traded/
capitalization), increased from 18 percent to 28 percent. [In 1998, value traded and the
turnover ratio decreased for reasons that were detailed in section II.
Table (10)- ESM Liquidity.
1994
1995
1996
1997
1998
2557
3849
10968
24220
23363
17.7
14.0
22.8
34.2
28.1
Market
concentration**
n.a.
55.4
52.1
40.7
36.0
Concentration in
the IFCG index***
n.a.
n.a.
n.a.
29.8
21.0
Value traded by
Million LE.
Turnover ratio*
Notes: *Turnover ratio: is the value traded relative to the size of the market.
It measures the market liquidity A high turnover ratio means lower transaction costs.
**Market concentration is the share of the ten largest stocks in total value traded.
*** Market concentration the share of capitalization held by the ten largest stocks.
A decrease in the concentration ratio, means that the market is becoming more liquid
n.a.: not available. Source :Capital Market Authority , and IFC Fact book 1998, 1999 .
Despite this increase in the ESM turnover ratio, it is still lower than some other
emerging markets as shown in the figure below.
Figure (4)- Turnover ratios in selected emerging markets- 1998.
200,00%
Egypt
150,00%
Malaysia
Argentina
100,00%
Brazil
50,00%
China
Korea
0,00%
Turnover ratio
Source: IFC, 1999.
The concentration ratio of the value traded decreased from 55.4 percent in 1995, to 36
percent in 1998. (Capital Market Authority, 1999). Thus, the market is becoming relatively
more liquid. This ratio is less than in Latin American countries, but higher than in Asia.
According to the IFC, in 1998, the ten most active stocks in Argentina and Brazil
represented 89.3 percent, and 54.1 percent of the value traded in these countries,
respectively, , while in China, Korea and Malaysia, they reached 5.5, 24.1 and 31 percents,
respectively. (IFC Factbook 1999).
29
C.3. Return characteristics:
The degree of correlation between the Egyptian stock market and some selected
markets, and the properties of equity return, will be investigated.
- Degree of correlation:
Diversification benefits arise when lower risks are achieved for equivalent returns, or
higher returns are realized for equivalent risks. These diversification benefits are stronger
across international financial markets than within domestic markets.
The following figure (5), shows the degree of correlation between the Egyptian stock
market and some other markets.
Figure (5)- IFC Egyptian index correlations
[22-month period ending 12/98].
According to
0.5
0.4
0.3
IFCI composite
IFCI regional
U.S. S&P 500
UK. FT-ST 100
Japan Nikkei
FT. Europac
0.2
0.1
0
-0.1
-0.2
-0.3
Correlations
Source: IFC Factbook 1999.
figure (5), the
correlation between equity returns in
Egypt and other countries, using the IFC
index for these markets is very low. For
example, the correlation between the
Egyptian equity return and the U.S. S&P
500 is 0.33, and is lower than that
between other emerging markets and the
U.S. index.
(the correlation with
Argentina, Brazil, Chile and Malaysia, is
0.64, 0.47, 0.49, and 0.43, respectively).
This implies that foreign investors,
especially
American
investors
consider Egypt as a highly diversified
market. (IFC, October 1998).
- Properties of return:
Table (11) below, presents the main statistical properties of the Egyptian stock market
return, that are of particular interest to foreign investors, during the period of 1996- August
1999.
The return used here is the IFC Global Index (IFCG), as it is considered the base for all
other indexes employed by the IFC. In 1999, the IFCG includes about 66 companies
representing nearly 60 percent of the market capitalization.
The rate of return was so high in 1996 due to progress in the privatization program. This
high return, and its low correlation with equity returns in industrial markets, attracted
foreign investors to the Egyptian market. (Portfolio inflows to Egypt, reached $1.463
billion in 1996/97 up from $ 258 million in 1995/96).
Due to the high increase in equity return, the financial authorities, established a price
adjustment mechanism in February 1997. Trading may not exceed a five-percent price
band above and below the previous day’s close without the permission of the stock
exchange.
30
Any sharp increase in prices that does not depend on fundamentals will fall sharply
upon abrupt change in market conditions causing speculative bubbles. (El-Erian,M. and
Kumar, 1995).
Table (11)- Properties of ESM return 1
1996
1997
1998
As of August 1999
Average daily mean.
0.001
0.0006
-0.001
-0.00085
Average daily median.
0.00
0.00
-0.0002
-0.001
Annual volatility2
0.09
0.193
0.13
0.13
Annual rate of return 3
0.32
0.165
-0.35
-0.146
D.F. unit root test. 4
-28.12
-27.8
-27.07
-13.6
Sharpe ratio. 5
2.4
0.39
-3.3
-1.8
Skewness. 6
0.424
0.955
-0.084
1.3
Kurtosis. 7
4.69
8.77
5.779
8.7
P/E ratio.
11.3
11.5
8.7
Notes:
1-The stock market return is defined as (r t), where r = log (Pt/ Pt-1) and Pt is the daily
IFCG index at day t.
2-Annual volatility is the annualized average of the daily standard deviations of the
returns. The average daily standard deviation* number of days.
3-Annual rate of return is the sum of the continuously compounded log (Pt/ Pt-1).
4- D.F. unit root test during the whole period is significant at 99%. ( Enders, 1995).
5-Sharpe ratio is a measure of the risk-return trade-off. It is computed as (RR-RF) / σσ ,
where RR is the change in the index and represents return on assets which include risk,
and RF represents the return on risk free assets (Treasury Bills). (σ ) is the standard
deviation for RR. (Sharpe, 1966).
6-Skewness: The skewness of a symmetrical distribution, such as the normal distribution is
zero. If the upper tail of the distribution is thicker than the lower tail, skewness will be
positive and vice versa.
7-Kurtosis of a normal distribution is three, if the distribution has thicker tails than does
the normal, its kurtosis will exceed three.
Source: Own calculations.
Stock market prices declined in 1997 to 16.5 %, but they stayed high relative to those in
industrial countries. The rate of return declined dramatically in 1998, for the reasons
previously discussed in section II, then improved slightly during the first three-quarters of
1999, but stayed negative (– 0.146).
Since 1997, the sharpe-ratio started to decline. It fell to –3.3 in 1998, down from 2.4 in
1996. A negative sharpe ratio implies that there is no return versus risk.
Thus, net portfolio equity flows continued to decline till the second quarter of 1999 and
became negative (capital outflows).
The abnormal change of return is reflected in the following calculated indicators:
i- The volatility is relatively high and fluctuating.
ii- The statistical distribution of the change in return is positively skewed in 1996 and
1997, but negatively skewed in 1998.
31
iii- The kurtosis’ value is bigger than three so the distribution has thicker fatter tails than
the normal distribution.
iv- The unit root test strongly rejects the hypothesis of nonstationarity. This implies that
the market is inefficient, as there is time dependence in stock returns that may allow for
past information to be used to improve the predictability of future returns. The negative
correlation between current and past returns means that the variance of return will tend to
be higher following bad news than after good news. (for more details see, Mecagni, M. and
Shawky, 1999; and Moursi,T., 1999 that examined the behavior of stock returns and
market volatility in Egypt).
