While Egypt makes headlines with its political crisis and street violence, behind the scenes another danger is lurking: its foreign exchange reserves are shrinking, with another sharp drop last month.

Reserves were down to $16.4bn at the end of January, compared to $18.1bn in December and $36bn in December 2010, just before the anti-Mubarak protests began, according to central bank data published on Tuesday. The pressure for political stability – and an IMF rescue – grows bigger by the day.

Heavy intervention by the central bank has helped keep the Egyptian pound steady through the turmoil, with losses against the US dollar of under 4 per cent last year. But as reserves dwindle its firepower is weakening. As Bloomberg reported, forward contracts indicate traders expect a 16 per cent decline in the pound over the next 12 months.

Since June 2011, import cover for goods – a key consideration for a poor country importing food and fuel – has fallen from 6.2 months to 3.7 months today. For goods and services combined it has dropped below 3 months, generally regarded by economists as a critical level.

Egypt has asked the IMF for $3.2bn and the World Bank for $1bn. But investors fear this may not be enough. As beyondbrics reported, RBS said in a report last month that a $3.2bn IMF loan might have been enough when Cairo first approached the Fund early last summer. But now $10bn-$12bn might be needed to restore foreign reserves to credible levels and cover payments for imports and debt-servicing.

The problem is that the worsening political crisis makes life harder for Egypt’s negotiators. How can they reassure IMF officials that state finances are under control when the political ground is shaking under their feet? And how can they sell any sort of financing packaging to domestic political leaders, when those leaders are split, with the ruling military council under pressure to quit from their opponents, notably the Muslim Brotherhood?

Following the fatal football riot in Port Said, in which more than 70 people died, many Egyptians blamed the authorities for instigating the trouble – to punish football fans seen as backing the anti-government protests. At least 12 more people have been killed in subsequent street demonstrations.

In such a febrile atmosphere, even the IMF may struggle to lend a hand. Egypt badly needs more support from its Arab neighbours, especially the oil-rich states. But how can they intervene without having to make an awkward choice between the military council and its challengers?

Related reading:
Guest post: Egypt must bite IMF bullet, beyondbrics
Egypt-IMF: back on track (at last), beyondbrics
Egypt 2011, FT
The economics of the Arab spring, FT

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