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Egypt Reserve-Ratio Cut Not Enough to Satisfy Needs: Arab Credit

Egypt’s move to cut banks’ reserve requirements is unlikely to be enough to meet the nation’s local-currency needs as a divisive presidential vote deters foreign investors, HSBC Holdings Plc and BNP Paribas Egypt said.

The central bank will lower the ratio of funds banks must set aside against deposits by 2 percentage points to 10 percent starting June 26. That frees up 9.2 billion Egyptian pounds ($1.5 billion), according to the average estimate from Beltone Financial, BNP Paribas Egypt and EFG-Hermes Holding SAE. Egypt will offer 9 billion pounds of debt over the next week alone, part of its 150 billion-pound quarterly fundraising target.

Treasury-bill yields are near records and are almost three times higher than Lebanon’s and four times higher than Portugal’s on the one-year maturities. The one-year yield soared 531 basis points, or 5.31 percentage points, since last year’s uprising began to 15.9 percent last week, as foreigners fled and left the onus on local banks to supply the state with funds.

Borrowing costs are rising due to “external account pressure, lack of foreign currency coming to the system, heavy borrowing by the government and lack of deposit growth to match that,” Liz Martins, Dubai-based senior economist at HSBC Middle East said by phone on May 27. “It’s all contributing to diminished liquidity in the system and the cut in the reserves ratio is not big enough to outweigh all of those pressures.”

Political Tension

The yield on Egypt’s 5.75 percent dollar-denominated bonds maturing in April 2020 has risen 26 basis points this quarter to 6.81 percent today, data compiled by Bloomberg show. That outpaced a two basis-point gain in average Middle East sovereign debt to 4.68 percent yesterday, according to the HSBC/Nasdaq Dubai Middle East Conventional Sovereign Average Yield.

Egypt’s first presidential election since a popular uprising ousted Hosni Mubarak more than a year ago has so far failed to reassure investors about a return to stability in the country of about 80 million. Protesters have already called for mass rallies after official results confirmed the Muslim Brotherhood’s Mohamed Mursi and Ahmed Shafik, the last prime minister under Mubarak, were the two candidates that advanced to the runoff next month.

“Both choices could increase political tensions, and in any case, the role of the new president or any other political institution has not been defined,” Said Hirsh, London-based economist at Capital Economics Ltd., said in response to e-mailed questions yesterday.

‘Out of Options’

The reserve-ratio change, which follows a similar cut in March that took the rate to 12 percent in its first reduction in 13 years, is the latest effort by the central bank to shore up cash among lenders.

The regulator also increased sales of repurchase agreements to give government-security holders access to funds for a week at 9.75 percent. It sold a record 34 billion pounds of the contracts yesterday, bringing this quarter’s total to 188.5 billion pounds, triple the amount from the year-earlier period.

“The bank is definitely running out of options,” Hirsh said. “Apart from changing reserve ratios, the fact is that it only has interest rates, repo facilities and outright money printing left. With politics and the economy where they are, their impacts will be limited and short-lived.”

Budget Deficit

The country has boosted debt sales as it seeks to finance a budget deficit that will exceed 9 percent of economic output for a second fiscal year, making it the highest in the Middle East according to International Monetary Fund forecasts. It plans to fund about three-quarters of that gap from sales of treasury bills and bonds, Finance Minister Momtaz el-Saieed said this month.

Foreign reserves tumbled almost 60 percent from before the uprising, while investors from abroad slashed their holdings of treasury bills by 97 percent to 1.6 billion pounds in February from the end of 2010, central bank data show.

Bank funds have also been strained by the central bank’s determination to defend the local currency against bets that it will weaken due to prolonged political turmoil, Hirsh said. Trading in non-deliverable pound forwards shows investors expect the currency to drop to 7.475 a dollar in 12 months, reflecting a 19 percent depreciation.

The pound, subject to a managed float, has lost 3.8 percent since the start of anti-government protests in January 2011 to 6.0470 a dollar at 12:49 p.m. in Cairo today. That compares with declines of more than 14 percent in the currencies of Turkey, South Africa and India.

Banks ‘Fragile’

“From the central bank’s perspective, they should keep the pound stable and focus on inflation, which has been coming down with weaker economic activity,” Turker Hamzaoglu, an economist at Bank of America Merrill Lynch in London, said by phone yesterday. “Government yields should come back only with some confidence on the economic program and some foreign interest after the elections.”

Inflation in urban areas slowed to 8.8 percent in April from 9 percent a month earlier.

Without foreign investors in Egyptian assets, the central bank’s efforts to boost local banks’ funding may not bring down the government’s near-record yields. Egypt’s benchmark EGX 30 Index posted its biggest three-day decline since March after the election, falling 5.8 percent through yesterday. Foreign investors were net sellers in the market, according to Khaled Nagah, trading manager at Cairo-based Mega Investments Securities. The gauge was up 0.5 percent today.

The reserve-ratio reduction won’t have “a prolonged effect, unless there is a fundamental change on the political and economic fronts,” Amr El Sherif, assistant derivatives dealer at BNP Paribas Egypt, said in a May 28 research note. “In the long run, we see higher systemic risk and a more fragile banking sector as a consequence of the move.”

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