With protesters returning to Cairo’s Tahrir Square, the political risks are leaving the Egyptian pound’s foreign exchange rate under pressure and vulnerable to a big fall as the Egyptian central bank runs out of reserves with which to support it.
The Egyptian pound has been remarkably stable for most of this year, despite political upheaval surrounding the “Arab Spring” pro-democracy protests, which led to the end of Egyptian President Hosni Mubarak’s three-decade hold on power in February.
The Egyptian pound has only weakened about 3 percent against the dollar year-to-date, a slower rate than that of many of its emerging market peers. That’s largely because Egypt’s central bank has sold foreign exchange reserves to prop up the currency.
But now, a new wave of political instability is at hand as three days of pro-democracy protests against the caretaker military government have left at least 33 people dead.
The turmoil is likely to hurt Egypt’s economy right at moment when the central bank’s reserves are running low. It may be left with no choice but to let the pound fall.
“It’s not possible for the Egyptians to maintain the current exchange rate,” said Wike Groenenberg, head of CEEMEA strategy at Citigroup. “At some point they’ll have to allow currency depreciation.”
The dollar traded against the Egyptian pound at EGP5.9993 earlier Tuesday, just shy of the EGP6.00 mark, a level at which authorities have taken action in the past to stem currency weakness.
The Central Bank of Egypt’s reserves have sunk by $14 billion since the end of December 2010 and are now sitting around $22 billion. But they are heading toward unsustainable levels, according to analysts.
Such a rapid depletion of reserves poses a serious threat to the pound, which the central bank has used as a stabilising factor for its economy. A weaker pound could result in higher inflationary pressures, which may only exacerbate discontent in a country with towering unemployment and already-soaring inflation.
Egypt’s annual headline inflation was 7.1 percent in October, while the country’s unemployment rate rose to 11.9 percent in the third quarter from 8.9 percent a year earlier. A high rate of youth unemployment was one of the factors that spurred mass demonstrations in Arab countries like Egypt, Tunisia and Yemen earlier this year.
A freefalling Egyptian pound could also lead to capital flight by local investors, whose investments are crucial to the economy’s stability. That, in turn, would have a self-perpetuating impact, putting fresh pressure on the currency.
“It’s less a question of foreigners exiting [Egyptian markets] because most of them already have,” said Ajmal Ahmady, analyst at Acadian Asset Management. “It’s more a worry of people within Egypt converting to dollars.”
He added that if the central bank keeps losing reserves, it is more likely to devalue its currency.
But Egypt instead may likely be able to get additional funding from the International Monetary Fund or from the nearby Gulf Cooperation Council, a bloc of Gulf states, including Saudi Arabia and Qatar, he said.
Citi’s Groenenberg expects up to a 5 percent depreciation against the US dollar in the next few months, followed by a 15% devaluation, most likely after the next several months of elections and once a new government is formed.
But for now, political unrest has returned in full force, leaving local markets shaky and even the future of upcoming elections uncertain.
Tens of thousands of Egyptians flocked to Cairo’s Tahrir Square on Tuesday, responding to calls for a million-man march demanding an end to military rule in the country, as the country’s generals struggled to contain an unprecedented challenge to their increasingly unpopular rule. There, many of the protesters clashed with security forces in a bloody exchange.
The head of Egypt’s ruling military council later Tuesday pledged to move up the timeline of presidential elections and suggested he was willing to hold a public referendum on the role of the country’s military. But the highly fluid political situation is keeping investors cautious.
Holding elections is key, many say, to restoring market confidence in the Arab nation and to prevent further outflows which may crush the Egyptian pound’s foreign exchange rate further.