Plunging foreign reserves pose new threat to Egypt

Danger level approaching faster than elections will yield new government.

By DAVID ROSENBERG / THE MEDIA LINE
Egyptian currency, Egyptian pound_311 (photo credit: Thinkstock/Imagebank)
Egyptian currency, Egyptian pound_311
(photo credit: Thinkstock/Imagebank)
Egypt’s political and economic clocks are running on dangerously different speeds: While Egyptians make repeat visits to the polls over the next three months to elect a new government and debate the future of their country under Islamist rule, the country’s foreign currency reserves are rapidly running down to perilous levels.
The reserves dropped to just over $22 billion in October from $36 billion since the start of the revolution last January. But with the latest round of unrest and the prospect of Islamist rule, the pace of the decline has picked up. On Thursday, the Supreme Council of the Armed Forces (SCAF) forecasted that the figure would plummet to just $15 billion by the end of January.
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“We’re nearing a critical benchmark, which is three months of imports. We’re not quite there yet, but at the rate reserves have been deteriorating we’ll be there by the end of January,” Magda Kandil, executive director of the Egyptian Center for Economic Studies, told The Media Line. “We can live with it a while if there are measures put into place. Left alone, it may become very critical.”
Reserves to pay for three months of imports is the minimum recommended for any country by the International Monetary Fund (IMF). But, according to Mahmoud Nasr, a senior army financial official, Egypt’s import cover will be even smaller because $5 billion of its reserves are already committed.
In a sign of how critical the situation is growing, the army announced on Thursday a loan of $1 billion to the central bank.
Egypt faces a raft of challenges, from staging elections and writing a constitution to maintaining security in the Sinai and keeping a lid on simmering sectarian tensions. But the economic meltdown, which has been given short shrift both by the country’s interim rulers as well as by elected candidates, poses an imminent threat and one that could easily foment a new round of political turmoil before an elected government can take office.
Plunging forex reserves are symptomatic of economy coming apart. Egypt eked out some economic growth in the second quarter of the year, but not enough to claw back the 4.2% drop in gross domestic product that occurred in the first quarter. The IMF expects the GDP to grow just 1.2%, down from 5.1% in 2010.
Revenue from tourism, a major source of foreign currency for Egypt as well as a major employer,  dropped by more than a third in the first half of the year. But other big forex earners - revenues from Suez Canal and energy exports - have held up well. The problem, said Kandil, has been foreign investment: overseas investors have pulled their money out of Egypt and funding for projects like factories and construction have all but dried up.
The percentage of Egyptian Treasury bills held by overseas investors declined to less than 5% in August from 22% before the revolution. Standard & Poor’s cut the country’s sovereign credit rating four notches to B+, putting it deeper into the “junk” category on November 24, the second such cut in five weeks.

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Absent demand from foreign investors, the cost of borrowing has gone up for the government, exacerbating its already difficult financial position. On Sunday, the Finance Ministry sold 273-day T-bills at an average yield of 15.084%, compared with 14.251% at the last sale on November 15.
Meanwhile, the Egyptian pound has lost some 3.8% of its value in the past year despite the government’s efforts to prop it up. Egyptian stocks briefly rallied last week on the elections, but turned lower on Sunday.
“People were encouraged that elections went on scheduled and went fairly peacefully. On the other hand, the strong showing of Salafist candidates has raised eyebrows. We’re waiting to see what kind of government we will get,” said an economist, who spoke to The Media Line on condition of anomity, citing the sensitivity of the foreign reserves issue.
Some analysts have pointed to the Turkey’s Justice and Development Party (AKP) as a model for Egypt’s prospective Islamist rulers. In power since 2002, the moderately Islamist party has presided over a period of export-led economic growth for Turkey. But Egypt’s Islamists, if they take power as expected, will be facing a severe economic crisis, high expectations for budget-busting social welfare programs and few clearly articulated ideas about how to solve the country’s multiple economic problems.
Kamal el-Ganzouri, appointed interim prime minster by SCAF almost two weeks ago, is an economist who helped shepherd economic reforms in his previous stint at the post a decade ago. But given the political upheavals underway now, he is likely to be more preoccupied with elections, constitutional questions and maintaining public order.
In any case, the policy remedies needed to stem the decline in reserves are all unattractive because they would impose political and/or economic costs on a country with little ability to absorb them, economists said.
In a rare proactive measure, Egypt’s central bank raised its benchmark interest rate the last week of November for the first time in more than three years. The increase was aimed at stemming a further depreciation of the pound by making dollar deposits less attractive. But raising interest rates will also deter investment at a time when the Egyptian economy badly needs it.
Raising money abroad is another policy alternative. Capital Economics, in a comment last week, said Egypt’s financing needs are likely to exceed $10 billion next year, leaving the government no choice but to seek outside financial assistance. Without that, the London-based firm warned, “a sharp fall” in the pound and assets value looks “inevitable.”
But the government has been loathe to borrow. Last spring, Egypt turned down an offer from the IMF for a $3.2 billion loan apparently out of national pride, saying it preferred to rely on domestic financing to cover the government’s growing budget deficit. Gulf Arab states have offered $10 billion, but little of this has been delivered.
But by taking up a bigger chunk of domestic capital to cover its deficit, the government deprives the private sector of investment funds.
Instead of borrowing more, the government could reverse some of the increased subsidies and wage hikes it introduced earlier in the year to put a lid on public discontent. But it risks rekindling protests from a populace pressured by double-digit inflation and unemployment.
Imposing capital controls is another alternative, but that might scare away foreign investors worried that they won’t be able to repatriate money they invest in Egypt. It would also signal a reverse in the free-market direction of economic policy of the past decade.
“At this late game in the process, it would be a step backward. It would be problematic as far as reform agenda,” said Kandil. “But if they have their backs against the wall, they may act.”