(Bloomberg) -- Money managers who pulled some $20 billion from Egypt in a matter of months two years ago will now find few places in emerging markets more alluring.

The verdict of investors is in, after a day that saw Egypt devalue its currency by more than 38% following a record interest-rate hike of 600 basis points. The backstop of the International Monetary Fund’s expanded $8 billion loan — and the United Arab Emirates’ commitment of more than four times as much money — has flipped the script for some of the biggest names in finance like Aviva Investors and Vanguard Asset Services.

Egypt now offers the third-highest yield on local-currency bonds among 23 developing economies tracked by Bloomberg, with average returns close to 30%. The pound on Thursday recouped some of its staggering losses with a gain of as much as 1.5% against the dollar. 

Investors previously shunned Egypt’s local debt as the central bank resisted a devaluation of the heavily managed pound. It became overvalued in the eyes of foreign traders, contributing to shortages of hard currency that caused inflation to soar.

“What Egypt has needed for a while now is a positive confidence shock,” said Nafez Zouk, an emerging-market sovereign debt analyst at Aviva Investors in London. On Wednesday, it “was an attempt of not only delivering that, but having it backed with actual funds.”

The return of portfolio inflows would lock in the final piece of the funding puzzle for Egypt after being recently excluded by JPMorgan Chase & Co. from local-currency bond indexes tracked by billions of dollars worth of funds. Egypt’s domestic bonds lost more than 10% last year, a period when local debt in emerging markets returned 6%, according to a Bloomberg index.

Russia’s invasion of Ukraine in February 2022 led commodity prices to surge, resulting in higher prices for imports of wheat and fuel for Egypt, and prompting bond investors to flee the country’s local debt.

But the asset class increasingly stands out for carry traders, who borrow where rates are low to invest where they are high. And while the nation’s eurobonds that traded at distressed levels as recently as December rallied on Wednesday, it’s the government’s local bonds that attracted investor attention.

“The next trade probably is Egypt local,” said Nick Eisinger, co-head of emerging-market fixed-income active at Vanguard Asset Services. “Now that the foreign exchange rate is cheaper, rates have risen and the funding outlook is stronger and not many people own Egypt local, we would buy local.”

In a game changer for sentiment, Egypt is opening a path for higher carry returns by hiking rates and removing currency controls. It won the IMF’s backing days after striking a $35 billion investment deal with the UAE.

Hardships are likely to worsen in the near term for an economy that’s also under pressure from the Israel-Hamas war. Consumers are likely to feel the sting of the latest devaluation in higher consumer prices, with inflation already running near 30%. 

But authorities are banking on the reforms attracting foreign investors back to the country of 105 million people and ending its worst economic crisis in decades. 

In Thursday’s T-bill auction, Egypt sold 87.8 billion pounds ($1.8 billion) of one-year debt at a yield of 32.3%, with investors offering to buy more than eight times the amount of securities sold. It also sold 14.2 billion pounds of six-month bills. 

Read more: Citi Recommends Buying 1-Year Egyptian Treasury Bills

Egypt’s investment case will become clearer into next week as the market settles, according to Gordon Bowers, a London-based analyst at Columbia Threadneedle Investments. 

‘Becoming Attractive’

“The local carry trade is becoming attractive,” Bowers said. “I would expect locals to test the new foreign exchange regime in coming days but once concerns around FX availability give way, we could see a wave of de-dollarization.” 

As Egypt replenishes reserves and stabilizes its finances, it may be a matter of time before the government can tap global capital again. The nation has been frozen out from the eurobond market, with the most recent dollar debt sale more than a year ago.

Egypt’s average dollars yields have now fallen below 10%, for the first time in almost two years. 

“The IMF agreement will help Egypt access capital markets that were effectively closed for it until now,” said Demetris Efstathiou, chief investment officer of Blue Diagonal Capital. “It is an opportunity for Egypt to present to international capital markets a positive case for its outlook, and the progress made, following a very difficult period for the credit.”

--With assistance from Srinivasan Sivabalan.

(Updates with T-bill auction results in 13th paragraph)

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