Egypt's elusive economic fix slips further away

CAIRO (Reuters) - The prospect of a coherent government that can heal Egypt's ailing economy receded further on Monday after the army rulers tightened their grip on power, throwing their promised transition to democracy into doubt.

A military decree issued on Sunday night as the country's first free presidential election was ending gave the generals power to make laws and decide who writes a new constitution. It follows a court ruling last week that effectively dissolved parliament, the only state institution with a popular mandate.

Egypt's economy has wilted since a popular uprising unseated president Hosni Mubarak 16 months ago, sparking months of social unrest and political turmoil.

Investors dashed for the exits after the uprising and are still sidelined, unimpressed by the army-backed government's attempts to stabilize the business environment and unnerved by the risk of a sharp currency decline that could wipe out any returns.

Egypt's fiscal deficit ballooned, leaving little room for urgent structural reforms without billions in financial support from foreign donors such as the International Monetary Fund.

But a $3.2 billion emergency facility from the IMF hangs on forging a political consensus for economic reforms that look harder to achieve as a stand-off worsens between the army and political forces.

"There is no parliament agreed on, so a military government cannot commit to long-term reforms in Egypt and neither can a president with very few real powers," said Said Hirsh, an economist at Capital Economics.

Since it took power, the army-backed government has drawn down foreign reserves by more than half to defend Egypt's currency and finance a growing balance of payments deficit.

At the same time, it has funded a mushrooming budget deficit with short-term borrowing from local banks, squeezing the credit market and pushing up interest rates.

At an auction on Monday, the yield on 91-day treasury bills touched its highest in at least 15 years.

The policies which helped the government get through the transition period are becoming increasingly unsustainable

On Friday, the credit-rating agency Fitch downgraded Egypt's sovereign credit rating further to junk status, saying the country's murky political outlook was likely to delay the structural reforms needed to kick-start recovery.

The rating, cut by one notch to B-plus from BB-minus, has a negative outlook, meaning there is a greater than 50 percent chance of more downgrades in the next 12 to 18 months.

The belief had been that a new government would move quickly to reach a loan agreement with the IMF to give it space to get its finances in order.

Before it agreed to a loan, the IMF had been demanding Egypt first implement austerity measures to get its budget deficit under control, line up billions of dollars in finance from foreign donors and get broad domestic political support for any agreement.

"How can you possibly make these huge economic decisions in such circumstances?" said Gabriel Sterne of Exotix. "You've had no decision on the IMF or the exchange rate since the start of the revolution and this looks like a further delay and possibly a considerable one at that."

BALANCE OF PAYMENTS

Egypt's uprising hammered the economy by chasing away tourists and foreign investors and prompting government employees to strike for higher wages. The economy contracted by 4.3 percent in the first quarter of 2011 and since then has remained stagnant.

The balance of payments deficit burgeoned to $11 billion in the first nine months of its 2011/12 fiscal year, more than double year-ago levels, as inflows of capital largely dried up.

Still, Egypt probably has quite a few months leeway before any crunch, economists say. In May, it raised $1 billion by selling dollar-denominated treasury bills to local banks, which led to a $300 million net increase in foreign reserves.

Earlier in June, the government received $1.5 billion in budget support from Saudi Arabia. Egypt is expected this month to get $1 billion to $2 billion from the sale of local mobile telephone operator Mobinil to France Telecom.

And last week, a group of investors announced it had secured a $3.7 billion loan for the construction of an oil refinery outside of Cairo.

This will help the economy cover $1 billion in maturing Eurobonds and $700 million in Paris Club debt it must repay in July.

But potential dollarization and more harm to tourism from the new political turmoil could put added pressure on the balance of payments.

Sterne said one danger was that Egyptians might move their funds out of Egyptian pounds and into dollars.

"What worries me about the foreign reserves is they are trending down because confidence in the Egyptian pound is being steadily eroded," he said.

The big test, however, may come late this year, when the first of the one-year dollar-denominated T-bills the government started issuing last year to shore up its reserves begin maturing. It will have to repay or roll over more than $4.25 billion of these bills from November 30 to February 22.

One economist said the central bank could muddle through by means of palliatives such as new dollar T-bill offerings, a squeeze on imports and small cuts to energy subsidies. A fall in international commodity prices would also help.

BROTHERHOOD TO THE RESCUE?

Whoever controls the government will need legitimacy to push through austerity measures such as tax increases and a reduction in the subsidies it pays on energy products.

"No government can handle the social and political ramifications of any real austerity or structural reform of the budget at this stage," said Youssef Kamel, a Cairo-based analyst with Rasmala.

In the run-up to the presidential vote, the Brotherhood said that if elected, it would move fast to negotiate IMF and World Bank loans, and hinted it might seek a bigger IMF package than the $3.2 billion the current government has asked for.

While in parliament, the strongly free-market Brotherhood blocked an attempt by the military-backed government to push through an IMF accord, saying it had not been given sufficient information and should not be held responsible for repaying funds whose disbursement it would not control.

Now, with the military possibly in control of legislation and the Brotherhood claiming the presidency, the tables may have reversed, and it may be the Brotherhood that faces trouble getting its policies adopted.

"It may be that once this settles down and assuming Morsy gets in, maybe they can start to do something. But you've got to get parliament sorted out too and that will take a while," Sterne said.

(editing by Ron Askew)

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