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Egypt's currency tightrope

The big immediate problem now is that the Egyptian pound is at a very real risk of succumbing to a disorderly default.
Financial Times | 03.04.2012
It has been a long road and it is threatening to get longer. Every month since the start of 2011 has brought with it an average fall of $1.4bn in Egypt’s foreign currency reserves reserves.

And according to the Egyptian ministry of finance they now sit at $15.1bn. That is below the three month’s of import cover viewed as safe minimum by the International Monetary Fund and well below the $36.1bn Egypt boasted in December 2010, before its revolution began.

More worryingly say Capital Economics:
"The central bank’s “liquid” reserves (that is, holdings of freely convertible FX securities, currency and deposits) have fallen even more sharply, from just over $30bn at the start of the year to less than $9bn in February (the latest month for which data are available). The drop in liquid foreign exchange reserves has taken them to a level that only just covers two months of imports."

The big immediate problem now is that the Egyptian pound, which is supported by the Egyptian government, is at a very real risk of succumbing to a disorderly default.

If the government lacks the liquid reserves to defend the currency it will be moved entirely by market forces. The best way to judge what that might look like is in the forwards market.

The Egyptian pound is currently trading in the spot market at E£6.0398 versus the US dollar and has been devauling gradually for quite a while (analysts have described this as a managed devaluation).

However, despite a 4 per cent decline in the Egyptian currency’s value versus the dollar since the start of 2011, its forward price in the 12-month non deliverable forwards market still implies a devaluation of some 20 per cent, to E£7.2750.

What could stop the shorts… short… is a $3.2bn programme between Egypt and the IMF – a programme which the markets had believed to be nearing fruition.

But broad political support is something that is getting further and further out of reach with tensions between the Muslim Brotherhood and the military council now being played out in the race for Egypt’s next president.

Elections for the Egyptian presidency are slated to begin at the end of May an the Muslim Brotherhood had not been expected to nominate an Islamist candidate for president.

That all changed last week when the Brotherhood put its deputy leader Khairat El-Shater up for the job.

As Eurasia Group’s Hani Sabra said, with that decision the Brotherhood broke a very public promise, which has raised the issue of its support more broadly:
"Critics now have the clearest example of duplicitous behavior on the Brotherhood’s part, and there will be some attrition for the Brotherhood’s support. The Brotherhood spent the last year insisting that it was committed to not fielding a candidate in order to assure the public that it had no intention of monopolizing power.
However, the Brotherhood is emboldened and appears to believe that this is its moment, and the about face on fielding a candidate will have limited impact on its support base in the short term. Of course, if the Brotherhood wins the presidency, forms a government, maintains a parliamentary plurality, and directs the crafting of a new constitution, it will not be able to deflect blame onto any other entity and will be solely responsible for tackling Egypt’s growing economic problems-a tall order."

The disorder has hit Egyptian equities – Egypt’s headline index had gained some 50 per cent of its value between the start of 2012 and March but has given back 9.1 per cent since then.

The authorities on Monday sold Egypt’s first 10-year bonds since the protests began more than a year ago – but at a price.

As Reuters and Bloomberg reported they sold 1bn Egyptian pounds ($166 million) of deb at an average yield of 17.03 percent yesterday, higher than the 13.04 per cent at the last sale of similar-maturity bonds in January 2011.

However, even these rates would look cheap in the event of a disorderly devaluation.