The inefficiency and volatility of the Egyptian stock market may be due to various
reasons:
i- Companies provide investors with little information.
ii- Companies are not subject to thorough investment research.
iii- A small market suffers some structural and institutional weaknesses causing
investors to have shorter horizons, and encouraging speculative bubbles, as observed from
the dramatic changes in market return.
Highly experienced foreign investors can realize benefits from these characteristics due
to their ability to predict the return. These foreign investors did affect the market
negatively especially during 1998 and 1999, and played a substantial role in maintaining
the drop in the Egyptian stock market values (IBTCI, February 1999).
So, there is a clear relation between the trend in return and the trend in foreign flows.
This conclusion emphasizes our previous finding that there is a causal relation between the
value traded by foreigners and the change in stock prices.
The previous analysis revealed that, although returns in industrial countries were
increasing over the period 1992-97, in comparison to the late eighties, yet Egypt started
receiving FPEFs, since 1993/94. Thus, these flows are mainly affected by: the fundamental
economic reforms the country has undertaken, the complete freedom enjoyed by foreigners
in the local market, the privatization program, and the improvements in the country’s
creditworthiness. In addition to the remarkable progress in the characteristics of the
Egyptian stock market, specially the infrastructure, size and liquidity. Moreover, the
Egyptian return has low correlation with returns in industrial countries.
The following table summarizes the main factors affecting foreign portfolio equity
flows to Egypt.
32
Table (12)- Main Factors Affecting FPEFs to Egypt.
Net FPI in
mill. $
year
Real GDP
growth
rate%
Annual
Average
Inflation%
Dollarization
Ratio (%)
Fiscal deficit
% of GDP
CapitaClearance
Turnover
ConcenReturn in
lization % of
and
ratio
tration Ratio
Egypt**
GDP
Settlement*
Sharpe
Ratio
Volatility
P/E Ratio
1993/1994
1.3
3.9
9.1
23.4
-2.1
59.9
0
13.95
-
17.7
8.3
n.a.
0
n.a.
n.a.
n.a.
n.a.
4.1
4.7
9.4
25.1
-1.2
54.8
0
11.1
-
14
13.4
n.a.
0
n.a.
n.a.
n.a.
n.a.
1995/1996
257.6
5
7.3
22.9
-1.3
45.9
0
10.4
-
22
21
55.4
0
n.a.
n.a.
n.a.
n.a.
1996/1997
1462.9
5.3
6.2
19.4
-0.9
38.1
20
10.4
stable
34.2
27.7
52.1
1
32%
2.42
0.09
11.3
-248
5.7
3.8
17.9
-1
34
13
9.9
stable
22.3
29.9
40.7
1
16.50%
0.39
0.193
11.5
1
-35%
-3.3
0.13
8.7
1998/1999
-197.2
6
3.8
17.3
-1.3
31.4
6
9
stable
23.5
31.4
36
*- (0) indicates no MCSCD, while (1) means MCSCD was established.- **- US S&P 500 = 18.01 during 1996- 1999, (IFC, 1999 & W.B., 1998).
2000
1500
1000
500
0
-500
8
6
4
2
0
1994/1995
1995/1996
1996/1997
Real GDP grouth rate%
1997/1998
0
-0.5
-1
-1.5
20
10
0
1994/1995
1995/1996
Dollarization Ratio
1996/1997
(%)
1997/1998
0
1997/1998
0
1994/1995
1995/1996
1996/1997
3
2
0.15
1000
1
500
0
-1
1997/1998
Capit alization % of GDP
1998/1999
2000
0.2
1500
1996/1997
1997/1998
1998/1999
500
0
-3
Srarpe Ratio
Net FPI in mill. $
33
1000
0
-0.2
1993/1994 1994/19951995/1996 1996/1997 1997/19981998/1999
-500
500
0
-500
Return
-2
-4
0.4
Net FPI in mill. $
1000
1995/1996
Net FPI in mill. $
-0.4
1500
1994/1995
2000
1500
1000
500
0
-500
1993/19941994/19951995/19961996/19971997/19981998/1999
2000
1993/1994
Net FPI in mill. $
40
30
20
10
0
1998/1999
2000
1500
1000
500
0
-500
1993/1994
1993/1994 1994/19951995/1996 1996/1997 1997/19981998/1999
Net FPI in mill. $
5
1500
Net FPI in mill. $
1996/1997
10
2000
Volatility
1995/1996
15
0.2
1993/1994 1994/1995 1995/1996 1996/1997 1997/1998 1998/1999
1994/1995
500
0
-500
Turnover
20
external debt % of GDP
2000
1500
1000
0
Net FPI in mill. $
Interest rate
-500
10
40
0.25
0
20
500
2000
1500
1000
500
0
-500
1993/1994
0
1000
60
Net FPI in mill. $
0.05
30
80
1998/1999
0.1
40
1500
-500
Net FPI in mill. $
2000
1500
1000
500
0
-500
2000
0
Fiscal deficit % of GDP
1993/1994 1994/1995 1995/1996 1996/1997 1997/1998 1998/1999
30
1996/1997 1997/1998 1998/1999
-2.5
2000
1500
1000
500
0
-500
Annual Average Inflation%
1993/1994 1994/1995 1995/1996
-2
1998/1999
Net FPI in mill. $
10
8
6
4
2
0
1993/1994
Majority
Privatized
Sovereign
companies Interest rate
Rating
public
offering
1994/1995
1997/1998
1993/1994
external
debt %
of GDP
Net FPI in mill. $
2000
1500
1000
500
0
-500
25
20
15
10
5
0
1993/1994 1994/1995 1995/1996 1996/1997 1997/1998 1998/1999
Majority Privatized companies public offering
Net FPI in mill. $
IV- Egypt’s financial integration: Opportunities and Challenges:
With the important potential benefits provided by foreign portfolio equity investment
flows for Egypt, have come tough challenges. This type of flow, subjects Egypt to more
sources of external disturbances, increases the speed at which these disturbances may be
transmitted, and makes the country more susceptible to external shocks. Foreign investors
have become very important in direct trading activity, and their value traded causes
changes in stock prices. Foreigners are increasing the likelihood or magnitude of market
bubbles, with securities prices rising far above the underlying fundamentals, which may be
followed by a market crash. These risks raise serious concerns particularly that our results
showed also that the market suffers from inefficiency and some weaknesses. Increasing
foreign ownership of domestic firms, may be another concern.
It has been shown, that the risk of volatile flows, varies according to the type of investor
and instrument. The most suitable types according to the Egyptian stock market stage of
development are not yet fully utilized, and some are non-existent.
Egypt needs to take full advantage of the substantial opportunities offered by the least
volatile types of foreign investors and instruments, and minimize the potential risks of the
other more volatile types, whose likely reversal will have adverse consequences on the
volatility of domestic asset prices and returns.
Although the improvements in the Egyptian stock market have been remarkable, yet the
market is still in its early stages of development. Egypt needs to enhance the reliability of
the system to settle transactions, to reduce principal risk and the opportunity cost of a
delay. Investors demand reliable systems that record ownership, ensure safe custody of
securities, and protect property rights. They want a reliable system that ensures disclosure
of material information to evaluate investment choices. Also, enhancing the liquidity of the
Egyptian stock market, is desired to enable investors to liquidate securities or change the
composition of their portfolios without incurring high costs.
Egypt should develop the institutional and policy requisites to attract a higher level of
portfolio equity flows, encouraging the least volatile types which Egypt has not yet utilized
and reduce the risks of instability.
