Foreigners, taking advantage of Egypt's high yields, rushed in to buy short-term securities after the government devalued the currency in early November.
Economists say these foreigners now hold around US$17 billion worth. The problem with short-term securities is that foreign investors can abandon the country as quickly as they entered: the infamous hot money problem.
Egyptian treasury bills have been the darling of the international community since the central bank devalued the currency in November. A group of such investors whom I spoke to recently said Egypt looked good over the next eight months, at least. Their main concern was political risk plus a longer-term concern over Egypt's ability attract foreign direct invetments (FDI) and equity investments.
How concerned should we be that investors suddenly pull their funds out of Egypt? It should not be a problem as long as the central bank moves cautiously.
The advantage of this great influx of funds is that it gives the government breathing space to work on reforms that would make the country attractive for longer-term money, especial FDI. It also provides the government with funds so that it does not have to borrow locally.
The short-term funds can help private companies as well. Businessmen complain that government borrowing to finance its huge budget has been crowding out lending to the private sector. A certain percentage of foreigners investing in these T-bills will no doubt roll them over even as interest rates come down, providing the government earns their trust.
Not all of these short-term inflows are available to the government, however. The central bank has been setting aside a major portion of these as a reserve in case there is a sudden outflow. One economist estimates the central bank is providing as much as one-third to help finance the government budget deficit and putting the rest in a reserve fund.
This is costly money for the government. The average yield on 91-day treasury bills sold on Sunday two weeks ago was 18.86 per cent (from which 20 per cent must be subtracted for an income tax that goes back to the government).
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Fixed-income traders and economists believe the central bank has been keeping the Egyptian pound undervalued, by as much as 20 per cent. An undervalued pound would explain part of the reason Egypt's foreign reserves have increased since the November devaluation. This what it did during the last major currency crisis in 2004. When the central bank actually floated the pound in December of that year it jumped in value.
If the pound is indeed undervalued, the central bank at some point will almost certainly allow it to strengthen, at least a bit, although this is fraught with danger. If the strengthening is sudden, this could remove the attraction of holding Egyptian treasury bills, prompting foreign investors to take their profits and pull their money out of Egypt, forcing the government to come up with billions of dollars quickly. Both the central bank and IMF are no doubt aware of the dangers of a sudden revaluation of the currency and likely to make any strengthening of the pound gradual.
In the meantime the government should be working overtime to attract longer-term investment. At the moment, such investment has not been coming fast enough.
Egypt's foreign direct investment rose 14.5 per cent to $7.9bn in the year that ended on June 30, the central bank said last week. Some $2.3bn of the increase went to the oil and gas sector. This is partly because the government repaid the last of the arrears to oil companies it had built up in the turbulent years after the 2011 uprising. Foreign investment should be rising much more quickly.
The rest of Egypt's private sector has been in crisis since the revolution. The Purchasing Manager's Index, which measures non-oil private sector activity, has contracted every month for the past two years.
Despite the lower pound, only about $850 million in foreign funds has entered Egypt's stock exchange, reflecting a wariness by investors that the reforms to the economy have not been enough.
Businessmen at the Euromoney conference held in Cairo this month say there is no quick fix to boost foreign or domestic investment, but rather it would require a series of individual steps throughout the economy.
One thing the government could do is to stop its frequent talk about intervening in the market place, something that makes investors extremely wary. It could also push ahead with the long-promised sale of stakes in large state companies, especially Banque du Caire, which has been repeatedly delayed.
Among other reforms, government employees should be taught how to implement the country's laws, something one lawyer said they were notoriously ill-informed about. Another would be to reduce to a minimum the huge number of government entities that companies currently must deal to get start up their projects.
Yet another reform would be to make it harder to punish employees who make mistakes. Currently, employees can be charged under criminal law for minor mistakes, something that makes them afraid to take any decisions at all.
