By Una Galani /Reuters
DUBAI: Egypt’s pound still looks vulnerable. Supporting the currency so far has been a costly strategy. Along with a decline in tourism and foreign direct investment, foreign exchange reserves have shrunk around 40 percent or by roughly $16 billion. But the decision may have helped avert a bigger capital flight. Furthermore, it makes sense for the central bank to carry on down that path until a new elected government is in place, which should happen later this year.
The pound has fallen just 2.6 percent against the dollar since the start of the year despite a huge slowdown in growth expectations. Barclays Capital forecasts that the Egyptian economy grew 1.4 percent in the fiscal year that ended in June, down from 5 percent last year. And Egypt’s balance of payments deficit widened to a record $6.1 billion in the last quarter. The government has intervened in the foreign exchange market directly, and is widely believed to be doing so indirectly.
Letting the currency move in a controlled slide would help boost growth and allow interest rates to decline. But Egypt can’t afford to let the pound fall too much. It would make imports more expensive and increase inflation – the headline rate is already 11.8 percent. That could stoke social tensions which are already mounting in the country over the slow pace of reform. Moreover a weaker currency won’t do much for exports without a boost to productivity, or much for tourism in the absence of political stability.
A slowdown in the decline of reserves also suggests Egypt may be past the worst of outflows. The current account deficit is expected to stabilize at around 3 percent of GDP, according to Fitch. Import cover has fallen from around 9 months pre-revolution to 5.3 months in June, using estimates from the International Monetary Fund. And investors are unlikely to panic until that hits around four times. That won’t happen until March if reserves continue to decline at the same pace as last month.
Of course, it is in Egypt’s interest to ensure that reserves stabilize well before that point. To do that, elections – already moved from September to November – must be held this year. A new government should help restore confidence and create an environment where the pound can move more freely with minimized risk of triggering a second major capital flight, says HSBC. If things play out like that, Egypt’s defense of the pound will have been worthwhile.