The following chart shows the main factors that enable Egypt to maximize benefits
from foreign portfolio equity flows and to minimize their potential risks:
Figure (6)- Maximizing the Benefits and Minimizing the Risks.
Strengthening
the
market infrastructure
and the regulatory
Macroeconomic
stability
Maximizing Benefits ..
Minimizing Risks.
Promote local
and
foreign
institutional
investors
Choose the
least volatile
i t
t
34
Following is a discussion of these main factors:
1-Macroeconomic stability: Commitment to achieve and maintain macroeconomic
stability is a prerequisite to attract foreign flows and enables the country to face any
potential risk that may be caused by the volatile types of these flows.
FPEI flows to Egypt are mainly affected by the fundamental economic reforms the
country has undertaken, including the privatization efforts, the improvements in the
country’s creditworthiness and the remarkable progress in the characteristics of the
Egyptian stock market. In addition to the complete freedom enjoyed by foreigners in the
local market and the low correlation between equity returns in Egypt and other countries.
2-Institutional investors: They are particularly important for the Egyptian stock market,
and offer fundamental advantages. These investors provide a potential source of large and
more stable funds. They dominate investment in private equity funds and in venture capital
funds, two of the least volatile types of flows. Also, institutional investors are often
prepared to accept less liquidity than retail investors.
If a growing share of foreign portfolio equity investment is accounted for by
institutional investors, this could magnify the positive impact on liquidity, since
institutional investors are very active traders (Samuel,1996).
Improved liquidity in the domestic market, will lower the investors’ demand for higher
yields, reflecting their ability to sell securities at decreasing costs, and the cost of capital
will decline. The declining cost of capital and the enhanced risk diversification should
induce the corporate sector to issue initial public offerings and additional shares. Also, as
liquidity improves, new domestic investors will be attracted to the market.
3-Encouraging the least volatile portfolio equity instruments:
The characteristics of each type of foreign portfolio equity investment instruments
reveal that the volatility of FPEI flows may vary with the type of mechanism through
which an investment is made. Some mechanisms are more suitable to the stage of
development of the Egyptian emerging market than others.
-Foreign direct equity purchases in the domestic stock markets:
Egypt approached liberalization, first by allowing foreigners complete freedom in
trading directly in its securities markets. Foreign direct equity purchases in the stock
exchange, are mainly short-term transactions, which encourage destabilizing price
speculations, and adversely affect the market price level.
Granger-causality test showed that trading by foreigners in the Egyptian stock market
causes changes in each of the publicly traded securities index and the IFCG index, and has
a clear effect on the Egyptian stock market price volatility.
It is worth mentioning that complete openness of a country’s securities market for
foreigners should come after appropriate regulatory structures are in place and suitable
corporate governance levels.
Various emerging countries in their first stages of financial integration, opened their
securities markets first through the establishment of country funds and/or GDRs’ issues.
When their domestic stock markets were more prepared to receive direct foreign portfolio
investments, foreigners were allowed to trade directly.
35
The emerging markets shown in the table below followed this sequence of
liberalization.
Table (12)- Market liberalization dates for some emerging markets.
Country
Liberalization
Country fund date
for
establishment
foreigners’ direct
trading.
Depositary
receipts issuance
Korea *
Indonesia
Philippines
Thailand
Brazil
Chile
Mexico
Turkey
India
1990
1991
1991
n.a.
1992
1990
1989
n.a.
1992
1984
1989
1987
1986
1987
1989
1991
1989
1986
1992
1989
1991
1987
1991
1990
1989
1989
1992
*Until 1992, foreigners could only buy Korean equities through country funds. (IFC, 1996, p.4).
Sources: 1-IFC, 1996; 2-Korean Stock exchange, 1996, p.70; 3-Egyptian Ministry of Economy and
Foreign Trade, 1999, p. 4.
Thus, direct equity purchases by foreign investors in the local stock exchange seem to
be the most volatile form of FPEI, particularly when retail investors manage them.
In order to mitigate the price volatility that may be caused by high turn-over foreign
investments, Egypt should:
a-Develop a strong domestic institutional investor base. Such investors will be able to
mobilize significant amount of resources, increase liquidity in domestic capital markets,
and thereby serve as a counterweight to foreign investors. They also reduce the
vulnerability of domestic capital markets in the event of a rapid liquidation of assets by
foreign investors. Active domestic institutional investors, by increasing depth and liquidity
in domestic markets, would reduce the sensitivity of domestic markets to small trades.
Also, they benefit domestic savers by reducing transaction costs and facilitating portfolio
diversification.
Developing a domestic institutional investor base, requires reforming and expanding the
legal and regulatory framework, in particular in the area of investor protection.
b-Encourage foreigners to keep Egyptian securities for a longer time period. It may be
useful to follow the American system, which imposes 30% taxes on mutual fund profits, if
they arise from securities that are not kept for at least three months.
c-Attract venture capital funds. The investment horizon of these funds tends to be somewhat
longer than that for other types of FPEI instruments and less volatile. A two-tiered venture
capital fund with limited life and a common goal for shareholders seems more suitable for
new unquoted Egyptian companies to encourage them to grow and go for an initial public
offering. The two-tiered structure, will also enable investors to control the manager’s
performance and the fund’s strategy, in addition to lowering management costs. Moreover,
the various types of finance provided by a venture capital fund (start-up, seed capital,
expansion, replacement, ..) are suitable for different developmental phases, for small and
medium enterprises, and those that are applying privatization programs.
36
In 1996, the IFC reported that Egypt has one foreign venture capital fund, with no
further details. Consulting various local sources, no information was provided concerning
this mentioned fund. This reflects the unawareness with the potential benefits of this
important instrument, which other emerging markets have largely made use of in their
early liberalization stages.
Attracting venture capital funds requires positive macroeconomic conditions, an active
and liquid capital market, and a transparent legal system.
d-Establish more closed-end diversified country funds and private-equity funds. Egypt
has seven offshore funds. Five of these funds are closed-ended. These are few funds, if
compared to other emerging markets, and considering their potential advantages.
Closed-end diversified country funds offer significant benefits. They are not required to
meet redemption requests, and therefore, they are less likely to contribute to market
volatility, and more likely to take a longer-term view. They usually pose no threat to the
control of domestically owned private firms. These funds may also participate in local
training programs, with positive effects on human development. Country fund managers
also press for growth of local credit-rating agencies.
The establishment of more country funds, and other specialized funds such as privateequity funds, should be encouraged. They require improvements in stock market size and
liquidity, and in disclosure and accounting standards. In addition to, high standards of
custody, clearing and settlement, and regulatory oversight.
e-Issue more depositary receipts. During 1996-July 1999, eight Egyptian companies
issued GDRs, representing four sectors only, whose value is very small, compared to other
developing countries.
Global depositary receipts have a positive effect on the efficiency of the domestic stock
market price, through the arbitrage process, which reduces the volatility of the issuing
companies’ share prices. Issuing GDRs may enable the Egyptian government to offer a
large number of public companies’ shares, and attract foreign investors, especially that the
size of the local market is relatively small.
Egyptian companies tend to be small with modest financial resources and low
international visibility. It is difficult for small capitalization Egyptian companies to issue
depositary receipts, because they must meet the partial or full reporting requirements, for
listing abroad, and other specific minimum requirements with respect to the size of total
assets, earnings and /or shareholders equity.
