A week is a long time in politics – the announcement of Mohammed Morsi as president ‎demonstrates political life is on the path to some sort of resolution. Serious economic ‎concerns however remain. On-going demonstrations and post-election stand-off in ‎Tahrir aside, as the newly fangled government will likely be occupied in untangling ‎Mubarak’s legacy the economy continues to teeter on the abyss.‎

Despite the suspicious Central Bank claims that reserves actually rose in May, the ‎economy may about to veer over the edge. The ‘early’ warning signs of disorderly ‎currency devaluation are omnipresent. According to Central Bank statistics, net foreign ‎currency reserves fell to $15.3 billion in May from $36.1 billion in December 2010 (inset ‎chart below). Foreign exchange reserves now cover around three months of imports and ‎freely convertible reserves (deposits), have waned from $30 billion at the start of the ‎year. These are not new or relative lows – rather, they are potentially insolvent lows ‎should something go wrong – such as a belief that the pound will devalue. The paradox is ‎that imposing foreign currency conversion limits only seeks to exacerbate anxiety over ‎the overall economic context. Venezuela is a case in point. In short, if imports slow (due ‎to exchange restrictions), everything slows.‎

What happens there is scant foreign exchange to pay for imports? When imports are ‎no longer affordable, Egypt can either (a) imports less (and spend less as a government), ‎‎(b) source existing product imports from markets that offer lower prices (and eventually ‎produce what it imports) or (c) forego more Egyptian Pounds for what it does import (at a ‎weaker exchange rate) – or a variation of all three.‎

The current composition of Egypt’s imports (by product and country) doesn’t give much ‎for manoeuvre. The single biggest import items are energy and food – the increase in the ‎cost of these anchor products contributed to unrest in the first place.‎

The single biggest import item for Egypt is fuel – some $9.3bn last year. Kuwait, Saudi ‎Arabia, Turkey and Algeria jointly supply approximately 60% of this. European refineries ‎providers supply the rest. The second most survival-dependent item in the ‎import bill, Cereal, is also relatively concentrated. More than 55% of cereal comes from ‎the United States and Russia. Argentina, Brazil, the Ukraine, Romania, France, Australia ‎and Canada supply an additional 42%.‎ The recent $1bn ITFC loan is a pale in comparison to Egypt’s import needs.

The good news, if any, is these products are coming down in price. Oil has tapered off its ‎‎2012 highs. The bad news is global cereal production insofar as the first half of this year doesn’t look promising. A heatwave is threatening the US grain harvest and the Latin American yield is lower than last year. This doesn’t mean Egypt ‎will spend less but it doesn’t necessarily mean less product will be imported. Egyptians ‎are already paying more. For everything – the likelihood of the average worker spending ‎more time in working for the same amount of foreign exchange is much higher. Inflation ‎in Egypt averaged over 10% in 2010 and 2011. Over the same period the Egyptian pound ‎‎‘slipped’ only 6% against major currencies. ‎

More bad news – some prices will remain sticky for some time. The price of some ‎items has forged ahead faster than others in recent years creating a skewed consumer ‎basket. The average Egyptian, if such a person exists, is estimated to be spending twice as ‎much on food compared to five years ago. ‎

What can Egypt do?‎
‎1) $1bn banked, negotiate with the IMF and apply another $3bn ‘band-aid’?
The real question is what happens when the $3bn runs dry? The reality is that Egypt ‎needs $30bn. The Minister of Planning and International Cooperation and other officials ‎suggested that Egypt was aiming to sign an agreement with the Fund in February, March, ‎April, May, June and now July perhaps? It’s no surprise that there is a complete ‎disregard or political currency for the IMF’s key conditions. They are (almost ‎everywhere) hugely unpopular and come at time when there are more pressing matters at ‎play. Ultimately the stand-off with international creditors is likely to leave the central ‎bank in a position whereby it would no longer be able to defend the currency. The irony ‎is, in the context of a devaluation, Egypt would probably need the IMF funding more. ‎Governments world over are no longer borrowing at competitive rates – foreign investors ‎have largely abandoned Egypt’s debt market sending yields on ‎one-year government bills ‎to about 16% from 11% at the start of last year. Foreign ‎holdings of Egyptian treasury ‎bills are one-twentieth of the level they were last year. Other sources of band-aid ‎financing are available and Egypt has sought to apply these as soon as possible:‎

‎2) Let the pound slide, impose capital controls and write lots of ‘I owe you’ stick-it notes. ‎AKA, ‘do nothing but pretend you’re doing something’ scenario. Assuming the ‎government is caught flat footed with very little vestibile currency banked, virtually little ‎more than a few chestnuts in the coffers, there would be almost no room for manoeuvre on ‎the currency. Ironically, letting the pound slide would make the fuel and food subsidy fix ‎unsustainable and the IMF would not needed to advise how to perform the ‎burdensome task of impoverishing millions of Egyptians. It would be a systemic outcome.‎

According to some REER estimates from the smart guys at Capital Economics, the pound ‎is likely to slide around 15%. I think 30% is much more likely. What happens if the ‎pound slides? It would give tourism the much needed boost provided operators don’t ‎ramp up their prices immediately. Tourist arrivals in Egypt are down 40% in May this ‎year compared to the October 2010 season peak of 1.48 million visitors. [Updates on the ‎impact analysis available by email]‎

‎3) Do the hard things first – get back to work and restore investor sentiment.‎
Egypt has the ability to produce what it imports domestically– an import substitution ‎cum industrialisation strategy – which would require at least a decade of industrial ‎resolve geared on the productive and technical constraints seen elsewhere. Import taxes ‎can only partially band-aid the hefty productivity gashes. Investing in a post-industrial ‎complex mind-set requires an education system geared to producing entrepreneurs who ‎can go from ‘0 to 1’. The ‘1 to n’ is relatively straight forward. We are perhaps a ‎generation away from this. ‎

Should the confluence of outcomes 1) and 2) prove difficult to bear for the population at ‎large there is always the option of targeted subsidies. The most vulnerable voted and they ‎will rightly be protected. The Brotherhood has nominal control of the parliament and the ‎constitutional assembly and now the presidency but they too understand that it could all ‎be lost if they fail to manage the economy. Their allies could too well be the military in ‎this regard. February’s military’s cash transfer of $1bn towards to the government budget ‎is a linchpin as much as the possibility an IMF hand out. Further, (low-spend) tourists ‎are coming to Egypt while prices are depressed, and its Peace Pipe (critical gas pipeline) to its ‎neighbour underlines that there is more foreign exchange slack than most statistics ‎currently show.‎

Verdict: Rhetorical discourse is likely to be directed at maintaining political ‎plurality, crafting of a new constitution – and we all know this does little to resolve ‎Egypt’s finances. This, however, bodes well for the IMF because right now it’s the ‎cheapest creditor in town.‎

Disclaimer:‎ The commentary is entirely a personal view, comes without guarantees and does not ‎represent the view of the entities or establishments the author works, or has worked for.‎