Few options left to stabilise a tottering Egyptian pound

Near-continuous unrest since January's uprising has battered Egypt's currency, sparking debate over the least destructive ways for the central bank to slow its decline against the dollar

For Egypt's currency, 2011 has not been the best of years.
Its value against the US dollar has dropped 3.4 per cent since January despite support from Egypt's central bank, with continuous waves of violence sincethe 25 January uprising having a brutal effect on the country's foreign currency reserves.
The resultant battering for the Egyptian pound has raised the prospect of the government placing controls to restrain capital flight.
The latest unrest in November, which left more than 40 civilians dead and thousands wounded, put further pressure on the already strained Egyptian pound, driving the currency to break LE6 to the dollar, its lowest level since January 2005.
The depreciation of the local currency is driven by both a surge in demand for the dollar, along with a shrinkage in the supply of foreign currency by both domestic and foreign players.
On the supply side, tourism -- one of the country's top currency earners and which generated more than $12 billion in 2010 -- has drastically declined.
Many flights to Egypt have been cancelled; occupancy rates in once-packed downtown Cairo hotels fell below 15 per cent in November.
Tourism revenues tumbled 35 per cent in the first six months of 2011, compared to the year before, reaching $3.6 billion. In light of November's violence and the tensions surrounding Egypt's parliamentary elections, few rule out a larger drop for the second half of the year.
On the demand side, foreign-held Egyptian treasury bills saw a significant outflow in 2011. In August 2011, the foreign share of total outstanding treasury bills dropped to a slim 4.89 per cent from 22 per cent a year earlier.
Their treasury bill holdings also plummeted from LE59.3 billion in December 2010 to LE17 billion in August. Total net foreign investor outflow from Egyptian bills and bonds is estimated at more than LE7 billion in 2011.
This has had a knock-on effect on the the rate at which the government borrows. Only last week, the ministry of finance sold one-year notes at a record yield of 14.932 per cent while the average yield on six-month notes jumped to 14.4 per cent.
To counter this, the government has turned to less expensive dollar bonds.
Egypt sold $1.53 billion worth of one-year, dollar-denominated treasury bills on Tuesday with a weighted average yield of 3.87 per cent. The CBE also sought to raise $2 billion in its first dollar-denominated issue this year.
Things are also bleak in Egypt's equities market.
The country's once-vibrant stock exchange has seen its main index slump some 43 per cent since the start of the year, driven by foreign investors' sales.This further flight of foreign capital has put additional pressure on the pound.
Foreign investment concern about Egypt's risky outlook was demonstrated in yields on the country's 5.75 sovereign dollar bonds due April 2020 which surged 79 basis points, to 6.94 per cent this week, its highest level since January.
In mid-November, ratings agency Standard & Poor's cut its long-term rating on Egypt by one notch to 'B+' citing a weak political and economic outlook. It was the second S&P downgrade in only five weeks. Other rating agencies are expected to follow suit.
Domestically, pressures are also building on the pound as it is losing its attractiveness with savers as a wealth vessel, despite high interest rates.
"Dollarisation is at its peak now, Egyptians are either doing it for bargain-hunting, to protect their funds in safer vessels or to flee the country," says Hany Genena, chief economist at Pharos Holding.
According to Genena, the Central Bank of Egypt's (CBE) current strategy is to prevent a sudden drop in the Egyptian pound, or an overshoot, which could deal a devastating blow to industries whose operations are dependent on foreign currency.
"A sudden decline in the pound would increase production costs for firms that import inputs in hard currency and are committed to supply their products at prices fixed by contracts," Genena said.
The same would also apply for firms that use bank facilities in foreign currencies, leading them to revise their business forecasts.
While the depreciation of the pound is inevitable, the Central Bank of Egypt is trying to arrange a slower, more controlled decline.
“The CBE has been very successful in maintaining a stable exchange rate through curbing the market's expectations on the Egyptian pound's price. But this has been done on the expense of depleting the country's once extensive foreign reserves,” Genena said.
Indicators, however, show that CBE can not continue supporting the pound for long.
Egypt's foreign reserves have plunged $14 billion in 2011, reaching $22.1 billion in October, according to central bank data. Reserves sank $1.93 billion in October and $1.87 billion in November.
This week, a top Egyptian army financial official predicted reserves would tumble to $15 billion by the end of January and a further climb in the budget deficit.
Another way for policymakers to limit the currency slide is to raise interest rates, stimulating demand for the Egyptian pound.
Last Thursday, the CBE raised the overnight deposit rate by 100 bps to 9.25 per cent and the overnight lending rate by 50 bps to 10.25 per cent.
The change in rates which haven't been altered since September 2009 were a strong indication of the CBE's willingness to support its battered currency.
Egypt's two biggest public sector banks, National Bank of Egypt (NBE) and Banque Misr (BM), have already raised interest rates on their Egyptian pound three-year certificate of deposits (CD). Rates climbed from 9.5 to 11.5 per cent.
Other private banks have followed suit.
Another option involves taxation on cross-border flows of capital, direct or indirect. The latter may include non-interest bearing compulsory reserve/deposit requirements, a common set of market-based controls to sustain currency.
Other administrative tools could also be used to stabilise the pound.
One method that Egypt hasn't used in decades is to impose restrictions on importing "unnecessary" or luxury goods.
According to Genena, this could eventually become essential but is highly unfavourable due to the market inconsistencies it would create and the harm it will do to many firms.
Another administrative tool could be putting restrictions on exchanging Egyptian money into foreign currencies. This, however, has the serious side-effect of creating an almost instant black market.
Following the popular uprising in January, CBE put a daily cap of dollar sales of $10,000 per client to curb the dollarisation spree expected to sweep the country.
“Such restrictions are placed in countries going through crisis, such as Syria which is experiencing a popular uprising and civil war, or Iran where a threat of war is eminent," Genena explained.
At the moment, dollar-denominated loans from international finance organisations seem to be the easiest way out of the crisis.
After turning down a $3.2 billion loan from the International Monetary Fund in June, officials announced in November that the Egypt will once again be seeking the same package.
"International borrowing is a must for the Egyptian economy at this point, but the one obstacle standing between reaching a deal is administrative instability in Egypt," Genena said.
"Even if a new cabinet is assigned in the coming days, it will be very unstable and find it difficult to provide enough guarantees to the IMF about its policy direction."
Even then, help may be hostage to political circumstances, he said.
The Eurozone debt crisis and a global economic slowdown may reduce the ability of the IMF and Western countries to help Cairo. At the same time, further bloodshed on Egyptian streets and election success for groups perceived as being anti-Western, may make the granting of such aid a politically divisive issue.
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