Thus, mergers between Egyptian companies operating in the same field of activity
should be encouraged. In addition to improving the disclosure, accounting and auditing
standards. All this will enable them, to meet developed markets’ requirements for listing,
or publicly offer their securities in the international stock markets, particularly that the IFC
ranked the Egyptian market as number 71, within emerging markets, with respect to
companies’ size. {Mexico, Taiwan, Brazil, and Chile, were ranked as numbers 12,14,20
and 36, respectively}. [IFC, 1998].
f-Create quasi-equity instruments; such as convertible bonds, and bonds with equity
warrants. These instruments have not yet been developed in Egypt. The creation of these
tools, may lead to a more balanced mix of debt and equity, that might attract more
investors, especially institutional investors and increase the liquidity of the market.
37
Moreover, the issuing company will be able to apply a larger amount of financing towards
expansion of the company or towards general operating expenses, as the interest payments
on these bonds, are lower than those on straight bonds.
Developing the local bond market, is required. Issuing companies should provide
attractive dividends and interest rates compatible with those on banking deposits, taking
into consideration that bonds are relatively less liquid than deposits.
4-Strengthening the market infrastructure and the regulatory framework:
Among the most important domestic factors that affect foreign investors decision to
invest in Egypt are the degree of reliability of the stock market’s infrastructure and the
effectiveness of the regulatory framework. Strengthening these two areas, will help in:
1-Attracting more foreign portfolio equity inflows and institutional investors.
2-Enhancing the efficient use of some suitable types (depositary receipts, country funds,
venture-capital funds,..), creating new types (bonds), and reducing the risks of all types
particularly foreign direct trading.
a-The settlement, clearance, and depository systems:
To accelerate the settlement flow, a good matching system should work quickly. Trade
matches between direct market participants should be accomplished in the same day of the
trade (T+0).
The rolling settlement system used in Egypt, has the advantage of effectively limiting
the number of outstanding clearances and reducing the time between trade and settlement
dates. It is recommended that the rolling settlement system have final settlement occur by
T+3. However, efficiency and reliability rather than speed of settlement should be the
primary objectives. (International Organization of Securities Commission, 1992b).
To concentrate settlement risks, the central clearing agency should:
1-Set stringent standards for membership, at least during the transition period, until
other risk reduction systems are in place and domestic investment firms become financially
stronger. However, due to inadequate information and weak disclosure standards, it may be
difficult to develop a comprehensive picture of the agency’s members.
2-Limit its net exposure to each participant and require collateral for some types of
exposure.
3-Develop a risk control system that timely reveals the exposure of its members.
4-Design procedures so that participants themselves have more of an incentive to
manage and contain the risks they bear. For example, loss-sharing rules among participants
in the event of a default could be established.
5- Have quick access to sufficient liquidity and be adequately capitalized.
6-Have branches in the main Egyptian governorates, or expand its activities in
cooperation with the banking sector.
It is worth mentioning that a settlement guarantee fund was established in Egypt, in the
second half of 1999, but has not come into force yet. Imposing penalties should discourage
resorting to this fund.
38
For the central depository to be cost-effective, firms’ participation should be
encouraged. More book-keeping companies should be established to cover the country.
Securities lending and borrowing should be encouraged as a quick method for the
settlement of securities transactions.
b-The regulatory framework should carefully balance between investor protection and
safety on the one hand, and market development or liquidity on the other.
*Disclosure: Among the most critical functions of a regulatory framework is to increase
transparency in the market by mandating public disclosure for all material information on a
timely basis, such as the disclosure of developments that may have an effect on the
company’s business or the stock price. Public disclosure is required both at the initial
phase, when a firm issues securities to the public, and continuously thereafter. Improving
disclosure will address investor concerns and will also reduce market volatility resulting
from asymmetric information.
The Egyptian Capital Market Authority should strictly apply its legal right in delisting
the companies that do not comply with the disclosure requirements, after three months
notification.
There are three types of disclosure requirements:
i-Listing requirements: These are particularly important for the Egyptian stock market
for two main reasons. First, because of lack of experience and financial expertise, investors
may not be able to judge the relative merits of alternative investments. Second, bad
performance of a listed firm causes negative externalities resulting from investors losing
confidence in the market.
The disclosure requirements for a firm to list in a securities market or trade publicly,
should include: minimum requirements regarding the number of shareholders and the value
and volume of public shares, earnings, balance sheet criteria over a number of years; an
assessment of the potential of the firm and industry it belongs to; qualitative criteria
regarding corporate governance; ...etc. There should also be continuing listing or
maintenance requirements.
For Egypt, if listing requirements are too stringent, few firms will be able to list and the
market will not be liquid. To solve this dilemma, the market could be segregated into more
than one section, with each section differing in its listing requirements. For example, the
distinguished companies that are compatible with the listing requirements for the
international issues will be in the first section while other firms with less established track
records could be listed in a special, perhaps over-the–counter market. The listing
requirements should consider the size of the company and the percentage of its shares
being offered to the public.
ii-Initial offering requirements: The disclosure mandated for a firm to issue new
securities, is of two types:
-information that allows investors to evaluate the overall condition of the firm issuing
the securities, including risk factors and prior performance.
–more specific information about the new issue: amount of capital to be raised and its
intended purpose, how the offering price was determined,..etc.
39
iii-Accounting standards: In order to be at par with international practice, joint stock
companies must prepare their accounts based on International Accounting Standards. This
is essential for investors to be able to evaluate the financial performance of a company.
Egyptian-auditing standards and practices need further improvement to ensure the
reliability of disclosed information.
*Insider trading should be prohibited: In 1998, insider trading was reported as one of
the main reasons behind the sharp decline in the Egyptian stock market index. Thus, Egypt
should try to eliminate insider trading. First, by defining what information is considered
illegitimate, (usually all facts that can have an impact on a company’s business and the
performance of its stock), who is subject to insider trading rules, the reporting
requirements for insiders, and what types of companies are subject to these rules. In some
countries, owners of more than a specific amount of a certain stock are considered insiders
and are required to file reports on their trading activities. Insider legislation also defines
insiders’ responsibilities. Second by imposing civil, administrative and criminal sanctions.
(World Bank, 1997).
*Self-regulatory organizations (SROs): Drawing from other countries experiences, it
was found that competing financial intermediaries in the stock market do have the
incentive to monitor one another, to develop fair and efficient markets. Market participants
are more able than the government to formulate good rules and procedures, and to keep
them current with new technology and industry practices. They will be better able to
monitor compliance, especially that self-imposed rules are usually better accepted than
rules mandated from the outside.
Applying this model in Egypt, will reduce the Egyptian Capital Market Authority’s
surveillance burdens, and increases its efficiency. However, care should be taken as the
ESM is still in the early stages of development, with limited competition, insufficient
institutions, human capital, disclosure and accounting standards, such that self-regulation
may not be enough to ensure fair and efficient markets. Thus, regulatory responsibilities
can be transferred first to the exchanges, clearinghouse, and depositories, since they would
be better able and more willing to develop and monitor rules of conduct. (Chuppe, and
Atkin, 1992).
