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Will government backtracking on the new capital gains tax put an end to the stock market blues, asks Sherine Abdel-Razek
The cabinet's decision on Monday to put on hold a tax on gains realised on stock market transactions for the next two years was warmly received by investors who blamed the tax for the recent declines in the market's indices.
The main EGX 30 market index reacted on the same day by gaining 6.5 per cent, the most since July 2013, rising to 8,798.17 points up from its year low of 8,260 points in early May. At least a dozen stocks reached their daily 10 per cent limits.
The rally continued on Tuesday but on a smaller scale with the index gaining 0.9 per cent .
The decision came as a pleasant surprise to the market, especially after Hani Kadri, the finance minister and main advocate of the tax, had told reporters last month that the government would not withdraw the tax but would only amend the payment method.
The prime minister and the investment minister together with Mohamed Omran, the head of the exchange and a major opponent to the tax, opened Monday's trading session to show their support for the decision.
The tax signed into law by president Abdel-Fattah Al-Sisi last July stipulated a 10 per cent annual levy on net profits realised from financial securities. It was only in April that the by-laws regulating the tax were released.
The market did not react negatively at the time the tax was signed into law as "it was accepted back then as a part of a wider package of reforms introduced by the new government to deal with the budget deficit," according to Omar Al-Sheneety, managing director of the Multiples Group, a regional private equity firm.
The reforms included the introduction of temporary taxes on those realising high profits, a 10 per cent tax on stock dividends, and a reduction in energy subsidies.
The market then saw an uninterrupted upward trend starting in July and lasting until early February. The delay in the introduction of the by-laws and the government's investor-friendly approach before the Egypt Economic Development Conference (EEDC) earlier this year raised hopes that it would cancel the tax, said Eman Negm, economist at local investment bank Prime Holding.
"This exacerbated the reaction to the by-laws, which are vague and complicated even for stock market professionals," Negm said.
Until mid-May, listed equities recorded a 17 per cent decline from a seven-year high in February, just shy of the 20 per cent threshold that would constitute a bear market.
The decline pushed Morgan Stanley to drop Telecom Egypt from its emerging market index, "leaving Egypt with the minimum three stocks required to be classified as a developing market and raising the risk it will be downgraded to frontier status," according to the Bloomberg news agency.
While stock market traders have lobbied for the law to be scrapped since early April, challenging it in court last month and even sending a petition to president Al-Sisi, some observers believe that the tax was not the only reason for the market's bearish performance.
"The general economic and political atmosphere, together with the slow results of the outcomes of the EEDC, are adding to the problem," Negm said.
More importantly, according to Negm, forex risk was an important reason behind the decline as owing to restrictions on dollar deposits and transfers and the scarcity of the US currency portfolio investors were unable to repatriate their profits, reducing their transactions.
Saudi Arabia's decision to open its market to foreigners added to the problem, as this would attract the attention of many portfolio managers who target emerging markets in the Middle East, Al-Sheneety said.
"The capital gains tax is applied in many other markets worldwide, but not in the regional and emerging markets we are competing with," he explained.
The freeze in the tax will not significantly affect the government's revenues as the expected yield was put at just LE3.5 billion by Prime Holding, the equivalent of less than 1.5 per cent of GDP.
With the new levy put on hold, market capitalisation and the liquidity of key Egyptian companies appear less likely to fall below Morgan Stanley (MSCI) thresholds, thus negating the possibility of any of the three remaining companies being excluded from the index.
Another benefit expected from the move is that it translates into a reduction in the cost of capital for investors in general and specifically Egyptian and Gulf investors, according to a research note issued by Naeem Brokerage and quoted by Reuters.
"At the same time, this also rules out earlier concerns over the actual implementation of the capital gains tax and the challenges that might arise on calculation and recoveries," it said.
But there is a negative side to the move. "It highlights the fact that the government is adopting the same economic strategy that fed the anger of people who took to the streets in 2011 by favouring businessmen and investors over the poor," said Reda Eissa, a stock market expert.
According to Eissa, the government prioritised the interests of stock market investors and froze the tax despite the fact that the overall decline in the market since last july is 2.3 per cent.
"While the government is planning to impose the Value Added Tax (VAT) on all Egyptians to yield LE30 billion per year, it is suspending a LE3-4 billion tax on much wealthier stock market investors," he added.
This highlights the unfairness of the local tax system, according to Eissa, who added that according to the "Paying Taxes: the Global Picture" report co-prepared by the World Bank, the IMF, and the consulting firm PricewaterhouseCoopers, while local companies pay 13.2 per cent of overall tax yields in Egypt, individuals contribute 25 per cent.
"It is very clear that this reversal is a result of continuous and sustained pressure from the business community," said Samer Atallah, professor of economics at the American University in Cairo. "The government seems to bow down to pressure from this interest group regardless of its goal of (tightening) the budget deficit. This reversal sets the record straight that public policy in Egypt is misguided and unbalanced."
Market observers expect it to gain some strength in the short term, especially until it reaches the resistance level of 9000 points.
The expected series of Initial Public Offerings will also help boost the appeal of the market by adding a wide array of traded commodities. This is in addition to the minister of investment's statements last week to the effect that his ministry is currently evaluating 120 state companies for offers in the local market.
Heavyweight private companies like real-estate developer Emaar Misr and refining business MIDOR are also planning to be listed on the market soon.
© Al Ahram Weekly 2015
