Egypt faces a risk-laden game of Beat the Clock as it tries to get its political house in order before its foreign currency reserves sink much more.
Reserves fell to $16.4 billion in January from about $36 million a year earlier, a drop that economists all agree imperils the economy and requires Egypt to seek support from external sources and make difficult decisions to cut back government spending and subsidies. But that will be difficult given the political situation.
Presidential elections are now scheduled for late-May, preceded by a six-week election season. Meanwhile, a parliament dominated by Islamists is tussling over who will control the government with the interim military council. A dispute with the US over foreign human rights activists detained in Egypt is threatening vital American aid to the country. In the meantime, no US assistance is being transferred to the country.
The timetable looks even more challenging when the role of the International Monetary Fund (IMF) is factored in. Egypt’s Ministry of Finance is reportedly counting on the IMF’s executive board to approve a $3.2 billion facility towards mid-March, which will then go to parliament for approval about the time the presidential campaign is getting under way.
“Time is not on Egypt’s side and politics could be the prime suspect to derail or delay an IMF program or exacerbate dollarization and [foreign currency] outflows,” Bank of America Merrill Lynch analyst Jean-Michel Saliba said in a note to investors last week.
Concerns that Egypt’s political trajectory looks to be on a collision course with its financial needs came in the form a downgrade in its bond rating by Standard & Poor’s (S&P) on February 10. S&P lowered its ratings to B from B+ on Friday, five notches into junk territory, and said further downgrades could be on the way.
“The negative outlook reflects our view that a further downgrade is possible if the government fails to stem the decline in reserves, or an uncertain policy environment and weak institutions emerge from the ongoing political transition," S&P said. Moody’s and Fitch, two other bond-rating agencies, cut their ratings on Egypt earlier.
Diminishing foreign reserves may be the most immediate threat to Egypt’s economy, but it is not the only one. More than a year after the revolution that brought down Hosni Mubarak, economic growth has stalled, the number of visiting tourists has plummeted and foreign investment has evaporated, all of which is exerting huge economic pressure on the government at a time of political flux.
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Bank of America Merrill Lynch estimated that Egypt’s draw-down of its foreign currency would slow to what it called a “more manageable” $500 million a month because the foreign capital that has been responsible for much of the decline has been nearly drained out of the country.
On the other hand, Egypt could also get a boost from a rare instance of foreign investment if France Telecom goes ahead with the purchase of a $2 billion stake in the Egyptian Company for Mobile Service, popularly known as Mobinil, which it agreed to buy from Egyptian entrepreneur Naguib Sawiris last week. If the transaction goes through, that money might be transferred to Egypt in March.
But Merrill also noted that Egypt’s finances look more precarious than the headline foreign reserves figures show. Taking out Egypt’s holdings of gold, reserves fall to $13.6 billion, which are equal to just 2.8 months of imports, Saliba wrote in the February 16 note. Meanwhile, Egypt’s external financing needs could reach some $11 billion through June 2013, Finance Minister Momtaz Saieed said February 10.
Accepting aid, however, is politically problematic because the public looks askance at foreign assistance, especially from the US Only 26% favor accepting American aid, according to a Gallup poll taken in December. The proportion willing to accept international aid rises to 50% (with 42% opposing) and those willing to accept it from fellow Arabs reaches 68% (28% opposing), Gallup found.
Egyptians don’t like aid because it usually comes with strings attached, such as unpopular economic reforms in the case of the IMF and maintaining the 1979 peace treaty with Israel, in the case of American assistance. Political opposition to foreign assistance caused the interim, military government to reject the original offer of an IMF credit last spring, a decision many economists say has exacerbated the financial troubles in which Egypt now finds itself.
Parliament must approve an IMF loan, but Essam Erian, a leader of the Muslim Brotherhood’s Freedom and Justice Party, which dominates parliament, said his group may vote against it because it might impinge on Egyptian sovereignty. “Look at Greece,” Erian said in an interview with Bloomberg News this week. “Everybody is telling it what to do.”
Above and beyond accepting foreign financial assistance, the other remedies for Egypt’s foreign reserves ailment are all painful for politicians and the public alike.
One is bringing down the budget deficit. As the economy has shrunk and the government boosted handouts in the early days of the revolution to try and palliate the population, Egypt’s fiscal deficit has ballooned. Officials recently revised upward their forecast for the budget deficit for the fiscal year ending June 30 to 9.4% of gross domestic product.
The solution would be to cut spending, particularly costly and wasteful subsidies on food and energy. Indeed, the military government recently announced plans for $4 billion in spending cuts and the IMF and others providing aid will have their own list of fiscal measures. But political analysts suggest that will inevitably mean cuts to popular energy and food subsidies of the kind that have set off riots in the past.
Another remedy is devaluing the Egyptian pound. In spite of Egypt’s mountain of economic woes, the pound had shed only about 1% of its value over the past year as the central bank acted to shore up its value by raising interest rates and drawing down on reserves. But the bank’s options are narrowing as it is forced to devalue the pound, which will almost certainly lead to higher inflation.
Analysts see some positive elements in the Egyptian political scene. Saliba notes that the decision to move up the presidential vote to May reduces the length of the campaign season and the opportunity for grandstanding by candidates. Ahmed Galal, managing director of the Economic Research Forum in Cairo, maintains that the Muslim Brotherhood has taken a pragmatic line on subsidiary reform and supports free markets.
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