V-Main Conclusions :
As concessional foreign credit flows to Egypt diminish, the country will have to find
alternative sources of finance for its investment. The present domestic saving levels, less
than 15 per cent of GDP, are far too low to allow Egypt to grow at 5 per cent per year,
which, besides the need to increase domestic savings, suggests an important role for
foreign investment in the country. One type of this investment takes the form of equity
portfolios, the subject of this paper.
As pointed out in the introduction, foreign equity portfolio flows provide a number of
very important benefits to the country, but they might also have, if not appropriately
regulated, very significant costs. The trick is therefore to implement policies and
regulations which maximize the benefits and minimize the costs, of foreign equity
portfolio investments. In the paper the list of benefits and costs of these investments have
been derived from the international literature on the subject, from the comparative analysis
40
of the characteristics of the different available investment instruments and from empirical
work on some aspects of the behavior of the Egyptian stock exchanges.
The paper suggests ways of maximizing the benefits and minimizing the costs of the
foreign equity portfolio investments through policies and market friendly regulations
which (i) provide macroeconomic stability, (ii) generate incentives to use the least volatile
of the existing portfolio investment instruments, (iii) promote the use of institutional
investors instead of individual investors and (iv) strengthen the existing market
infrastructure.
Of all the suggested measures, the significance of macroeconomic stability can never be
sufficiently stressed. As shown in the paper, equity portfolio investments are extremely
mobile, macroeconomic instability invites speculation and, as experience shows, it is hard
to find a practical way in which governments can prevent capital flows to move in and out
of countries. The paper, given its financial focus, does not discuss the necessary recipes to
achieve macroeconomic stability, but they are at this point in time relatively well known,
although very difficult to implement in practice.
The volatility of these portfolio investment flows can be further reduced by providing
incentives to use more of those investment instruments which are less volatile. In this
respect the paper suggests an optimum order of opening-up the economy to portfolio
investments, first country funds and GDRs and only thereafter direct investments, order
which was not followed by Egypt. At this stage it would, however, not be advisable to turn
back and therefore alternative means of achieving a similar end are proposed in Section III
of the paper. In particular, taxes and tax-exemptions can be used to induce a preference for
longer term investments in general, for venture capital investments, country funds, GDRs,
and convertible bonds, in particular, until the necessary institutions to handle direct equity
portfolio investments have fully developed.
The paper stresses the advantage of institutional investors over individual investors,
since the former are more likely to provide stability to the market, given that they have
more expertise and information . Therefore it proposes to use the regulatory framework to
develop capital market institutions, especially in the area of investor protection.
A final, but related and also important concern of the paper, is the regulatory
framework, which should balance carefully investor protection and safety, on the one hand,
and market development and liquidity on the other, as way to reduce the destabilizing
effects of equity portfolio investments. In this respect, the paper addresses needed reforms
in the areas of disclosure, insider trading and regulatory organizations. As is the case with
most measures proposed in the paper, these regulatory reforms are not only important to
increase the net benefits of foreign equity portfolio flows, but they will also contribute to
the improvement of the workings of the whole Egyptian capital market.
41
Appendix (1)- Review of the recent literature on the determinants of FPE flows:
summary findings.
A- The cyclical downturn in industrial countries and the associated decline in global
interest rates were the main factors driving private flows to developing countries: (A reversal
of favorable global conditions could induce a capital outflow from these countries).
Study
conducted
Main findings:
by:
1-Calvo, Leiderman
and Reinhart (1993).
Investigated whether private capital flows to ten Latin American
countries, for the period January 1988 to July 1991 were driven
primarily by cyclical factors in the international economy [particularly,
U.S. interest rates, the U.S. recession and the slowdown in U.S.
industrial production], or by improvements in these countries’
economic fundamentals.
Taking international reserves and the real exchange rate as proxies
for private capital flows, they analyzed the degree of co-movement in
these variables using principal component analysis. They found that:
* there was a significant co-movement among countries’ foreign
reserves and among their real exchange rates, and that the degree of comovement increased in 1990-1991, compared with 1988-1989.
* the first principal component of both reserves and the real
exchange rate exhibited a large bivariate correlation with several U.S.
financial variables, including interest rates.
This suggested that the main factor driving private flows to Latin
America was the cyclical downturn in industrial countries and the
associated decline in global interest rates.
2-Fernandez-Arias,
(1994).
Fernandez-Arias argued that some studies like that conducted by
Chuhan, Claessens and Mamingi, (1993), may have overstated the
proportion that could be attributed to improvements in domestic
fundamentals, because it considered country creditworthiness as being
solely determined by improvements in the domestic economy, whereas,
in reality, global interest rates also affect country creditworthiness.
By decomposing the improvements in creditworthiness into those
arising from the decline in global interest rates and those arising from
improvements in the domestic environment, Fernandez-Arias found
that global interest rates accounted for around 86% of the increase in
portfolio flows for the “average” emerging market during the period
1989-1993.
3-Frankel
Okongwu (1996).
and
In an analysis of the determinants of portfolio capital flows in nine
Latin American and East Asian countries (Argentina, Chile, Mexico,
the Philippines, Korea and Taiwan) using quarterly data covering the
period 1987-94, found that U.S. interest rates had a major influence on
these flows.
42
B- Country-specific factors: improvements in countries’ economic fundamentals allow
investors to achieve higher returns and offers them opportunities for risk diversification.
Study
conducted
Main findings:
by:
4-Chuhan,Claessens
and Mamingi, (1993).
Using panel data for 1988-1992, they found that improvements in
countries’ economic fundamentals- the country credit rating, secondary
bond prices, the price-earnings ratio in domestic stock markets and the
black market premium- were as important as cyclical factors in
attracting portfolio flows to Latin America. Domestic factors,
moreover, were three to four times more important in explaining
capital inflows to Asia.
5-Gooptu,S., (1994).
Examined econometrically whether portfolio investment
flows to one region in the developing world were
significantly related to those that went to another region.
An inverse relationship between total portfolio flows to
emerging Asian stock markets and those to Latin America
was found. This result indicated that developing countries
must compete for portfolio flows and that increasing the
pace of reform is essential for an emerging market to be
able to sustain this type of flows.
6-Hernandez
Rudolph, (1995).
and
A panel regression of total private long-term capital
flows/GNP, was run on total investment/GNP, private
consumption/GNP (as private investors may consider
private savings to be a sign of confidence in a country’s
prospects), the stock of total external debt minus
international reserves/GNP, volatility of the real effective
exchange rate, a dummy for the successful completion of a
Brady deal, real export growth, the 12-month U.S. treasury
bond rate and a dummy for U.S. interest rates, during
1990-1993.
The results showed that countries with strong economic
fundamentals have received the largest proportion of private flows
relative to the size of their economies. When foreign direct investment
was excluded, the downturn in U.S. interest rates during 1990-1993,
was a significant factor in explaining flows to developing countries,
although domestic economic factors were also important. [foreign
direct investment may be more sensitive to domestic factors than the
more-liquid portfolio flows].
7-Motaal (1995).
Examined the determinants of capital movements in some MiddleEastern countries (including, Jordan, Egypt, Morocco, and Tunisia) and
Asian countries (Bangladesh, India, Pakistan, and Sri Lanka).
His analysis suggested that external factors (reductions in world
interest rates) played a less important role in the increase in capital
inflows to these countries; more important were internal factors (the
momentum for reform), which led to improvements in the longer-term
economic prospects of these countries.
