Why Egypt may eventually need a larger IMF loan

Despite the recent support from the Gulf, Egypt's reserves remain below safety levels.

One of the first things the new political order in Egypt did was to dispatch Hisham Ramiz, the governor of the Central Bank of Egypt, on a fund-raising trip to the United Arab Emirates. His visit was evidently fruitful as it resulted in an aid package consisting of grants, loans and energy products worth $12 billion not just from the UAE but also from Saudi Arabia and Kuwait.

Some of these loans will enter as deposits at the central bank, boosting the headline figure for international reserves, which took a hit in June largely due to the fall in gold prices. The significant inflow of funds from the Gulf notwithstanding, it remains unclear whether Egypt's reserves are sufficient for the economic needs of the country and an analytical framework to assess that question is needed.

Reserves act as a precautionary tool to absorb shocks to the economy and ensure the availability of sufficient funding to pay for imports and debt service if and when crisis hits. Given this role, there are at least two methods to evaluate the adequacy of reserves.

Method 1. Reserves should be large enough to cover three months’ worth of imports. On this measure Egypt’s reserves are only just about sufficient as both current reserves and quarterly imports stand at around $15 billion. This means that if Egypt lost all its income from tourism, Suez Canal and other exports and investments abroad, it would still be able to cover the cost of all its imports for three months. However, it would not have any funds left to service its debt.

Method 2. This method asks if a country can cope with a shock which simultaneously reduces exports, makes borrowing harder and results in capital flight. More specifically, it is assumed that the shock would result in a 10% drop in exports; 30% fall in short-term debt; 15% reduction in medium-and long-term debt; and 5% decline in broad money as a proxy for capital flight. For reserves to be considered adequate, they are recommended to be around 100-150% of the total loss of funds from the shock.

Without the Gulf’s aid, Egypt's reserves are below the safety range at around 78% of the potential losses under the scenario described above. Reserves should rise to about $21 billion with the Gulf support but that is still lower than the safety level of $25 billion implied by the method.

While the choice of the particular reserve-assessment method may be a matter of taste, the IMF has applied the second method in its recent agreement with Tunisia. Under this method, and even with the new deposits from the Gulf, Egypt's reserves are $4 billion short of adequacy and therefore need to be supplemented. The implication is that if Egypt decides to fill this gap with a loan from the IMF, it may need to negotiate a larger sum than $4.8 billion given its other fiscal and external needs.