Heavy weather

Almost as striking as the scale of the US economy's current setback is the relative immunity the Egyptian economy has enjoyed in its face, Sherine Abdel-Razek reports

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World leaders and leading economists attending the World Economic Forum meetings in Davos last week focussed predominantly on fears of a pending global economic meltdown triggered by the evident signs of an impending US economy recession. Referring to the old economic saying: "When the US sneezes, the world catches a cold," BBC online quoted New York University economist Nouriel Roubini as saying in one of the forum's sessions: "This time, the US suffers a protracted pneumonia, and we can only guess what will happen in the rest of the world."

What happened earlier last week in the global international markets was a dummy run of what Roubini might have meant. Fears of economic recession in the US, resulting from the recently released employment figures and the credit crunch caused by the collapse in the US mortgage market -- known as the sub-prime crisis -- weighed down on Wall Street and was transferred in a domino-like movement to financial markets around the globe. Starting with the FTSE in London and up to the Tadawul index in Saudi Arabia, most indices worldwide followed a downward trend and a handful of markets shouldered double-digit losses.

The aggressive intervention by the Federal Reserve Bank, the US Central Bank, on 23 January, to cut the interest rate by 0.75 per cent -- its highest reduction in almost 20 years -- cushioned the fall. However, it failed to calm recession concerns, particularly amid strong projections of another impending reduction in interest rates by the Federal Reserve -- a move which, coupled with the current red hot oil prices -- would fuel inflation, reduce private consumption and investment and push the dollar and global economy over the edge.

According to a report issued this month by the United Nation's Department of Social and Economic Affairs, a new steep fall of the dollar would immediately depress United States demand for goods from the rest of the world. In addition, according to the report, since many developing countries are holding a large amount of foreign reserves in dollar- denominated assets, a sharp depreciation of the dollar would entail substantial financial losses for these countries. Since 2002, the US dollar lost nearly 35 per cent of its value against other major currencies. The situation is particularly critical now as one quarter of this depreciation occurred between January and November 2007.

In the midst of a dismal world outlook, how does Egypt fare? The 6.73 per cent decline in the Egyptian market in last week's transactions was marginal when compared to other regional markets, such as that of Saudi Arabia, Kuwait and the UAE.

"What happened was an adjustment move, with local market investors cashing in on their holdings to make profits from the increase in share prices since the beginning of the year," said Bassim Arida, head of international sales at the Commercial International Brokerage Company (CIBC). "We cannot consider it a market collapse or even a steep decline. It is very healthy," he said.

The silver streak, according to Arida, is that the cause of the decline was not the heavy-weight investment funds pulling out. It was the small-sized, speculating hedge funds that flee the market.

Foreigners -- mainly institutional funds -- were net market buyers during this week's early transactions, a sign that they were here to stay owing to both a robust economy and solid market fundamentals.

Nevertheless, what is usually impacted more forcefully with a dollar decline is not as much the stock market as the foreign exchange market.

Surprisingly, the dollar's exchange rate to the Egyptian pound did not change. On the contrary, it increased at the end of last week to reach LE5.55, which is almost one per cent higher than its level at the beginning of January, when the green-backed currency lost 10 piastres to reach LE5.45.

"This increase can be justified only by a hike in dollar demand last week, as hedge funds pulled out of the market to transfer their money in dollars to their home countries," Arida said.

Market observers believe that the increase might also have been the outcome of the Central Bank of Egypt's intervention to support the dollar at the expense of the local currency, in the hope of shielding Egyptian exports from being negatively impacted.

A report released by EFG-Hermes three months ago when the dollar value retreated against the Egyptian pound ruled out any adverse effects on exports in case of an increase in the value of the pound versus the dollar, as the EU is our main trading partner, with more than 40 per cent of our commerce going to and coming from the union. According to recent figures, Egyptian exports to the US stands at around 28 per cent of total exports, while imports from it represents 19 per cent of total imports.

Meanwhile, investors holding on to dollar-denominated deposits have sustained a hard loss. Following the move, Egyptian banks cut dollar interest rates to less than three per cent. This came after a series of cuts introduced since mid-September that shaved the revenues off dollar deposits by 1.75 per cent.

"This will encourage increased investment in local currencies, although the pound's increased liquidity will cause a fall in interest rates, which, in turn, would exacerbate the already painful inflationary pressures," pointed out Amr Bahaa, head of treasury at Piraeus Bank.

According to Bahaa, banks are now competing to offer their dollar holdings to local companies as loans. "This competition will result in better terms for borrowers," he said. Banks have recently expanded their dollar lending activities at interest rates of 4.5 per cent, compared to a high of 12 per cent on local currency-denominated loans.

Bankers believe that fears of the volatility in stock and forex markets would expand an already existing trend of foreigners investing in treasury bills and bonds with yields that are four per cent higher than interest rates on dollar deposits.

"The banking sector should be cautious as the money invested in treasury bills and bonds is hot money," Bahaa said. With the slightest change of fate in international markets, those investors would sell the bills to buy dollars and leave the country with a problem in both the dollar and treasury bills markets. "The CBE now has to regulate these investments," Bahaa concluded.

The burning issue now is whether the CBE will make a decision to lower inflation in its monetary committee meeting scheduled for today.

Ruling out this possibility, bankers say the CBE will not cut interest rates since there is no need for the reduction as we are not pegged to the dollar.

Previously, the CBE used to protect the pound so that when the US lowers the rate we would follow suit and vice versa. While this policy was effective at the time, there are now other determinants for the decision.

"It is now hard to lower the interest rates further as it has been negative for some time due to the high inflation rate." Bahaa said.