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Why South Africa's pain has become Egypt's gain

South African president Jacob Zuma
Justin Sullivan | Getty Images
South African president Jacob Zuma

To understand the depths to which South Africa—until recently Africa's 2nd largest economy and an emerging market powerhouse—has sunken, look no further than the country's finance minister.

January capped a tumultuous period in which South Africa's finance ministry changed hands three times in just a week. After only months on the job, incumbent Pravin Gordhan has been dogged by controversy as the country struggles to overcome the sandbags of slumping commodity prices, tumbling exports and extreme weather. Meanwhile, political risk has become a big factor as President Jacob Zuma fights calls for his resignation.

It all underscores why South Africa has lost its shine with investors, which have taken fright at the country's slumping currency and worsening growth prospects. Last week, the government reported South Africa's economy contracted in the first three months of 2016.

The grim state of South Africa's economy has dragged it to third place on the continent, according to International Monetary Fund (IMF) data. Meanwhile, Egypt—the country that overtook South Africa—is newly ascendant as investors search for an alternative in the volatile emerging market space.

According to analysts, it's been a slow and grinding fall from grace for the country.

"South Africa has been hit by a prolonged slowdown coupled with a weaker currency," said Win Thin, head of emerging market strategy at Brown Brothers Harriman (BBH). IMF figures from 2015 show that in the pecking order of the continent's economies, South Africa is now sandwiched between Nigeria and Egypt.

"So in U.S. dollar terms, South African [growth] has shrunk 4 straight years and likely to make it 5 straight after 2016," Thin added.


'Most vulnerable' to Fed rates

The country statistics office reported its farm sector contracted by a whopping 6.5 percent while mining plunged by nearly 20 percent, according to South Africa's statistics office. As a consequence, the South African rand, which has fallen has become the canary in the economic coalmine: The currency has been whipsawed by fears the country's credit rating will be downgraded to "junk" status, although all three major ratings agencies recently stayed their hand on South Africa's ratings.

David Rees, an analyst at Capital Economics, points out that emerging currencies may come under added pressure when the U.S. Federal Reserve tightens rates later this year. Investors normally chase higher yields, which could leave currencies like the rand as "the most vulnerable" to shifting interest rate expectations, Rees wrote recently.

Separately, investors are warming to Egypt. The Middle East's most populous country continues to see its fundamentals slowly improve, and the economy is seen growing around 4 percent this year and next. Analysts are not certain how long the renewed confidence will last, however.

"The government of President el-Sisi has not been able to push through many economic reforms," BBH's Thin said. "And investors in general are nervous about emerging markets given the potential for Fed tightening," in addition to generalized risk aversion, he added.

A skyline view of Cairo, Egypt
Mohamed El-Shahed | Getty Images
A skyline view of Cairo, Egypt

While South Africa struggles in the growth department, Egypt has seen its economy expand by an average of 7.5 percent during 2012-15, according to data by KPMG, a consulting firm.

Tight control of the Egyptian pound by the central bank has "contributed to Egyptian GDP eclipsing its South African counterpart during 2015," said Christie Viljoen, a KPMG financial risk analyst, wrote recently.

"Were it not for the rand's slump, South Africa would not have surrendered its second place during 2015," Viljoen added.

Analysts expect Egypt to continue to attract at least $6 billion in annual foreign direct investment, which bodes well for the country in the near term.

"Beyond 2016, FDI could increase significantly if the Egyptian authorities implement deeper structural reforms--including major improvement in the business environment--and if geopolitical environment in the region improves," Garbis Iradian, chief economist for the Middle East and North Africa at the Institute of International Finance, told CNBC.