By David P. Goldman
JINSA Fellow
Egypt is effectively out of cash. With foreign exchange reserves at a “critical minimum,” Egypt’s central bank imposed exchange controls and let the Egyptian pound exchange rate fall by about 5 percent from the level prevailing through most of 2012. The central bank will ration foreign exchange by holding auctions at which a limited amount of hard currency is offered, and restrict corporate cash withdrawals to $30,000 per day as well as limiting the amount of cash an individual may transfer out of the country to $10,000.
Because Egypt’s main source of foreign exchange is remittances from Egyptian citizens working overseas, the latest set of measures are likely to backfire. Individuals are likely to delay sending remittances until they believe that the Egyptian pound has stabilized, aggravating the foreign exchange shortage.
On paper, the central bank still has $15 billion in reserves, of which about half is ready cash. That covers about a month and a half worth of imports (now running at around $5 billion a month) and a little over two months of the trade deficit (now running at around $3 billion a month). After taking into account the arrears of Egyptian importers to suppliers, though, the actual level of cash reserves probably is zero or negative.
Unable to reduce subsidies that account for most of a budget deficit that now exceeds 14 percent of GDP, and unwilling to raises taxes in the face of political opposition, President Morsi has taken the path of least resistance. Currency devaluation accomplishes the same thing as higher taxes or lower subsidies, that is, reducing consumption, but it does so in a haphazard way, by raising the price of imported items.
Egypt’s Foreign Exchange Reserves (Source: Central Bank of Egypt)
In the advent of last week’s referendum on a proposed new Islamist constitution, the Morsi government postponed negotiations for a $4.8 billion loan from the International Monetary Fund, out of fear that the austerity measures required by the IMF would elicit a wave of political opposition. As Andrew Bowman wrote in the Financial Times:
The loan is conditional on some very unpopular tax increases and fuel subsidy cuts to reduce the deficit to 8.5 percent during the financial year starting July 2013. The government is loathe to take these on at this moment in time with its authority fragile and new elections looming in 2013. Indeed, when it tried to introduce new taxes on consumer goods a few days before the constitutional referendum, it removed them within a few hours following public outcry. Its loan request has been postponed until January and the delay may entail renegotiation.
The Morsi government’s failure to secure the IMF loan also jeopardizes other expected loans, including a $500 million credit from the African Development Bank. . This is a failure of governance, of the sort I analyzed on this site in September. Morsi cannot get a popular mandate without reneging on essential economic reform measures, but he cannot obtain the financing that Egypt requires to avoid bankruptcy if he reneges on reform.
That leaves Egypt’s central bank with cash reserves of just $7.1 billion (out of total reserves including gold of $15 billion), enough to cover just over two months’ worth of the country’s $36 billion annual trade deficit, equivalent to about 16 percent of Egypt’s GDP. Against this trade deficit, Egypt has
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Tourism revenues that peaked at $12.5 billion in 2010 before falling to only $9 billion in 2011, and now may be running as low as $6 billion a year, according to one estimate in the Egyptian press;
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Suez Canal revenues of somewhat less than $5 billion a year; and
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An indeterminate volume of workers’ remittances, estimated at anywhere between $7.7 billion and $18 billion;
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Whatever Egypt can borrow, which at the moment is essentially nothing.
Remittances almost certainly have risen since 2009, when the central bank estimated the flow at $9.5 billion, although a major source of those remittances—the 2 million Egyptians working in Libya—dropped sharply after the Libyan civil war. 1.7 million Egyptians work in Saudi Arabia, 500,000 in Kuwait, and 500,000 in Jordan. Their repatriated earnings are in many cases the main support of their families at home.
Egypt’s dependence on remittances, though, makes a devaluation of the Egyptian pound an especially dangerous exercise. As long as Egyptians overseas expect the national currency to keep falling, they are likely to delay sending money home as long as possible. That in turn will worsen the central bank’s foreign exchange position and make devaluation more likely, in a vicious circle. It seems clear from the earlier intervention pattern that the Egyptian central bank hoped to prevent devaluation. Since the collapse of the IMF loan negotiations, though, it may have concluded that it has no other alternative.