43
8-UNCTAD (1997).
A survey of international emerging market equity fund
managers was conducted by UNCTAD in January 1997, in
order to determine what elements they considered to be
most important in making investment decisions at the
country level. The survey found that the potential rate of
economic growth was identified most frequently as being
highly important in investment decisions. Market size can
have an indirect influence because larger markets tend to
have better developed capital markets, greater market
capitalization, higher degree of liquidity and a wider array
of investment opportunities. In less-developed emerging
markets in which total capitalization is especially small,
market size may become a constraint on foreign portfolio
equity investment by some large institutional investors that
tend to invest in large blocks. The degree of volatility of
exchange rates and political stability are also important
considerations. The overriding motivation for foreign
portfolio equity investors is their participation in the
earnings of local enterprises through capital gains and
dividends. Hence, it is more important for them that capital
be easily transferable and that disclosure standards be high.
Thus, the level of ease of capital repatriation and disclosure
standards for companies operating in the local market
appear to be very important.
Other factors frequently identified as being important
include the existence of a good settlement system, the
comprehensiveness of securities market regulation, the
degree of securities market liquidity.
More mature markets also tend to offer a superior level
of regulation regarding information-disclosure and
accounting standards.
44
9-World
(1997).
Bank,
Explored the influence of global interest rates on
portfolio flows in particular. It analyzed the extent to which
portfolio flows from U.S. to twelve emerging markets in
Latin America and East Asia moved together and the
degree to which this co-movement was related to U.S.
interest movements.
Co-movement in flows was measured by the first
principal component of the flows. The analysis was done
for countries in each region separately and then in
aggregate.
The results showed that there was a high degree of comovement in flows during 1990-1993, for both regions and
that this co-movement was related to movements in U.S.
interest rates. This supports the hypothesis that U.S.
interest rates played an important role in driving portfolio
flows during 1990-1993.
However, since 1993, there has been a decline in the co-movement
of portfolio flows to both regions, especially for East Asia, suggesting
that country-specific factors are becoming more important.
10-Taylor,
Sarno, (1997).
and
Examined the determinants of U.S. capital flows directed to nine
Latin American and nine Asian countries over 1988-92. In particular,
they investigated whether bond and equity inflows were induced by
push or pull factors, differentiating between short- and long-run
determinants.
The authors, considered in their set of country-specific factors the
domestic credit rating and the black market exchange rate premium as
well as a set of global factors including two U.S. interest rates and the
level of U.S. real industrial production.
They examined the long-run determinants of portfolio flows by
employing two complementary cointegration techniques.
The results provide unequivocal evidence that:
* long-run equity and bond flows are about equally sensitive to
global and country-specific factors and, therefore, that both sets of
variables help to explain U.S. portfolio flows to the developing
countries considered.
* Both push and pull factors seem to be equally important in
determining short-run equity flows for Asian and Latin American
countries.
* When bond flows were considered, however, global factors seem
to be much more important than domestic factors in explaining the
short-run dynamics of flows. In particular, changes in U.S. interest
rates are found to be the single most important determinant of short-run
movements in bond flows to developing countries.
C- Diversification benefits from investing in emerging markets.
Study
conducted
Main findings:
by:
45
11-Divecha, Drach
and Stefak, (1992);
12-Harvey,
and (1995).
(1993),
* Examined the risk-return trade-off from emerging market
portfolio investments.
* Only a handful of emerging markets were found to have
significant exposure to five global risk factors (the world market equity
return, the return on foreign currency index, the change in oil price, the
growth in world production and the world inflation rate). Thus, many
emerging markets are not well integrated into the global economy.
The results showed that developing countries’ stock returns tend to
have low correlation with those of industrial countries. This low
correlation should reduce the volatility of portfolio flows in emerging
markets.
It was concluded that there are significant diversification benefits
from investing in emerging markets relative to asset portfolios that
focus solely on industrial country securities.
D- The removal of barriers by industrial and developing countries on foreign
participation in developing countries’ securities markets:
Study
conducted
Main findings:
by:
13-Claessens
Rhee, (1994).
and
14-Bekaert, (1995).
15-Claessens
Glen, (1995).
Several barriers to portfolio equity flows in recipient countries were
identified. By relating these barriers to various measures of market
integration, it was found that the most effective barriers were:
macroeconomic instability, poor credit rating, high and variable
inflation, lack of a high-quality regulatory and accounting framework
and the limited size of the domestic stock market.
and
16-Daveri, (1995).
Showed that the removal of barriers by industrial and developing
countries on foreign participation in developing countries’ securities
markets has been a significant factor that has contributed to this surge
of private capital flows to the emerging markets. These measures
include, the removal of restrictions on foreign ownership, liberalization
of capital transactions, improved general accounting principles,
addressing the financial securities clearing and custodial problems and
enhanced disclosure requirements by securities issuers.
Found that some emerging markets function inefficiently due to
“insider trading”. These markets will be stacked against outsiders and
will be less likely to attract new investors.
Using a model with partial irreversibility of investment derives a
negative relationship between foreign investment and costs of entry
and exit from financial markets.
Appendix no.2
Listing requirements in selected emerging markets.
Emerging
market:
Korea (*)
Requirements
Korea’s stock exchange is divided into two trading sections. The
main requirements for the first section are:
*Paid-in capital for the last business year must be five billion
won or more.
*The ratio of net profit to capital, must be 10% at least, for the
46
last three business years.
*The firm’s debt ratio must be less than the average debt ratio
for the relevant industry, for the last three business years.
The Korean stock exchange authority, evaluates the last annual
business report of all the listed companies to determine whether
they meet the requirements needed to assign for the first section, or
not.
Companies that can not meet the requirements for section one
and the newly listed stocks are automatically assigned to the second
trading section for at least one year. [http://www.
Kse.or.kr/operate/sm.htm].
Argentina
The stock exchange is divided into a special section and a
general section.
Shares listed in the special section are for companies having:
*a capital of over $60 million, and sales or service revenues in
excess of $100 million.
*1000 stockholders, that are not related together by agreements
concerning the governance or management of the company.
*The par value of listed securities should be higher than $60
million.
Companies not fulfilling the above-mentioned requirements are
included in the general section.
http:www.bcba.sba.com.ar/bolsa/requi.cot.ing.htm.
Malaysia
1- The main board listing requirements are:
*Minimum paid-up capital is RM 50 million, comprising
ordinary shares of RM 1 each.
*Profit track record for the last three financial years.
*After tax profit of not less than RM 4 million per annum.
*Aggregate after tax profit of no less than RM 25 million, over
the last three financial years.
2- The second board listing requirements are essentially the
same as those of the Main Board, but differ in the amount of capital
and profits. For example, the profit track record needed here is for
five financial years with an after tax profit of not less than RM 2
million per annum.
Sources: Korea: [http://www. Kse.or.kr/operate/sm.htm].
Argentina: [http:www.bcba.sba.com.ar/bolsa/requi.cot.ing.htm].
Malaysia:
47
References
Arab Monetary Fund, Data base of Arab Financial Markets, various issues.
Barry, et.al., 1990, “The role of venture capital in the creation of public companies,
evidence from the going-public process”, Journal of Financial Economics, vol. 27 (2).
