R.catch Egyptian pound gains on October 27th. Since Russia invaded Ukraine, the country’s central bank has depleted its foreign exchange reserves to keep the currency pegged against the dollar as foreign investors flee risky assets. But last week, officials agreed to the pound’s volatility. imfThe currency quickly fell off a cliff, plummeting to all-time lows.
Egypt now faces the challenge of rebuilding its foreign exchange reserves. The projected current account deficit and debt service over the next 18 months is about the same as the $33 billion in reserves. Using the international bond market is out of the question. Economic turmoil will keep foreign investors away. So Cairo will probably turn to old friends in the Gulf. From October 2021 to March this year, Kuwait, Saudi Arabia, United Arab Emirates Lending $18 billion to Egypt for foreign exchange reserves.of imf reports that another package worth $5 billion is in the works, but did not disclose where the money will come from.
Egypt is not alone in relying on this extraordinary foreign generosity. In August, Saudi Arabia updated her $3 billion deposit with the Central Bank of Pakistan. It sits alongside her $2 billion RMB-denominated offering from China. About 60% of its reserves come from her $23 billion worth of Chinese currency swaps, as Argentina struggles to keep the peso pegged against the dollar.
Depleting foreign exchange reserves could be a nightmare for central banks. Governments cannot make loan repayments, sometimes have to limit withdrawals, and have to introduce import controls. Basic items may continue to be out of stock. In a worst-case scenario, upset foreign investors triggered a currency crisis.
Deposits and swaps offer quick solutions. Contract details are kept secret and interest rates tend to be low. Officially, Gulf lenders want the money back. But updates are common. Given the speed with which Egypt and Pakistan have depleted their reserves, it is unclear whether they will be able to return the funds if necessary.
Once the transaction is agreed, the debtor suddenly has a significant amount of foreign liquidity. For years, Argentina’s renminbi swaps have masked the country’s rapidly dwindling piles of foreign money. But unlike Gulf lenders, China places strict conditions on its funding. In some circumstances, Argentine officials need Chinese permission to use cash. therefore, imf Argentina’s headline reserves are $39 billion, but after deducting swap lines and other adjustments, the net numbers are less impressive at $2 billion, the company’s focus.
Informal lending can also be a problem when friendships are broken. In 2016, as the Iran-backed militia Hezbollah gained ground in Lebanon’s politics, Saudi Arabia expressed its displeasure by withdrawing deposits held at the country’s central bank. Three years later, pressure on foreign exchange reserves led to Lebanon’s financial collapse. Egypt and Pakistan effectively tie their foreign exchange reserves to recognition of the Gulf states and China, a precarious foundation for economic stability.
The situation in Egypt may present another problem with this kind of informal lending. It is not entirely clear how lender deposits will be treated if the country defaults. Their status should be tested during the rebuild process. As noted by Brad Setser of the Council on Foreign Relations, a New York think tank, this sets up the potential for standoffs among donors.
of imfEgypt’s loan on Oct. 27 was more modest than expected and relied on additional bilateral funding. The Saudi loan was made earlier this year when Egypt’s economic situation was less dire. Both sides seem eager to get out of a sticky situation. Neither of them want to be involved in any more big loans. But they don’t want to lose their money and they don’t want Egypt to fall. They must keep Egypt from collapsing from below to make sure the other side is still in sight as both sides drift apart. ■
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https://www.economist.com/finance-and-economics/2022/11/03/the-growing-popularity-of-a-strange-form-of-debt-diplomacy Odd forms of debt diplomacy grow in popularity