Egypt: Currency woes

Still in a difficult transition period following its revolution, Egypt’s politics are in a state of flux. One of the most persistent challenges over the past two years has been maintaining currency stability, and the intricately linked issue of the depleting foreign currency reserves. The Central Bank of Egypt’s (CBE’s) interventions have helped manage the Egyptian pound’s decline during that time but have also put pressure on foreign exchange reserves. However, emergency measures cannot be a long-term substitute for attracting more investment.

At the end of February, Egypt’s foreign currency reserves fell to $13.5bn from $13.6bn at the end of January. This is significantly below the $15bn floor the IMF suggests the country needs to cover three months of imports. At the end of 2012, reserves had stood just above this level, at $15.1bn, implying the country expended $1.5bn of foreign exchange in January – a month that saw political tensions escalate and anti-government street protests lead to dozens of deaths. International press reports have suggested that Egypt is now “on the verge of a liquidity crisis”.

Reserves have steadily declined from the $36bn recorded at the end of December 2010, the month before the revolution that brought down President Hosni Mubarak. The decline has largely been caused by the CBE’s efforts to prevent a precipitous fall in the Egyptian pound, which would spook investors and broaden what is already a large fiscal deficit (running at 5.1% of GDP in the last half of 2012), while also stimulating inflation.

A substantial proportion of Egypt’s population lives on or below the poverty line, and price increases are a sensitive issue. Given the country’s budgetary problems, the government has limited scope to boost subsidies to offset rising prices of basic goods. In January, monthly inflation reached 1.7%, the highest level for two years, and the annual rate climbed to 6.3% from 4.7% in December, with the rise largely linked to the declining pound.

Despite the CBE’s strategy, the pound has still fallen – to around LE6.75 to the dollar in early March, from just over LE5.5 before the revolution in early 2011 – though it has not plunged as some had feared, thanks to the CBE’s efforts, which have won the approval of some investors.

“There is a possibility of a sharp devaluation, but a controlled devaluation is what the industry is looking for,” Mohamed El Mikawi, the managing director for Egypt at Al Futtaim Group Real Estate, a UAE-based investor, told OBG. “The government has taken steps for that to happen. Investors are hesitant to bring in new foreign currency until the devaluation takes place. A gradual devaluation and a soft landing is what we need.”

On February 4, the CBE introduced further measures intended to prevent the pound falling rapidly, while trying to defend foreign exchange reserves. The bank cut the number of currency auctions from five to two per week, as well as lowering commissions on foreign currency purchases. Analysts from Cairo-based Pharos Holding said the new policies appeared to be an attempt to implement a “crawling peg” model targeting a specific exchange rate, but expressed concerns about the policy’s sustainability.

Such is the squeeze on reserves that it is becoming increasingly clear that the CBE cannot rely on them indefinitely. Soon, Egypt will need to bring in more foreign currency through investment; linked to this is a potential $4.8bn loan from the IMF, which has been discussed for many months but has been postponed due to political tensions. It appears to be back on the agenda now.

An IMF deal would both provide a useful foreign exchange buffer and should help bridge the budget gap, thus boosting investor confidence in the country’s macroeconomic stability. However, it may not be possible to seal an agreement before parliamentary elections expected in April.

Investors who speak to OBG express optimism about Egypt’s long-term prospects, given its large, youthful and growing population; reasonably diversified economy; strategic location and position as a leader in the Arab World; and some useful resources (proven gas reserves have increased substantially over the past two decades, for example). For the time being, though, many are cautious, seeking clear economic direction and a lowering of political tensions.