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Jet Crash Seen Adding to Pressure on Egypt to Devalue Pound

Updated on
  • Government had hoped tourism revival would help FX shortage
  • Suspected bomb adds to challenges facing new central banker

The plane crash in Egypt’s Sinai peninsula couldn’t have come at a worse time for an economy already reeling from a dollar shortage and in dire need of emergency funding.

Growing evidence that a bomb downed the Russian Metrojet plane on Oct. 31 will have potentially ruinous implications for Egypt’s tourism industry. These charts illustrate why Egypt’s economy is ill-positioned to lose this vital source of hard currency.

Dollar Shortage

Tourism is one of Egypt’s biggest employers and foreign currency earners, bringing in $7.4 billion in the fiscal year that ended in June -- almost 40 percent more than Suez Canal tolls. It was also supposed to be a major part of Egypt’s economic turnaround, but following the airline crash Egypt suspended a $68 million, three-year promotional campaign and canceled events built around it.

In September, Egyptian security forces bombed a convoy of tourists traveling in the Western Desert region, killing 12 people, including 8 Mexicans. The tourists and their guides were mistaken for terrorists.

The Metrojet crash is “another nail in the coffin of Egypt’s tourism sector,” said Jason Tuvey, London-based Middle East economist at Capital Economics, adding that foreign visitors will stay away if they think the government isn’t getting to grips with Egypt’s security situation. “This will only add to pressure on the pound and make devaluation more likely,” he said.

Debt Exodus

More than $10 billion of foreign investment in Egyptian T-bills fled the country after the ouster of longtime leader Hosni Mubarak in a popular uprising in 2011. “It’s very hard to gauge quite how far the pound needs to fall” to bring it back, said Simon Williams, chief economist for central and eastern Europe, the Middle East and North Africa at HSBC Holdings Plc.

The central bank has already allowed the Egyptian pound to depreciate by 11 percent in three rounds since the beginning of the year, though it remains near a 15-year high relative to the country’s trading partners when adjusted for inflation. There’s general agreement that any solution to the dollar shortage requires further weakening.

“FX risks, which were already high before recent events and which have now become higher, will push inflationary expectations in Egypt to new highs as traders and consumers expect another major devaluation,” the Cairo-based investment bank Pharos Holding for Financial Investments said in a report Sunday.

Williams said before the crash he predicted the local currency would fall to 9 pounds per dollar by mid-2016, from the official rate of 8.03 currently and a black market rate of about 8.56.

Egypt’s main stocks benchmark EGX30 was down 1.6 percent on Monday, for a year-to-date loss of 19 percent that has made it the fourth-worst performer of 93 indexes tracked by Bloomberg.

Dwindling Reserves

Egypt’s foreign currency reserves have been falling since 2011, as the government propped up the currency and maintained spending. Though aid from Gulf countries has kept Egypt afloat since 2013, that’s budgeted to fall this fiscal year and foreign direct investment hasn’t recovered under President Abdel-Fattah El-Sisi.

The dollar scarcity prompted authorities, led by outgoing central bank Governor Hisham Ramez, to try to conserve them by limiting access. He prioritized companies bringing in goods deemed vital to the economy. Restrictions on dollar cash deposits were implemented to prevent businesses from using black market currency inside banks.

The measures crimped business investment, and didn’t prevent reserves from dwindling to less than half of their pre-2011 level, or roughly equivalent to about 3 months of imports.

Inflation Risk

Solving the crisis by weakening the currency carries risk, the most obvious being an increase in the cost of imported goods. Even with the global decline in oil and food prices, Egypt’s annual inflation is expected to be 9.5 percent in 2015, the second-fastest of all oil importers in the Middle East and Central Asia analyzed by the International Monetary Fund.

“You don’t want prices to soar as you devalue the currency,” Bank of America Merrill Lynch economist Jean-Michel Saliba said before the plane crash. “People are not very wealthy in Egypt, and the country has had upheavals in the past, so they probably want to move very carefully on this front.”

The government has so far avoided signing on to an IMF program, which would increase investor confidence in the health of the Egyptian economy -- and may also entail unpopular economic measures. Egypt’s emergency funding requirement may have risen by as much as $2 billion since the plane crash, on top of the $4 billion the government has already said it needs, Pharos Holding said.

None of which will make welcome reading for Tarek Amer, the incoming central bank governor who takes the helm on Nov. 27. Egypt’s foreign currency crisis stumped his predecessor Ramez -- a crashed plane has made solving it even harder.

— With assistance by Ahmed A Namatalla

(Adds EGX30 stock index falling in 10th paragraph.)
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