Donor support to avert payments crisis

21 December 2001

The government is counting on receiving some $2,000 million in cash aid over the next six months to help stave off a balance of payments crisis provoked by the sharp drop in tourism income.

The extra cash will be used to support the exchange rate following the 13 December devaluation. Prime Minister Atef Obeid says the IMF will make a significant contribution, with other funds coming from bilateral donors - primarily the US - as well as the Abu Dhabi-based Arab Monetary Fund and the Jeddah-based Islamic Development Bank.

The most recent quarterly balance of payments figures issued by the Central Bank of Egypt give an indication of the vulnerability of the economy to an external shock such as has happened to the tourism industry following the 11 September attacks on the US.

The figures for the first quarter of 2001/02 (July-September) show a small deficit on the current account and an overall payments surplus of $575 million. However, the second quarter of the financial year will show the effects of the collapse in tourism income. In the first quarter, tourism brought in $1,146 million. In the period from October-December, revenues from the sector are likely to be reduced by at least 50 per cent. Another important one-off factor in the figures for the first quarter is the inflow of $1,500 million to the capital account as a result of the issue of Egypt's first sovereign Eurobond (MEED 13:7:01).

The loss of tourism income suggests that the current account will show a deficit of some $600 million in the second quarter, and the overall balance is also likely to be deeply in the red.

The economy faced similar problems after the 1997 Luxor attacks on tourists, but the government took a long time to react. This time round, economists say the response has been relatively prompt and decisive, reflecting a shift in style on the part of the newly appointed central bank governor Mahmoud Abul-Ayoun.

In the previous crisis, the central bank tried to defend a fixed exchange rate against the dollar. However, this proved unsustainable, and resulted in the central bank's foreign exchange reserves falling by some $5,000 million over two years, from a peak of $20,000 million. Reserves stabilised at the start of 2001, and stood at $14,839 million at the end of September. However, the central bank's net foreign assets - which give a more accurate picture of funds available to intervene in the market - are more limited, at the equivalent of about $3,680 million. Economists say this explains why the government is so anxious to receive balance of payments support despite the apparently robust position of its foreign reserves, which are sufficient to cover 11 months of imports.

The 7.5 per cent devaluation to a central rate of $1=£E 4.50 was announced just before the Eid al-Fitr holidays, giving the market ample time to digest the move. Parallel market rates of up to $1=£E 5.00 had been quoted in the run-up to the devaluation. However, analysts say the size of the devaluation and the commitment of the central bank and the government to keep the market well supplied with dollars should ensure stability in the weeks ahead. Egypt has very little short-term debt, and there has been little evidence of a link between devaluation and inflation in the past, so the risks normally associated with devaluation in emerging economies are minimal, HSBC noted in a briefing issued in mid-November (MEED 7:12:01, Cover Story).

However, analysts say the central bank should ensure that the new rate is managed more flexibly than has been the case in the past. Abul-Ayoun has indicated that the central bank is considering shifting the peg for the local currency to a basket of currencies rather than just the dollar, a move that analysts say would make sense given that a large slice of Egypt's trade is with the euro-zone.

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