This guest post is by Karim Abadir, professor of Financial Econometrics at Imperial College London’s Business School. He is also a founding member of the Free Egyptians Party.
The Who once sang, “We won’t get fooled again”, and this is the message we should keep sending to the individuals mismanaging Egypt. I’ll tell you about just one of their tricks to try and fool you: Egypt’s foreign currency reserves figures.
Egyptian officials may have conveyed an appearance of organisation by releasing to the media monthly figures for gross reserves, but they have been reluctant to tell you the whole truth.
Gross reserves climbed to $16 billion at the end of May 2013, the highest point since February 2012 but look closer and not all is what it seems. This figure has been inflated by massive short-term borrowing and other activities. Behind these headline numbers, Egypt’s effective reserve level tells a very different story.
Although Egypt reports its gross reserves figure, if you calculate Egypt’s short-term net reserves, you will come up with something very different: Egypt is precariously in the red. Here are some ways to calculate short-term net reserves, depending on how deep you want to go:
1. The simplest calculation you can make is to subtract the total drains due in the short term (within a year), which are detailed in Sections II and III of the IMF’s report, from the gross figure listed in Section I there: you will reach the result that Egypt has basically no reserves left, without even taking into account what it will want to spend on importing wheat, fuel, etc.
2. Before making the subtraction, you can start by digging deeper into what constitutes the gross reserves in Section I. The result is even worse. We’re carrying illiquid assets (like gold) that cannot be transformed into cash without taking a large cut in their book value, so even the big figure totalled in Section I is misleading.
3. There are massive foreign-currency debts that our public sector companies are carrying; e.g., the many billions of US dollars (estimated to be up to $20 billion) owed by our state-run oil company, the Egyptian General Petroleum Corporation. Subtract these, and the country’s reserves position is even uglier.
4. There’s no limit to how ugly this gets! We are now borrowing from Qatar on an 18-month deal. Why do you think we went for this awkward maturity period, as opposed to just a year or maybe something longer term? Because if it’s a year or less, it will appear in Section II and make the net reserves position look more negative; and they wouldn’t want the IMF to see that Egypt has more short-term debt than reserves. And forget about a substantial longer-term loan: with our credit rating deep into junk status and close to default, who would take this risk and at what price?
An economy that’s doing well would generate income for its population, but we are not: our gross domestic productper person is continually shrinking. A successful economy would accumulate wealth and see its gross reserves increasing as a result of real economic growth, not because it is getting much more indebted or because it is relinquishing control of its historical and strategic assets. And net reserves would be increasing too. We haven’t seen this for a while.
Spread the word and monitor NET (not gross) reserves. We won’t get fooled again!
The monthly announcement of Egypt’s net international reserves figure has become more of a spectacle of the country’s economic woes than a reflection of recovery.
Egypt’s foreign reserves have tumbled more than 60% from $36 billion before the uprising that toppled Hosni Mubarak in early 2011 and as the country’s key sources of hard currency – investors and tourists – have dried up.
Reserves rose slightly to $15.5 billion helped by a deposit by Qatar to support the economy, Egypt’s minister of finance said yesterday, but they remain at a dangerous level after being run down to defend Egypt’s currency.
Though sporadic official announcements convey seemingly unwavering optimism that reserves will be back to normal levels, behind these headline numbers is a more worrying figure.
In reality, liquid reserves, or convertible foreign currencies including securities, cash and deposits that can be used to defend the Egyptian pound, are at $11.8 billion, according to Egypt financial consultancy Dcode, which used data from the Egyptian Central Bank.
According to Dcode:
Liquid Net International Reserves (net of Gold reserves) declined from $21.3 billion in September 2011 to $11.8 billion in November 2012, covering only 2.2 months of commodity imports. This figure includes past debt repayments, including a $1.6 billion debt repayment in July, but does not include any other repayments post-November 2012.
That suggests the Central Bank’s monthly announcement is extremely misleading and in fact Egypt is well below the three months of cover for imports that the IMF recommends its members retain.
But not only have economists suggested liquid reserves are falling at a faster rate than net international reserves, but that the $11.8 billon could be even lower in reality.
In a November 2012 note, Capital Economics economist William Jackson suggested liquid reserves are under $10 billion:
Jackson writes:
The CBE has intervened aggressively in the foreign exchange market to defend the pound against the backdrop of capital flight. As a result, FX reserves have fallen from a peak of $36.2bn to just $15.5bn at present (and liquid reserves have fallen even further). (See Chart 1.) The good news is that the CBE’s reserves have stabilised in recent months, mainly thanks to the drip feed of aid from the Gulf. And so long as the IMF deal is ratified by the Fund’s board next month, the Bank’s reserves should receive a more sizeable boost in the coming months.
As liquid reserves run dry, the Central Bank’s ability to defend an already overvalued pound has become untenable.
With no sign of a final agreement on the IMF loan, the Bank’s decision to launch dollar auctions (which many regarded as a late reaction) to effectively depreciate the pound makes a lot of sense.
Even more intriguing is the IMF’s own breakdown of Egypt’s reserve level.
The IMF figures suggest that the bulk of Egypt’s liquid reserves, excluding gold and other non-convertible assets, stand at about $7.1 billion. That’s in stark contrast to the Central Bank, which says foreign currency reserves are $10 billion. That $7.1 billion figure may not represent the only liquid reserves but economists say they are unsure of what this level could be at the moment.
The Central Bank’s late decision to allow the pound to fall has cost the country and the Morsi administration.
Now Egypt has little choice but to rely on immediate, easy aid from the Gulf, and a long-term (and very contentious) loan from the IMF before it can recover to its original reserves level.