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BREAKING VIEWS

Egypt's pound pledge may return to bite

Dubai, August 28, 2012

Egypt's politicians and central bankers are in the business of downplaying fears over a currency. New Islamist President Mohamed Mursi, however, hasn't left himself much room for manoeuvre after ruling out a widely anticipated devaluation.

The pound has been fiercely defended by Egypt's central bank, falling just five per cent against the dollar since the uprising 18 months ago, against a backdrop of high inflation. This has proven a high-cost defence. Foreign reserves have fallen by more than half.

The current account deficit will widen to $8.5 billion in the fiscal year ending in June or 3.3 per cent of GDP, according to HSBC. That has raised the cost of borrowing, with the government currently paying near 16 per cent interest on treasury bills.

A lot would need to happen for Mursi to fulfil his pledge on the currency. Investor confidence is slowly building after a move to retire two top military chiefs and force legislative powers to civilian rule. But security must improve before the recovery in tourist numbers translates into higher revenue. And a deal with the International Monetary Fund is needed to win back foreign investors en masse, and kick start economic growth to the level required to create jobs.

Devaluation is a more certain path. A weaker currency would boost Egypt's competitiveness. Egypt's export-to-GDP ratio increased by over 10 per centage points on average in the three years following previous devaluations, according to Capital Economics.

A weaker pound would also win back foreign investors. The increase in the cost of food and fuel subsidies, which already account for one quarter of government spending, could be limited if coupled with sensible reforms.

The IMF is likely to seek a guarantee that the $4.8 billion loan Egypt has requested won't be frittered away in a hopeless defence of the pound. A number of economists had speculated that devaluation would be a condition of the agreement. Investors might not take Mursi's assertions at face value but if the pound does fall, Egypt's president will lose credibility along the way.

Context News

- Egypt's new president Mohamed Mursi said on Aug. 28 that he would not impose new taxes in the short term or devalue the country's currency and rely instead on investment, tourism and exports to fix the economy.

- Asked in an exclusive interview with Reuters if his government had any thought of devaluing the Egyptian pound, Mursi said: "No. Definitely not. This is completely out of the question."

- On Aug. 25, Gehad El Haddad, a senior adviser to the ruling Freedom and Justice Party said on Twitter that devaluation was "Still in debate. Recognize necessity, but debating when & how to do it and how much."

- The pound has fallen 5 per cent against the dollar over the last 18 months despite the drop in demand from tourists and investors.

- "The tax system needs reviewing so that government support reaches those who need it, not those who don't," Mursi added. "There is a gradual plan so that taxpayers bear their true responsibility and pay what they truly owe."

- The government last week formally asked the International Monetary Fund (IMF) for a $4.8 billion loan to plug the financing gap in its budget and balance of payments.

- Foreign reserves have fallen by more than half since the uprising began to $14.5 billion. The government is paying interest rates of up to 16 per cent on some treasury bills.

- Egypt's core inflation, which is used by the central bank to help set interest rates policy, slowed to 6.34 per cent in July from 7.2 per cent a month earlier. – Reuters




Tags: Egypt | Central Bank | Currency | Pound | Mursi | Devaluation |

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