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Egypt and its implications for emerging markets.

February 08, 2011
Geoffrey Dennis, Global Emerging Markets Strategist

The major political unrest in Egypt provides another concern for emerging market investors and, most likely, another reason for global investors to seek safety in developed markets, at least in the near term.

With the end-game in the political crisis in Egypt unclear, I see the key issues for investors are now: i) whether calm can be restored or disorder continues (or even worsens); ii) whether President Hosni Mubarak remains in office or passes rule to a successor, and how any successor is accepted in the country; iii) what new political reforms are introduced; and iv) how financial markets react to recent developments, particularly the outlook for the currency. If the Egyptian population loses confidence in the banking system and seeks to buy dollars aggressively, the currency would be very vulnerable.

Egypt is a small emerging market, representing just 0.5 percent of the Morgan Stanley Capital International Global Emerging Markets [GEMs] benchmark index. It is already down by 21 percent so far this year, by far the worst performer in GEMs, which has declined just 2.8 percent in the same period. In Citi's view, the market is not big enough to trigger much forced selling by emerging market investors across emerging markets as a whole, while the Egyptian situation alone should not lead to sustained weakness in emerging markets.

What matters is the broader ramifications of the Egyptian crisis beyond the country's borders: Will unrest spread across the Middle East? Could the situation cause oil prices to spike and threaten global recovery? Will there be any change in the regional balance of power that threatens the security of Israel?

Given the apparent role of rising food prices in the original unrest in Tunisia, which then spread to Egypt, the risk of political protests in other emerging market countries in response to rising food and energy prices must also be watched closely.

On balance, we think the unrest in Egypt is likely to pose another short-term challenge to emerging market equities, but not trigger serious and prolonged selling across the asset class. As our regional team notes, the Egyptian economy has been doing well of late, with several recent key reforms put in place. It has a healthy and under-leveraged banking sector and some well-run companies. Although further weakness in emerging markets is possible in the near-term, we would look for a medium-term buying opportunity in emerging market equities from this political crisis.

NOTE: This piece is adapted and updated from a Citi Global Emerging Markets Strategy note, "Egypt: Implications for GEMs," published on Jan. 30, 2011.

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