Bekaert, G., 1995, “Market Integration and Investment Barriers in Emerging Markets”,
The World Bank Economic Review 9 (1).
Burki, Shahid Javid, and Guillermo E. Perry, 1997, The Long March- A Reform
Agenda for Latin America and the Caribbean in the Next Decade, World Bank Latin
American and Caribbean Studies, World Bank, Washington, D.C.
Cairo and Alexandria Stock Exchanges, Monthly Bulletin, various issues.
Calvo, Guillermo A., Leonardo Leiderman, and Carmen M. Reinhart, 1993, ”Capital
Inflows and the Real Exchange rate Appreciation in Latin America: The Role of External
Factors.” IMF Staff Papers 40(1):108-51.
_____, 1996, “Inflows of Capital to Developing Countries in the 1990s.” Journal of
Economic Perspectives 10(2):123-39.
Central Bank of Egypt, Annual Reports. (1991/92-1995/96).
Central Bank of Egypt, Monthly Bulletin, various issues.
Chuhan, Peter, Stijn Claessens, and Nandu Mamingi, 1993, “Equity and Bond Flows to
Asia and Latin America: The Role of Global and Country Factors”, World Bank Policy
Research Working Paper, no. 1160, July.
Chuppe, T., and Aitken, M., 1992, “Regulations of Securities Markets, Some Recent
Trends and their Implications for Emerging Markets”, World Bank Policy Research
Working Paper, no. 829.
Claessens, Stijn and Moon Whoan Rhee, 1994, “The Effect of Barriers to Equity
Investment in Developing Countries”, in Jeffrey A. Frankel (1994) ed., The
Internationalization of Equity Markets, NBER Project Report, Chicago: University of
Chicago Press: 231-76.
Claessens, Stijn and Sudarshan Gooptu, 1994, “Portfolio Investment in Developing
Countries”. World Bank Discussion Paper, no. 228, Washington, D.C.
Claessens, Stijn, 1995, “The Emergence of Equity Investment in Developing Countries:
An Overview”. The World Bank Economic Review 9 (1):1-18.
Claessens, Stijn, 1995, “Equity Portfolio Investment in Developing Countries, A
Literature Survey”, World Bank Policy Research Working Paper, no. 1089.
Claessens, Stijn, Michael P. Dooley, and Andrew Warner, 1995, “Portfolio Capital
Flows: Hot or Cold?” The World Bank Economic Review 9 (1): 153-74.
Chuhan, P., 19954, “Are institutional investors an important source of portfolio
investment in emerging markets”, World Bank Policy Research Working Paper, no. 1243.
Chuhan, P., and Claessens, S., 1993, “ Equity and Bond Flows to Asia and Latin
America”, World Bank Policy Research Working Paper, no.1160.
48
Corbo Vittorio and Leonardo Hernandez, 1994a, “Macroeconomic Adjustment to
Capital Inflows: Latin American Style versus East Asian Style”. World Bank Research
Working Paper, no. 1377.
_______, 1994b, “Macroeconomic Adjustment to Portfolio Capital Inflows: Rationale
and Some Recent Experiences”, in Stijn Claessens, and Sudarshan Gooptu, (1994), “
Portfolio Investment in Developing Countries”, World Bank Discussion Paper, no. 228.
_______, 1996, “Macroeconomic Adjustment to Capital Inflows: Lessons from Recent
Latin American and East Asian Experience”, The World Bank Research Observer. 11(1):
61-85.
Daveri, Francesco, 1995, ”Costs of Entry and Exit from Financial Markets and Capital
Flows to Developing Countries.” World Development 23(8):1375-85.
Divecha, Arjun, Jaime Drach, and Dan Stefak, 1992, “Emerging Markets: A
Quantitative Perspective “, Journal of Portfolio Management 19:41-50.
Dooley, Michael, Eduardo Fernandez-Arias, and Kenneth Kletzer, 1996, “Is the Debt
Crisis History? Recent Private Capital Inflows to Developing Countries.” The World Bank
Economic Review 10(1):27-50.
Economist Intelligence Unit, 1997, Egypt Country Report, 1st quarter 1997.
Edwards, Sebastian, 1991, “Capital Flows, FDI and Debt-Equity Swaps in Developing
Countries”, in Siebert, Horst, ed., Capital Flows in the World Economy. Tubingen: Mohr:
255-81.
El-Borsa Magazine, various issues, (Cairo: The Egyptian Company for Publishing and
Media).
El-Erian, Mohammed A., 1992, “Restoration of Access to Voluntary Capital Market
Financing”. IMF Staff Papers, march, 39:175-94.
El-Erian, and Kumar, 1995, “Emerging Equity Markets in Middle Eastern Countries”,
World Bank Conference on Stock Markets, Corporate Finance and Economic Growth,
Washington, D.C.
Egypt’s Capital Market Authority (CMA), 1996, A New Era of Development.
_______, Annual Report, various issues.
Egyptian Ministry of Economy, 1998, New Business Environment for a Great
Country, Cairo.
Egyptian Ministry of Economy and Foreign Trade, 1999, The Egyptian GDRs:
Performance and Index Methodology. Cairo.
_______, Monthly Bulletin, various issues.
Enders, W., 1995, Applied Econometrics Time-Series, (New York:John Wiley and
Sons.Inc.).
Feldman, and Kumar, 1995, “Emerging Equity Markets: Growth, Benefits and Policy
Concerns”, The World Bank Research Observer, vol.10, no.2.
Fernandez-Arias, Eduardo, 1996, ”The New Wave of Capital Inflows: Push or Pull?”
Journal of Development Economics 48:389-418.
49
Fernandez-Arias, Eduardo, and P.J.Montiel, 1995, “The Surge of Capital Inflows to
Developing Countries: Prospects and Policy Response”, World Bank Policy Research
Working Paper, no.1473, June.
_____, 1996, “The Surge in Capital Inflows to Developing Countries: An Analytical
Overview.” The World Bank Economic Review 10(1): 51-77.
Frankel, Jeffrey A., and Andrew K. Rose, 1996, “Currency crashes in emerging
markets: An empirical treatment”. Journal of International Economics, 41 : 351-66.
Frankel, J. “ Types and measures of capital flows”, Economic Bulletin for Europe,
1997, vol. 49.
French, D., 1989, Security and Portfolio Analysis Concept and Management. OH.,
(N.Y.: Merrill Pub.).
Goldstein, Morris, D. J. Mathieson, and Timothy Lane, 1991, ”Determinants and
Systemic Consequences of International Capital Flows”. In IMF Research Department,
Determinants and Systemic Consequences of International Capital Flows. Occasional
Paper 77. Washington, D.C.: International Monetary Fund, March.
Goldstein, Morris, 1995, “Coping with Too Much of a Good Thing: Policy Responses
for Large Capital Inflows to Developing Countries”, World Bank Policy Research
Working Paper, no. 1507, September.
Gooptu, Sudarshan, 1993, “Portfolio Investment in Developing Countries”, World Bank
Policy Research Working Paper, no. 1117. March.
_____, 1993, “Portfolio Investment to Emerging Markets”, in Claessens, Stijn, and
Sudarshan, Gooptu eds., Portfolio Investment in Developing Countries. Washington D.C.:
World Bank: 45-77.
_____, 1994, ”Are Portfolio Flows to Emerging Markets Complementary or
Competitive?” World Bank Policy Research Working Paper, no.1360, September.
