Egypt’s financial system faces a moment of truth

February 3, 2011

Egypt’s financial system faces a moment of truth. The country didn’t have an economic crisis before the past ten days of protests began. But its banks and stock exchange have been closed for a week. When they reopen, starting on Sunday, the fear is that the political turmoil could prompt a financial meltdown.

The central bank is due to reopen on Sunday, while stock market trading will resume the next day – though that could be delayed if violent clashes continue. So far, markets across the Mid-East region have largely ignored the unrest. Yet before the Egyptian market closed, there were signs that investors were fleeing.

An exodus of foreign investors would probably be manageable. The central bank says its official reserves are $36 billion. Additional assets held with commercial banks – regarded as unofficial reserves – are estimated at around $20 billion. Before the crisis, foreigners held just 7 percent of Egypt’s total public debt, equivalent to a little over $11 billion.

The bigger worry is if Egyptians also take fright. The rich could decide to shift their money into gold, dollars or overseas markets. The poor, many of whom are relatively new to banking, may choose to stash their life savings under mattresses instead.

Egypt’s banks could probably cope with a short-term run. Lenders are well funded with loan-to-deposit ratios of around 50 percent. More than half the country’s 38 banks are owned by foreign groups, which are likely to back their subsidiaries. Public sector banks, which account for about half the market, benefit from full government support.

However, banks are the main buyers of government bonds. So sustained bank trouble would make it harder for the Egyptian government, already running a deficit, to borrow or refinance debt as it comes due. A declining currency, one possible consequence of turmoil, could fuel inflation.

Any prolonged unrest will, therefore, force Egypt to make more tough choices. Propping up its banks and currency could quickly drain the central bank’s reserves. But keeping banks and the stock exchange closed could further erode confidence. Capital controls and withdrawal limits at banks may be the least bad of several unattractive options.

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…a moment of truth…to make more tough choice/rvdrhayr

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