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Dire forecasts for Egyptian economy

Political turmoil in Egypt may more than halve the Arab country's economic growth this year, push its budget deficit into double digits and weaken its currency, boosting already high inflation.

world Updated: Feb 09, 2011 21:07 IST

Political turmoil in Egypt may more than halve the Arab country's economic growth this year, push its budget deficit into double digits and weaken its currency, boosting already high inflation.

A month before massive anti Hosni Mubarak protests erupted on January 25, analysts polled by Reuters had expected Egypt's economy to grow 5.4% in the fiscal year ending in June, second only to Qatar. The government had forecast 6% expansion.

Banks are now reopening but with shops still closed and tourists shunning the popular holiday hub, those growth predictions now look optimistic. Some analysts have already trimmed their growth projections as the disruption strips at least $310 million per day from the crude importing economy, said Banque Saudi Fransi.

"Tourist arrivals were 20% to 30% lower year on year after the (1997) Luxor attacks or when the global economy fell into recession," Bank of America Merrill Lynch analysts said. "Should political uncertainty not abate meaningfully and remain in place for an extended period, similar contraction would shave off some 2% to 3% points from headline growth, which, along with contracting investments, would bring annual GDP growth to the 1% to 2% year on year range."

Lower private consumption, which accounts for around 70% of GDP, a drop in foreign investments and higher unemployment are also expected to hurt economic performance. Egypt's economy was worth an estimated $217 billion last year, half of oil giant Saudi Arabia, and relies on foreign investments, tourism and Suez Canal fees, but faces challenges such as poverty, high unemployment of at least 10% -- but many suggest the real figure is much higher -- and stubborn inflation.

Some analysts warn that the central bank could raise borrowing costs, with the overnight lending rate now at 9.75%, to stem capital outflows. Citi estimates outflows of $500 million to $1 billion per day.

"Tourism revenues are taking a big hit and are unlikely to recover quickly," Reinhard Cluse, economist at UBS in London, said. "Retail and foreign trade seem to be disrupted and cash reserves might still be running low."

Income from tourism -- estimated at 5% to 11% of economic output -- is an important lifeline for the Arab world's most populous country, where about 40% of people live on less than $2 per day. As protests intensified in the past two weeks, ratings agencies downgraded Egypt's sovereign ratings by one notch citing possible damage to already weak state finances.

Budget gap up

Facing public anger and a presidential election in September, the government is likely to keep spending high. Lower taxes, higher subsidies and pressures to give more money to unemployed are poised to undermine the fiscal health.

"We have already seen a 15% rise in salaries and we will probably see more government expenditure and more emphasis on wealth distribution within Egypt (taking) from the more privileged in the society and giving to the poor," said Farouk Soussa, Middle East chief economist for Citi in Dubai.

As a result, the government budget gap is likely to balloon towards 10% of GDP this year, BNP Paribas estimates, above the government's 2010/11 guidance of 7.9%. Moreover, inflation that is running at around an annual 10% is seen creeping higher on the back of loose fiscal policy and the weak pound currency.

"Our analysis shows that a 1% depreciation in the Egyptian pound versus a 50:50 euro/dollar basket adds approximately 0.3-0.4% points to headline inflation," said Dina Ahmad, CEEMEA strategist at BNP Paribas in London.

"Pass-through is therefore quite substantial and would need to be addressed by the central bank either defending the currency or hiking rates," she said.

Rate hike possible

The pound retreated 2.4% against the dollar since the beginning of the protests, that claimed some 300 lives so far. It erased part of its losses on Tuesday, following the central bank's intervention, and was quoted at 5.8800 to the dollar as of 1100 GMT on Wednesday.

Analysts said some $36 billion in central bank reserves at the end of December gave it enough fire power to face imminent capital outflows, but that longer term political instability and the risk of a run on local banks could push the pound much lower, paving the way for capital controls.

It also had an estimated $7 billion to $21 billion of additional assets with commercial banks, its so called unofficial reserves. "Over the short term, we expect the Egyptian pound to fall by 20%," said John Sfakianakis, chief economist at Banque Saudi Fransi.

Non deliverable currency forwards implied on Wednesday that the pound would soften to 6.600/900 to the dollar over the next 12 months.

To stave off inflation, the central bank could also opt to hike interest rates aggressively ahead of its planned policy meeting on March 10 to counter capital flight. "We believe the central bank will hike rates by 100 basis points in an emergency meeting this month as inflation is likely to surge on the back of a weaker pound," Ahmad said.