_____, 1996, ”The Analysis of Emerging Policy Issues in Development Finance”,
World Bank Policy Research Working Paper, no. 1589, April.
Granger, C.W., 1969, Investigating Causal Relation by Econometric Models and CrossSpectral Methods, Econometrica, vol. 37, no.3.
Haque, Mathieson and Sharma, 1997, “Causes of Capital Inflows and Policy Responses
to them”, Finance and Development, March, 1997.
Hargisk, B.W., 1997, “Forms of External Capital and Economic Development in Latin
America: 1820-1997”, World Development, vol.25, no. 21.
Harvey, Campbell, 1993, “Portfolio Enhancement Using Emerging Markets and
Conditioning Information”, in Stijn Claessens and Sudarshan Gooptu (1994), eds.,
“Portfolio Investment in Developing Countries”. World Bank Discussion Paper, no. 228,
Washington D.C.
Helmy, Omneia, 1997, “The Impact of Capital Inflows on Egypt’s Exchange Rate
Policy”, L’Egypte Contemporaine, LXXXVII, no.448.
50
Hernandez. Leonardo and Heinz Rudolph, 1995, ”Sustainability of Private Capital
Flows to Developing Countries: Is a Generalized Reversal Likely?”, World Bank Policy
Research Working Paper, no.1518, October.
Hindy, M., El-Said, H., Samak, N., and El-Shazli, A., 1999 “Analytical Study for the
Liquidity and Efficiency of the Capital Market, 1992-1998”, EPIC, Cairo.
International Business Technical Consultants, Inc., (IBTCI), USAID Privatization
Project Evaluation Services Contract, Cairo, Egypt, various issues.
International Finance Corporation, 1996, IFC’s Experience in Promoting Emerging
Market Investment Fund 1977-1995, (Washington: IFC, 1996).
International Finance Corporation, 1998, Lessons of Experience, Financial
Institutions, no.6, (Washington: IFC, 1996).
International Finance Corporation, Emerging Market Fact Book, various issues,
(Washington: IFC).
_____, 1994, International Capital Markets Developments, Prospects and Policy
Issues, World Economic and Financial Surveys. Washington : IMF, August.
_____, 1995, International Capital Markets Developments, Prospects and Policy
Issues, World Economic and Financial Surveys. Washington : IMF, August.
______, 1995, World Economic Outlook. World Economic and Financial Surveys.
Washington : IMF, May.
_____, 1996, World Economic Outlook. World Economic and Financial Surveys.
Washington : IMF, October.
_____, 1997, Exchange Arrangements and Exchange Restrictions. Annual Report
1996- Special Supplement. Washington, D.C.: IMF.
_____, 1998a, International Capital Markets Developments, Prospects and Policy
Issues, World Economic and Financial Surveys. Washington : IMF, September.
_____, 1998b, “Egypt Beyond Stabilization, Toward a Dynamic Market Economy”,
Occasional Paper, 163, Washington, D.C.: IMF.
International Organization of Securities Commissions, 1992a, Survey of the
development committee on disclosure, Montreal, Canada.
______, 1992b , Clearing and Settlement in Emerging Markets, Montreal, Canada.
Jack, G., and Brian, P., 1994, “Emerging Capital Markets and Corporate Finance”,
Columbia Journal of World Business, vol. 29,no.2.
Julian W., 1997, New Financial Instruments, (New York: John Wiley and Sons).
Khan, Mohsin and Carmen Reinhart (eds.), 1995, ”Capital Flows in the APEC Region”,
IMF Occasional Paper, no.122, March.
Lee, Jang-Yung, 1997, ”Sterilizing Capital Inflows”, Economic Issues, no.7,
International Monetary Fund, Washington D.C., February.
Mathieson, Donald and Liliana Rojas-Suarez, 1993, Liberalization of the Capital
Account : Experience and Issues, IMF Occasional Paper, no. 103, Washington D.C. : IMF
51
Mecagni, M., and Shawky M., 1999, “Efficiency and Risk-Return Analysis for the
Egyptian Stock Exchange”, The Egyptian Center for Economic Studies Working Paper,
no.37, Cairo.
Moursi, T., 1999, “Examining the behaviour of stock return and market volatility . The
case of Egypt”, paper presented to the EPIC, Cairo.
Rennan, M., and Henry,H., 1997, “International Portfolio Investment Flows”, The
Journal of Finance”, vol. LII, no.5.
Sahlman, A., 1990, “The Structure and governance of venture-capital organizations,
Journal of Financial Economics, vol. 27, (2).
Samuel, Cherian,1996, “Stock Market and Investment:The Governance Role of the
Market. Policy Research Working Paper 1578. World Bank.
Savvides, A., 1991, LDC Creditworthiness and Foreign Capital Inflows: 1980-1986,
Journal of Development, vol. 34.
Schadler, Susan, Maria Carkovic, Adam Bennet and Robert Kahn, 1993, “Recent
Experiences with Surges in Capital Inflows”, IMF Occasional Paper, no. 108,
Washington, D.C., December.
Schadler, Susan, 1994, “Surges in Capital Inflows: Boon or Curse?” Finance and
Development, march: 20-23.
Sharpe, W., 1966, “Mutual Funds Performance”, Journal of Business.
Taylor, Mark, P., and Lucio Sarno, 1997, “ Capital Flows to Developing Countries:
Long- and Short-Term Determinants ý”. The World Bank Economic Review. 11(3): 45170.
Ul Haque, Nadeem, Donald Mathieson and Sunil Sharma, 1997, “ Causes of Capital
Inflows and Policy Responses to them”, Finance and Development, march.
UNCTAD, 1997, Trade and Development Report.
United Nations, 1997, World Investment Report: Transnational Corporations, Market
Structure and Competition.
World Bank, 1994, World Debt Tables. Washington, D.C.: World Bank.
________, 1995 a, Arab Republic of Egypt: Egypt - Into the Next Century.
________, 1995b, Global Economic Prospects, and the Developing Countries.
Washington D.C.: World Bank.
________, 1996, Trends in Developing Economies. Washington D.C.: World Bank.
________, 1997a, Global Development Finance. Washington D.C.: World Bank.
________, 1997b, Arab Republic of Egypt: Country Economic Memorandum. Four
Volumes. March 15.
________, 1997c, Global Economic Prospects, and the Developing Countries.
Washington D.C.: World Bank.
52
World Bank, 1997d, Private Capital Flows to Developing Countries: The Road to
Financial Integration, World Bank Policy and Research Report. New York: Oxford
University Press.
________, 1999a, Global Development Finance. Washington D.C.: World Bank.
_______, 1999b, Global Economic Prospects, and the Developing Countries, Beyond
the Financial Crisis, Washington D.C.: World Bank.
Zhaohui, Chen and Khan, Mohsin S., 1997, “Patterns of Capital Flows to Emerging
Markets: A Theoretical Perspective”, IMF Working Paper, WP/97/13, January.
53
Cairo University.
Faculty of Economic and Political Science.
Economics Department.
Foreign Portfolio Equity Investment in Egypt:
An Analytical Overview.
Submitted by:
Dr. Nagwa Abdallah Samak
And
Dr. Omneia Amin Helmy
To the:
Economic Policy Initiative Consortium.
54
55