Egypt VS Coronavirus: The pound faces a war of attrition, not crisis

This is part 2 of a series.

“Damocles” is the label used by Nomura to identify emerging market currencies which are seen as at risk of a crisis within the next 12 months. On the index, if a country receives a score above 100, it is then labelled as vulnerable.

Egypt was added by Nomura to the six-country danger list in April, jumping straight into first place despite having previously failed to make the list.

The COVID-19 pandemic raised the risks for the Egyptian currency in several ways. Tourism, which was bringing in US$1b a month, has collapsed. Many foreign investors have sold their Egyptian T-bills. Revenue from the Suez Canal has slumped, with the Economist Intelligence Unit in London predicting a 22.6% decline in global trade volume in 2020.

READ MORE Coronavirus: How is Egypt navigating the economic fallout?

The Egyptian pound had been weakening even before Nomura’s April report. The currency has been declining since reaching a high of 15.6 to the US dollar in mid-February, and now trades at 16.18.

• Nomura sees the pound ending 2020 at 16.55, before falling by another 4% to 17.20 by the end of 2021.
• Nomura tracks 30 countries for its measure. A score of 100 or more puts a country on the danger list.
• Egypt now has the highest Damocles score of 176, a jump of 91 points from July 2019.
• Eight factors are used in Nomura’s assessment: import coverage, short-term external debt, exports, foreign reserves, broad money, short-term real interest rates, cumulative non-FDI gross inflows, fiscal and current account balances and the real effective exchange rate.

Liabilities Covered

Nomura says that the approach has correctly predicted 67% of 54 currency crises since 1996 – though it doesn’t say how many countries were wrongly labelled as being “high risk”. Others are taking a more sanguine view that won’t grab as many headlines.

• Egypt’s external risks will remain relatively contained because foreign-exchange reserves “sufficiently cover the economy’s external liabilities over the next few years,” Moodys analysts led by Elisa Parisi-Capone wrote on 8 June.
• The central bank’s foreign-exchange reserves dropped by almost a quarter between the end of February and the end of May, when they stood at $32.1b.
• But A $5 billion eurobond sale at the end of May as well as access to new IMF funding should be enough to ensure that the pound avoids sudden decapitation.
• The eurobond sale was Egypt’s largest ever, and was subscribed more than four times.
• The IMF said on June 5 that it had agreed to lend US$5.2b to Egypt as part of a one-year stand-by arrangement.
• This is in addition to $2.8b from the IMF in the form of a “rapid financing instrument” in May.
• All told, the government was able to raise US$13b in April and May.

If the central bank’s objective is to smooth the pound’s volatility, then “I would say that the central bank has enough reserves,” says Pascal Devaux, senior economist for the Middle East and North Africa at BNP Paribas in Paris. The IMF funding and the eurobond issue are “very positive for external liquidity”.

READ MORE Egypt VS Coronavirus: Banks take stimulus cash but don’t onlend

Much will depend on oil, and the resulting foreign remittances which flow into Egypt from expatriates living in the Gulf. According to the American Chamber of Commerce in Egypt, expatriate worker remittances are the country’s biggest source of hard currency, bringing in US$27b per year and accounting for about 30% of foreign currency revenues.

Bottom line: Egypt’s ability to refinance internationally means that the pound faces a war of attrition rather than an immediate crisis.

For part 1, click here.

For part 3, click here.