Egyptian Crisis and Globalization’s Currency Risk

Egyptian Crisis and Globalization’s Currency Risk

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The good news in Cairo is that banks are open for business again. The bad news could be that as a result, the country witnesses a vast outflow of capital.

‘Outflow of capital’ is a nicer way of saying ‘a frenzied run on the banks.’ The last thing any society in political turmoil needs is for foreign investors to pull their cash out of its economy and watch liquidity dry up. The Central Bank of Egypt is closely watching the Egyptian pound’s exchange rate. If foreign investors continue to convert local currency deposits to foreign currency, the central bank will find it all the more challenging to honor its foreign obligations.

Why should Americans care what happens to a Middle Eastern country’s economy? There’s the usual answer: We live in an age of globalization in which financial markets are more connected than ever before. But what really matters to American companies, their investors, and to American foreign policy is that two very important things – energy and food – are priced in dollars. The value of the Egyptian pound has dropped 20 percent in the past two weeks – meaning that suddenly it’s become a lot more expensive for Egyptians to feed themselves and to keep the lights on.

This economic crisis affects multinationals doing business in Egypt and throughout the Middle East. Large-cap stocks are the foundation of every American investor’s portfolio and companies doing business in Egypt have taken a 20 percent hit to their profits there simply because of currency risk. Telecommunications companies, for example, love the Egyptian market. Egypt has a population of 60 million people, and many of them are young, so telecoms sell lots of mobile phones and pre-paid cards. These firms take in huge revenues … in Egyptian pounds. At the end of the day, companies like Motorola and France Telecom have to convert those pounds into dollars and euros.

In Egypt’s banking system, two important ratios (loans-to-deposits and liquid-assets-to-deposits) were both around 51 percent as of the end of 2010, says Nondas Nicolaides, a vice president and senior analyst at Moody’s Investor Service. Liquid assets of Egyptian banks are largely in government securities -- 33 percent of total assets. “Selling these government securities in the secondary market, or even discounting them at [the Central Bank of Egypt] to obtain immediate liquidity in case of need may prove difficult if the unrest persists and market conditions deteriorate further,” Nicolaides said.

Tourism is vital to the Egyptian economy. So is foreign direct investment. That the economic benefits of both could begin to dry up in Egypt is a concern for American banks and industrial companies with exposure to that economy. Most Americans looking at their well-diversified investment portfolios this week are wondering what could be causing their drop in value. Most of them have no idea that a rapidly falling Egyptian pound is to blame.