The Egyptian pound has been suffering a dramatic devaluation in recent weeks, falling to record lows as political turmoil casts doubt over the country’s economic prospects.

The slide continued on Thursday, albeit at a slower pace, with the currency reaching a record low of £6.42 to the dollar in the spot market as of 15.30 GMT, as the central bank completed its fourth successive dollar auction in a week. This adds to declines of over 3 per cent since Monday when the auctions began – the biggest falls since 2003.

Foreign exchange reserves, reported as $15bn in November, have fallen by around 60 per cent since the overthrow of Hosni Mubarak in February 2011 and are now at what the central bank earlier last week called “minimum and critical levels” sufficient to cover less than three months of imports.

The central bank says its daily auctions this week, at each of which it has sold $75m, are intended to “preserve foreign-currency reserves and ration their use” for essential transactions such as paying for key imports and repaying external debts.

The auctions have accelerated the devaluation of the pound but, significantly, are an attempt to lead a managed rather than a disorderly devaluation – such as could have followed an unsuccessful attempt by the central bank to maintain its previous unofficial peg of around £6 to the dollar.

Bartosz Pawlowski, a strategist at BNP Paribas, described the auctions to beyondbrics as “first of all inevitable, and second of all a sensible way of trying to handle the situation. Much better than letting it [the currency] go at random.

“They are moving in the right direction but at this point its not like they have a lot of choice. They don’t have sufficient reserves to defend the currency.”

The economic turmoil of recent weeks prompted a ratings downgrade on December 24 to B- from Standard & Poor’s – six notches below investment grade and the same rating as Greece. The crisis has prompted ordinary Egyptians to start swapping local currency for dollars. Foreign exchange houses in Cairo are reported by news agencies to be turning away customers for lack of supply.

The nervousness has been shared in the markets. A government bond sale was cancelled on December 27 and forward contracts suggest the pound could drop a further 14 per cent in the coming year, according to Bloomberg.

Momtaz El-Saieed, finance minister, said this week the pound would “never” be allowed to fall to £7 to the dollar. Some argue though that a devaluation of this measure would ultimately be positive for the Egyptian economy. Neil Shearing of Capital Economics in London told beyondbrics the auctions were “an acknowledgement that policy towards the currency has shifted and become more transparent”.

Previously, the central bank had claimed to be running a floating exchange policy but, Shearing says, “in practise it was a very tightly managed floating currency, it had been falling for a while in baby steps.” In a note on Wednesday, Capital Economics said the pound might weaken by 10 to 15 per cent over the year, to a ‘fair value’ of £7.5 per dollar.

Prior to its recent falls, the pound had fallen only slightly from £6.02 in January 2012 to £6.11 at the start of December and this had led, Shearing says, to a gradual erosion of external competitiveness.

The Egyptian stock market has reacted positively to the devaluation, rising by over 3 per cent so far this week.

“The banking system and economy in general doesn’t have that much external debt. It is mainly domestically held and denominated in pounds. Normally you’d get concerned about an emerging market currency devaluation, but it’s less of a concern in this case”, Shearing added.

However, Egypt is vulnerable to swings in the currency because it imports almost half of its food. Prices of key goods are regulated so the impact can be delayed – but for how long? Without subsidies, any weakness in the pound would feed directly into higher food prices, prompting further instability on the streets.

Whether the central bank’s efforts are ultimately successful in preventing a disorderly devaluation will be out of its hands.

“The main risk is dollarisation,” Pawlowski says. “No central bank in the world would be able to resist if the population decided to convert its money into dollars.”

As well as the Egyptian population, the IMF will play a key role. Financial support from Gulf states has provided a lifeline to Egypt in recent months but the government has also sought a $4.8bn loan from the IMF to put an end to the threat of a balance of payments crisis.

However, while an agreement on a loan was signed in November, the Egyptian government has asked for it to be delayed. The conditions attached include unpopular tax increases and reductions in fuel subsidy, which the government is reluctant to embark on in the face of renewed political instability – tax increases were cancelled hurridly after they sparked more protests.

Talks with the IMF are due to begin again later this month, according to Prime Minister Hisham Qandil, but their outcome will depend on Egypt’s political situation.

Separately on Thursday, Egypt’s General Authority for the Supply of Commodities said it had enough strategic stocks of wheat to last the country until June – a sure sign that the issue is a big concern.

Related reading:
Egypt: cancelled debt issue and downgrade cements poor December, beyondbrics
Egypt’s Morsi preaches optimism for 2013, FT
Gulf banks ready to invest in Egypt, FT
Special Report: Egypt 2012, FT

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