Egypt on the brink


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Capital is always a coward. So goes the saying. It goes where there is political stability and it leaves when political risk increases, confidence has been eroded and the investment environment becomes unstable.

For Egypt, the toppling of Hosni Mubarak's regime two years ago brought tremendous euphoria to thousands of people who hoped the demise of the old system would usher in a new era of accountability, stability, transparency and some measure of equity when it comes to wealth distribution that would diminish the existing disparities in society.

Instead, Egypt has been on a thorny road, infused with violence and a chaotic state of disorder that bodes little for reconciliation or a democratic transition in a post-Mubarak era. The prevailing environment has failed to restore investor sentiment.

Egypt's new president Mohamed Mursi, who comes from the Muslim Brotherhood, has irked only regional governments who fear the destabilising influence of his Islamist allies on their countries. The new Egyptian president has, more importantly, failed to dispel people's fear that he's not very different from his predecessor. Attempts to expand his constitutional powers and deem them “unchallengeable" last year - until a new constitution was ratified and new parliament elected - ignited widespread protests from liberals, secularists, Coptic Christians and members of the judiciary.

His election has been marred by ensuing violence that has essentially left the country in a state of limbo, with the economy in a state of inertia. Egypt’s talks for a $4.8bn loan from the International Monetary Fund (IMF) have stalled, making it much more difficult for the country to find other means of funding or to carry out much-needed reforms.

“Political unrest makes it more difficult to take economic decisions," says Richard Fox, head of Middle East and Africa sovereign ratings at Fitch Ratings. “The president revoked sales tax adjustments that were a key prior action for the IMF programme, which is also crucial for economic progress as it would demonstrate that the government was finally getting to grips with the economy. It would also catalyse substantial multilateral and bilateral funding."

Egypt's sovereign rating has been cut by Standard and Poor's and Fitch Ratings to junk status which puts it on a par with Greece. The central bank's foreign currency reserves have nose-dived more than 60 percent in two years to $13.6bn (enough to cover about three months of imports). In 2011, the regulator spent an average of $1.4bn a month to defend the Egyptian pound in the wake of declining tourism receipts. That has made it all the more challenging to retain confidence in the currency, which has lost about 8 percent of its value against the dollar since end of last year - leading Egyptians to buy up foreign currency in the market and the re-emergence of a black market.

“The central bank has only limited firepower to defend the pound," says William Jackson, an economist at London-based Capital Economics. “It has tried to alleviate pressures on the pound by letting it fall gradually and limiting banks' access to foreign currency. However, in the absence of private capital inflows, this policy is unsustainable."

The concern now is about rising unemployment (estimated at above 12 percent), declining tourism receipts (forecast to have plunged more than 30 percent to about $7bn) and surging inflation, as market expectations point to a further devaluation in the currency.

“We are going down an inflationary path, everything that is happening is pointing in this direction," says Wael Ziada, Head of Research at the Cairo-based EFG Hermes investment bank. “Unfortunately the performance of the government from an economic standpoint has not been one that could prevent an inflationary shock or slow down the impact. One would have hoped for a better-orchestrated plan to prevent inflationary shocks but at this stage and with the current government performance I don't believe this is avoidable."

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