The Economist: Egypt’s foreign reserves; Dwindling dollars

Facing a shortage of foreign exchange, Egypt allows its currency to fall.

Despite the government’s best efforts, the rattle of money-counting machines can again be heard in Egypt’s back alleys, where traders sell dollars at a premium to the official rate. The government devalued the pound to match the black-market price earlier in the year, thereby wiping out the illicit trade. But demand for greenbacks is outpacing supply once more, leaving the government short of cash and putting the traders back in business.

Egypt’s foreign reserves fell to $16.4 billion in September, enough to cover about three months of imports—the minimum the IMF considers advisable. But Egypt is not attracting many dollars at the moment. Years of political turmoil have hit tourism and foreign direct investment (FDI), which amounted to $6.4 billion in the last fiscal year (running from July until June). The government hopes for $10 billion in FDI this year—wishful thinking, analysts say.

At the same time, demand for dollars is rising. Egypt has run annual trade deficits for over a decade. Lately they have grown. Although the bill for oil has come down along with the price, Egypt still imported $12.3 billion-worth last year. It also spent $48.5 billion on other imports, including wheat, cars and metals. “This is where the pressure comes from,” says Allen Sandeep of Naeem Holdings, an investment firm. The country’s exports, totaling $22 billion last year, don’t match up.

No wonder, then, that the current-account deficit is expected to hit $20 billion this year. In addition to FDI, Egypt has financed such shortfalls in recent years with handouts from Gulf states eager to support its military regime. But these are likely to dwindle as the low oil price diminishes the revenues of Egypt’s benefactors. The government has announced new loans worth $1.5 billion from the African Development Bank and the World Bank, and is negotiating a separate $3 billion loan, over three years, from the latter. More dollars may come from the sale of land to Egyptians living abroad, which the government hopes will earn $2.5 billion. But there is still a sense that the country will have to tighten its belt.

So it did not come as a total surprise when the central bank allowed the Egyptian pound to hit a record low on October 18th. As The Economist went to press, the pound sat at 8.03 to the dollar, 11% weaker on the year. The black-market rate is still over 5% cheaper, so a further decline is expected. “It probably needs to fall a lot further to restore Egypt’s external competitiveness,” says Jason Tuvey of Capital Economics, a research firm. He expects a dollar to buy 8.25 pounds by the end of this year and 8.50 pounds by the end of next year. Others are more bearish.

The central bank’s reluctance to allow the pound to fall faster stems from a fear of stoking inflation. Egypt imports many staples, which would jump in price if there were a sudden depreciation. That would cause widespread pain and might stir social unrest. “They won’t want to risk another revolution,” says Mr Sandeep. But it is possible that a new head of the central bank, announced on October 21st, will adopt a more decisive policy.

In the meantime, the prospect of further devaluation has put off investors, as have the capital controls intended to bolster the pound. Last year the government limited transfers abroad to $100,000 a year. Earlier this year, in an attempt to squeeze the black market, deposits in foreign-currency accounts were capped at $10,000 a day and $50,000 a month. Those moves, together with the government’s rationing of foreign currency, have hurt business. Firms complain of a lack of cash for imports. Mr Tuvey believes this has contributed to a sharp slowdown in growth in the first half of the year.

If Egypt can muddle through the crisis, there is some cause for optimism. The government has invested in manufacturing in the hope of boosting exports. More importantly ENI, an Italian oil firm, has discovered a vast gasfield off the Egyptian coast. According to some estimates, the Zohr field could turn Egypt from an importer to an exporter of gas by 2020. That should bring in a dollar or two.

Source: The Economist