By Carolyn Cohn
LONDON (Reuters) - International investors see Egypt's request for a loan from the International Monetary Fund as a major step to attracting money back into the country, but may want more progress before they commit their own funds.
Once a darling of frontier market investors, Egypt has lost appeal since the overthrow of President Hosni Mubarak 18 months ago. Worries about instability have combined with concern over a declining currency and dwindling foreign exchange reserves.
But Egypt's official request this week for a $4.8 billion loan from the International Monetary Fund, announced during a visit to Cairo by IMF President Christine Lagarde, may help.
It is likely to avert a currency or debt crisis, investors say.
"An IMF loan will be seen as positive," said Daniel Broby, chief investment officer at Silk Invest. "Although a further (currency) depreciation is on the cards, a loan will help shore up the pound against a worse outcome."
Silk Invest holds Egyptian corporate debt and has recently added to its holdings of bank EFG-Hermes, Broby said, bringing the frontier fund manager's Egyptian exposure to nearly 10 percent of its assets.
The Egyptian pound hit fresh seven-year lows after the loan was announced because investors expect the IMF to encourage the central bank to allow the currency to weaken more rapidly.
Since last year's popular uprising against Mubarak, Egypt has spent well over half its foreign reserves to support its currency, allowing the pound to weaken only by about 5 percent despite a sharp drop in tourism and foreign investment, two of Egypt's main sources of foreign exchange.
But a gradual depreciation of the pound, with financial support from the IMF, will allow the central bank to rebuild reserves. It is also less unpredictable for investors than a sudden one-off devaluation.
"They can't announce one-way bets, but the IMF could say 'we need to have more exchange rate flexibility'," said Gabriel Sterne, economist at frontier markets brokerage Exotix. "It's about getting the policies in place that restore confidence."
Reflecting the positive sentiment towards the loan talks, Egyptian stocks are trading at five-month highs, while the country's debt insurance costs have fallen by 50 basis points to around 500 bps in the past week in the five-year credit default swap market, according to Markit.
The yield on Egypt's dollar-denominated bond due 2020, which avoids the local currency risk, has plunged 75 basis points this week, to 5.4 percent, far lower than the euro-denominated debt of Italy or Spain.
Egyptian stocks were among the world's worst performers last year, sinking 50 percent, but they have made a 43 percent gain this year.
Egypt also has support from other channels. Saudi Arabia transferred $1.5 billion to Egypt as direct budget support in June, along with other aid measures. Qatar also promised $2 billion in support this month.
The loan talks also reflect a more secure political situation, investors say, after Egypt's military-appointed interim government handed power to President Muhamed Mursi on June 30. The military government had been negotiating a $3.2 billion package with the IMF before it handed over, but the deal was not finalized.
Political risk remains, however, with legal challenges to a decree issued by Mursi that removes army-imposed curbs on his powers.
Richard Fox, head of Middle East and Africa sovereign ratings at ratings agency Fitch, said it was too soon to change the country's rating.
Fitch cut Egypt's rating to BB-plus with negative outlook in June, though Standard & Poor's took Egypt off CreditWatch negative on Thursday.
Sterne at Exotix has kept a hold, rather than buy, recommendation on Egypt's 2020 Eurobond, with agreement on the deal not due before the end of the year and the possibility of popular or political reaction to it.
Fox also said it was early days for any deal euphoria.
"There will come a point in the future when we will get a trigger and it brings back lots of portfolio investments, I don't think we are there yet."
(Editing by Jeremy Gaunt.)