Egypt has substantial reserves to avoid an external payments crisis but these could be seriously depleted within weeks if political protests continue, while its banks may struggle to cope with a rush of withdrawals.
In the two working days after the protests erupted last Tuesday, which was a bank holiday, Egyptians and foreign investors transferred hundreds of millions of dollars out of Egypt, currency traders estimated.
The government had $36 billion in foreign reserves at end-December, central bank figures showed. According to a Jan. 27 note by Citigroup, it also had $21 billion of additional assets with commercial banks at end-October — its so-called "unofficial reserves."
These numbers suggest there is no immediate danger of a balance of payments crisis. But scenes of chaos at Cairo's main airport on Sunday, as both foreigners and Egyptians tried to get flights out of the country, indicated outflows of money could reach damaging levels over the medium term.
Egypt has a financial war chest, "but the war chest is going to be depleted if this situation continues for several weeks rather than a few days," said John Sfakianakis, chief economist at Banque Saudi Fransi.
"When markets begin to make bets against (the Egyptian pound), it will have a severe impact. The whole fiscal position of the Egyptian economy is going to be put to a very hard test if the violence, rioting continues for several weeks."
REVERSAL OF FLOWS
Egypt is vulnerable to a reversal of large flows of foreign portfolio investment that have been attracted by high yields on domestic government debt. Barclays Capital estimated foreign holdings of Egyptian assets before the protests were close to $25 billion, with roughly half held in Treasury bills and bonds.
Foreign direct investment is based on long-term planning and is less likely to be influenced by the political unrest. Egypt drew $6.76 billion of such investment in the last fiscal year to June 30, of which $3.6 billion went to the petroleum sector.
But the damage from any extended disruption to tourism could be considerable; Egypt earned $11.59 billion from tourism last fiscal year. It ran a current account deficit of $802 million in the July-September quarter of 2010, and because of tourism the deficit is likely to be much higher in the current quarter.
Equally worrying is the risk that middle-class and wealthy Egyptians will send more of their savings abroad. These outflows might match or over the long term, even exceed money pulled out by foreign portfolio investors.
Official figures are not available but a dealer at a medium-sized bank based in Cairo, who declined to be named, said clients at his medium-sized bank alone had transferred $150 million out of the country in two days. Some bankers said total outflows of funds from Egypt might have been at least $500 million per day last week.
If outflows continued at that speed without accelerating, Egypt could lose over a quarter of its official reserves within a month.
Much will depend on how authorities try to manage the Egyptian pound when financial markets eventually resume trading. The government closed the markets and commercial banks on Sunday, citing security concerns, and has said they will stay shut on Monday; it has not indicated when they will reopen.
Last week the pound shed only 0.7 percent of its value, to 5.855 against the U.S. dollar. The central bank said it did not intervene directly or indirectly in the market; the Cairo dealer said banks remained willing to sell dollars in the expectation that the central bank would provide dollars at a stable rate if needed.
When the markets reopen, however, traders may test the central bank's willingness to keep the exchange rate stable. If it spends what is necessary to keep the pound stable, it may start running through its reserves at an alarming rate. If it lets the pound fall towards a rate at which buying dollars would be less attractive, it may simply fuel panic in the market.
A substantially cheaper pound would also increase the prices which Egyptians pay for foreign goods, contributing to the high inflation which helped spark the anti-government protests.
Some analysts think authorities may therefore consider imposing controls to limit transfers of funds overseas. But this might damage Egypt's reputation in the markets further, while simply driving Egyptians to seek underground channels.
"There is always a reluctance to go down the route of imposing capital controls," said Ann Wyman, analyst at Nomura.
"If you do that to stop capital exiting, the long-term implications are negative. Egypt does rely on foreign inflows so it's important to keep long-term prospects in mind. Any decision like that will not be taken lightly."
Central Bank Deputy Governor Hisham Ramez told Reuters on Saturday: "We are ready. Our reserves are very strong. We have no problem." He did not elaborate on how authorities would cope with pressure on the pound.
Egypt also faces a dilemma over reopening its banks. It will probably need to reopen them within days to avoid serious damage to the economy, and to continue funding itself.
The government was due to sell a total of 4 billion Egyptian pounds ($685 million) of short-term Treasury bills on Sunday but this sale did not go ahead in their absence of banks to buy them, traders said. It was not clear when the debt would be sold.
But when the banks eventually reopen, they may struggle to handle a flood of people scrambling to take out cash in case of another closure.
"People are running out of money, this is clear. We expect that when banks do reopen, there will be quite a run," said one Cairo banker.
It is also unclear whether banks will continue do to business as usual with each other during the turmoil. The offshore rate for overnight Egyptian pound deposits between banks soared to about 19 percent last week from normal levels of around 6 percent in January.
This suggested some banks might be having difficulty attracting Egyptian pound deposits — an early sign that the interbank money market could freeze up if banks became nervous about lending out their funds.
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