MIDEAST MONEY-Egypt Takes Step Back from Brink with IMF Talks

By Andrew Torchia

CAIRO, Jan 11 (Reuters) – Egypt is taking a step back from financial crisis by resuming talks with the International Monetary Fund on emergency aid, but it is unlikely to escape a drop in its currency or see any quick revival of the investment needed to fuel growth.

For seven months, since the army-backed government which replaced ousted ruler Hosni Mubarak rejected the IMF’s offer of a $3 billion loan, the economy has been in limbo. Investment has largely dried up as a slide in foreign reserves threatens a currency crisis, and as the policies of the democratic government that will replace the army remain uncertain.

An IMF deal could break this cycle — not only by giving Egypt an infusion of fresh cash, but also by committing it to a set of policies to rein in the state budget deficit and push through economic reforms.

However, an IMF agreement will be negotiated under difficult political conditions, by a government which is expected to hand over power within months. And it is probably already too late to prevent some depreciation of the Egyptian pound, which could push up living costs for the country’s angry poor.

Alia Moubayed, senior economist for the Middle East at Barclays Capital, said an agreement with the IMF might be reached quite quickly, perhaps in time to allow an initial disbursement of money in March.

But she added: “At this stage, only a comprehensive package of coherent policy actions and commitments will be enough to restore consumer and investor confidence.”

That package needs to include steps to contain the budget deficit, restore public security and advance the transition to democracy, and attract aid from other international donors on top of the IMF, she said. Even with an IMF deal, the currency is likely to stay under pressure for now, she added.


Egypt and the IMF will begin talks in Cairo this week on the possibility of a $3 billion, 18-month loan to ease immediate balance of payments needs, an IMF source told Reuters on Tuesday.

The IMF has successfully negotiated deals with caretaker governments before, for example in Portugal last year. But in Egypt’s case the political uncertainty is greater.

Elections to the lower house of parliament, now drawing to a close, are expected to lead to a governing coalition led by the Muslim Brotherhood, which has not previously held power. The military plans to continue ruling until the end of June, by which time a new president is to be elected; major aspects of the new political system, including the balance of power between the presidency and the parliament, have still not been decided.

The military rejected last year’s offer of aid from the IMF out of a mixture of national pride and a reluctance to commit itself to policy conditions required by the Fund, such as curbs on government spending. Any new Egyptian government may have similar reservations.

There are signs, however, that the IMF and Egyptian politicians are finding ways around these obstacles. The Muslim Brotherhood has not opposed the idea of IMF aid, and since it became clear the Brotherhood will probably dominate the next government, it has been developing communications channels with the military-backed government; this suggests any IMF deal might be reached with the Brotherhood’s tacit consent.

One option may be for the IMF to extend aid under a facility it created in November, the Rapid Financing Instrument. This does not require traditional IMF conditions attached to loans, though the Fund says countries “still need to set out their policy commitments in a letter of intent and be willing to cooperate with the IMF in addressing their difficulties”.

Another positive sign was a statement by Egyptian Finance Minister Mumtaz al-Saeed this month that Egypt would limit its budget deficit to 8.6 percent of gross domestic product in the fiscal year to June 2012, versus an official estimate last June of 9.5 percent for 2010-11.

The IMF said in June 2011 that fiscal measures announced by the ministry at that time might be benchmarks for a loan deal — so this month’s talks will not start from scratch.

Sayem Ali, senior economist for North Africa at Standard Chartered Bank, said Egyptian politicians would be forced by the economic situation to be pragmatic, and that an IMF dealt “may be the only option left for Egypt to avoid a serious balance of payments crisis”.

“The only way to pacify the market is to have an institution with the IMF’s expertise and experience overlooking the economic reform agenda,” he said. He added that an IMF deal would probably involve commitments on fiscal reforms, taxes and subsidies which harsh economic circumstances would eventually force Egypt into making anyway.


An IMF agreement would avert disaster by forestalling any uncontrolled collapse of the Egyptian pound that disrupted imports, hurting factories’ ability to operate, analysts said.

“The challenge is avoiding a chaotic maxi-devaluation of 30 to 40 percent that could stir further panic,” said Moubayed. “That should be do-able in the context of an open and regular policy dialogue with the IMF.”

But while a $3 billion IMF deal seven months ago might have reignited capital inflows into Egypt, economists think an accord of that magnitude would no longer be enough. They cite the precipitous drop in the country’s foreign reserves, which halved over the past year to $18.1 billion in December.

The reserves have recently been shrinking by about $2 billion every month; $3 billion would only offset about six weeks of the slide, or cover less than a month’s imports of goods and services. Ali estimates Egypt will need about $20 billion of external financing over the long term to allow its balance of payments to stabilise.

This suggests the IMF may eventually have to provide much more aid to Egypt than it originally envisaged, and that contributions from other donors will be important.

Cairo has received in-principle offers of aid totalling well over $10 billion from Qatar, Saudi Arabia, the United Arab Emirates and other countries, but actual aid flows have been slow to arrive, possibly reflecting diplomatic tensions over the putting on trial of Mubarak.

So economists still expect the Egyptian pound to weaken gradually in coming months. Standard Chartered forecasts the pound, now near a seven-year low at 6.03 against the U.S. dollar, will hit 6.3 by June this year; Ali said it could reach 7 or 7.5 by mid-year and perhaps close to 8 by the end of 2012 if the political transition does not go smoothly. Moubayed said the pound could reach around 6.5 by June or 7 by September.

Investment has not entirely died in Egypt. In Cairo, renovation work continues on the opulent Nile Ritz-Carlton hotel, located next to the burned-out shell of Mubarak’s National Democratic Party headquarters, which was torched in last year’s uprising; reviving tourism is important to boosting foreign reserves. This month Arqaam Capital, a Dubai-based regional investment bank, said it acquired Egyptian brokerage firm El Rashad Securities.

But with the currency expected to fall and the political outlook uncertain, there are still strong deterrents for both local and foreign investors. Foreign direct investment into Egypt shrank to $440 million in the third quarter of last year from $1.60 billion a year earlier, the latest data shows.

“It might be three or four months until we have a clear indication of who is in control in Egypt and what policies are in place,” said Ali. (Editing by Stephen Nisbet)


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