The position of Egypt’s foreign workers, moreover, is fragile. King Abdullah of Jordan warned at a private meeting (cited by the news site AI-Monitor) that Jordan might use the 500,000 Egyptians now working in in his country as “bargaining chips” against the Muslim Brotherhood, which he denounced as part of a “new extremist alliance” in the Arab world. Jordan’s monarchy has been under pressure from the Muslim Brotherhood during the past year, and it seems clear that the Hashemites will not sit on their hands. A major Jordanian complaint is the interruption of piped Egyptian natural gas, at an estimate cost to the Jordanian government of 5 billion Jordanian dinars. The same pipeline through which Egypt supplied Israel also met four-fifths of Jordan’s gas requirements.
Egypt’s ability to tap its neighbors for short-term loans seems exhausted. Highly publicized loans from Qatar and Turkey during the second half of 2012 were more show than substance. Turkey gave little or no spendable cash, and Qatar appears to be forcing Egypt to repay its $2 billion loan in the form of excessive natural gas prices.
According to a Dec. 17 report in Egypt’s Official Gazette quoted in the Egypt Independent, Egypt will import gas from international companies in Qatar at a cost of U.S. $14 per million BTUs. Qatar’s government sells gas at $9 per million BTUs, and Egypt is contractually obligated to sell gas to Jordan at $5.50 per million BTUs. The unfavorable terms suggest that something else is at work: Egypt may be overpaying for Qatari gas to amortize Qatar’s $2 billion emergency loan to the country’s central bank last fall. Qatar has given the Morsi government indispensable support. Announcement of this loan Aug. 12 coincided with President Morsi’s dismissal of the old-line Egyptian military leadership, and the funds have allowed Egypt to maintain wheat stockpiles at adequate levels during the past several months. It appears, though, that Qatar’s aid comes with a price tag, and that Egypt’s import costs will rise as a result.
Turkey’s pledge of $2 billion in aid does not help Egypt’s cash predicament, according to Turkish press reports. Half of the money is reserved to finance the operations of Turkish firms in Egypt, which does nothing for Egypt's urgent import requirements. The other $1 billion, according to a report in the Turkish newspaper Star wrote September 15, is an advance on a prospective International Monetary Fund (IMF) loan. With the IMF negotiations suspended, it is unclear whether the advance ever will be paid.
Egypt’s foreign exchange reserves, meanwhile, are so squeezed that banks are refusing to provide financing for food imports (other than wheat bought directly by the government) because importers have not had access to hard currency to pay their arrears, the Food Industries Association warned Nov. 27. The importers’ association warns that food imports may drop by 40 percent during coming months as a result.
It is not clear where President Morsi can turn. He is at a stalemate in discussions with the international financial organizations. The Gulf States are even more hostile to the Muslim Brotherhood than before Egypt’s political crisis, and less inclined to help. Even Qatar, it appears, is extracting payment for its previous help on a cash-and-carry basis through the energy market. The most likely outcome will be austerity through devaluation rather than tax increases or subsidy cuts, with deleterious consequences for the already-failing Egyptian economy. Morsi’s hold on political power is fragile after the mass protests that preceded this month’s constitutional referendum and the opposition’s unwillingness to concede legitimacy to the government’s narrow victory. Prior to the referendum, Morsi showed himself unable to reduce subsidies or raise taxes in order to control a domestic budget deficit and a trade deficit that are both running at close to a sixth of GDP. If he takes the path of least resistance and allows the Egyptian pound to depreciate severely, as the local market evidently expects, it may be hard for the hard-pressed Egyptian pound to find a stable bottom, for reasons noted earlier: fears of devaluation will delay remittances and provoke capital flight, worsening the central bank’s already dire cash position.
The danger is that Egypt will descend into a banana republic inflation, but without the bananas (Egypt does in fact grow bananas, but not in sufficient quantity to mitigate its dependency on imported food). We have witnessed many cycles of devaluation and inflation in Latin American countries, but all of those cases involved food exporters. Egypt by contrast imports half its food.
The government’s likely response will be to employ state controls in a heavy-handed but haphazard fashion: imposing foreign exchange controls, rationing essential items, raiding alleged speculators, and stirring up have-nots against supposed haves. If the opposition is unable to unseat Morsi, he is likely to lead Egypt to an extreme degree of statism—a sort of North Korea on the Nile.
On the strength of the available evidence, we would have to answer our question of September—“is Egypt governable?”—in the negative.
David P. Goldman, JINSA Fellow, writes the "Spengler" column for Asia Times Online and the "Spengler" blog at PJ Media. He is also a columnist at Tablet, and contributes frequently to numerous other publications. For more information on the JINSA Fellowship program, click here. For more information on the JINSA Fellowship program, click here.