Egypt: FX policy key to attracting foreign investment

Are international investors returning to Egypt? Recent announcements suggest they might be. The Finance Minister, Medhat Hassanein, on Tuesday announced that he had entered into talks with several investors about buying the state's stake in several joint-venture banks. Following UK Bank Barclays' March buyout of the government's stake in Cairo Barclays, such comments have credibility.

On the same day the Egyptian parliament also approved nine new oil and gas exploration agreements, which require an initial investment of at least USD 152m from Egyptian and international companies. Market sources also suggest a return of foreign portfolio flows recently, attracted in by the strong performance of Egyptian equities - 88% gains last year, 25% year to date - although most of it is regional rather than international money.

It could hardly get worse. Official data shows that foreign direct investment fell to the lowest level for 25 years in 2003, just USD 240m. Although there is some concern over the accuracy of the numbers, there is no doubt foreign inflows in Egypt have dropped dramatically in recent years. A stagnating economy, higher geopolitical risk and government policy have all impacted. Egypt's drop below investment grade in 2002 also didn't help.

On the surface these factors have diminished. The government is confident that growth will reach 5% in the 2003/4 fiscal year, which ends this month, as exports, tourism and Suez canal dues are all performing strongly. Thanks to last year's devaluation Egypt is enjoying an export led economic rebound. Moreover, while the situation in Iraq has not stabilised, Egypt so far has not suffered the political contagion many analysts had feared.

This is being reflected in the exchange rate. Local reports suggest that the pound has strengthened in the black market close to the official rate of 6.2 to the dollar. The spread had been as much as 20% in 2003. Foreign currency inflows are likely to remain strong in the near term, particularly with the repatriation of remittances from Gulf workers over the summer. Some in the market expect the pound to begin trading below the official rate in the near term. Certainly our real effective exchange rate study suggests that, at least from a competitive standpoint, the pound does not need to weaken further.

However the exchange rate also remains the most immediate hurdle to foreign investment. Uncertainty over FX policy has hurt investor confidence. Until the exact nature of the foreign exchange regime and current currency restrictions are made clear, a sustained return of foreign investment is unlikely. This does not necessarily mean a return to a truly floating currency, rather clarity over policy. The narrowing of the black market rate offers a good opportunity to do just that, the Egyptian authorities need to use it.