By Sujata Rao
LONDON, Jan 8 (Reuters) - The key to preventing a messy
devaluation of Egypt's pound may lie with the country's
households, whose dollar holdings are being eyed by foreign
investors as a critical gauge of trust in the authorities.
Countless emerging market crises have shown over the decades
that it is not the withdrawal of foreign investors from a market
but the flight of local households and businesses from a
currency that is instrumental in its collapse.
Egypt, despite months of upheaval, is not there yet.
But investors are watching closely for evidence of a
significant rise in ordinary Egyptians' dollar holdings.
Households' dollarisation ratio -- broadly, the level of
foreign currency holdings as a proportion of money supply -- was
15.5 percent at the end of October 2012, according to Bank of
America-Merrill Lynch estimates, based on central bank data.
That will undoubtedly have gone up in recent weeks as
panicky Egyptians have rushed out to buy dollars in the face of
rising political turmoil and as the central bank has allowed the
currency to fall -- by 0.5 percent a day for the past week.
In Luxor, for example, a town that makes its living from the
tourists who visit its Pharaonic temples, some taxi drivers have
started asking for payment in euros or dollars.
But the household dollarisation ratio is still likely to be
well below the 41 percent ratio among companies, or the 33
percent household dollarisation levels seen back in 2004.
"Increased household dollarisation and a run on the
currency, that's the big risk," says Jean Michel Saliba,
BofA-Merrill Middle East economist, who estimates households
account for more than 70 percent of deposits in the banking
In contrast, foreigners hold a mere 3-4 percent of the local
bond market, according to other estimates from Barclays.
"If the (dollarisation) ratio goes back to the 2004 peak
that would create additional demand for $15 billion and will
wipe out the central bank's reserves," Saliba says.
What could precipitate such a move?
The central bank's decision to allow some weakening in the
pound after spending two years and $20 billion propping it up,
has broadly been welcomed by economists and equity investors who
say Egyptian exports need to become more competitive.
But this is a tightrope from which it is easy to fall.
Moved from a peg to a managed float in 2003, the pound has
traded between 5.5-6 per dollar since then and citizens have
enjoyed some reassurance from the central bank's sturdy defence
of the exchange rate during the 2011-2012 turmoil.
But Egypt's hard currency reserves are at $15 billion or
below the three-month import cover deemed the minimum safe
level, and that as forced it to embark on dollar auctions
allowing the pound to sink to a series of record lows.
Around a third of the pound's depreciation since early-2011
has come in the past week and that may well have spooked
households who hold over 600 billion pounds ($93.05 billion)in
local currency bank savings.
"I felt (devaluation) was coming. So for hedging purposes I
changed half my savings into dollars just a couple of days
before the pound slump," said one Egyptian who works in the
financial sector and who asked not to be named.
"I don't trust the current regime ... and see no opportunity
for growth on the short term ... no hope," he said. "I think
that the pound slump is not going to stop."
The risk is that other locals feel the same, viewing
authorities' tacit acceptance of a weaker currency as a sign
that they are no longer able to stabilise the situation, a story
that has played out time and again in emerging markets, from
Russia to Indonesia.
"It's not a question now of how much (the central bank has)
in reserves ... their top priority is to prevent people from
exchanging their pound savings into dollars," says Bartosz
Pawlowski, a strategist at BNP Paribas in London
"That's something no central bank in the world can survive."
Most analysts expect the pound to fall at least to 7 per
dollar while currency forwards are pricing it at 7.75 per dollar
in six months, a drop of 16 percent from current levels.
There are signs the currency would have fallen more already
but for the shortage of dollar liquidity. Banks have slapped
limits on deposit withdrawals and transaction fees on dollar
purchases. Travellers can now carry a maximum $6,000 each while
leaving the country.
"There is significant amount of financial repression that
will artificially put on hold dollarisation," said Alia
al-Moubayed, senior Barclays economist for the Middle East and
Analysts agree that what stands in the way of massive
household flight from the pound is the prospect of external aid,
particularly from the International Monetary Fund which has sent
an official to discuss the disbursement of a $4.8 billion loan.
The problem is that the more fiscal reforms are delayed, the
greater any currency adjustment will have to be. Second, many
worry that Egypt's leaders, fearing further protests, will delay
the austerity measures the IMF has set as loan conditions.
Barclays' Moubayed notes that currency forwards are pricing
a significant depreciation but not a collapse.
"So far people seem to believe that an IMF deal could still
be leveraged and the government will go ahead with reforms
needed to get IMF and donor support," she said.
"(But) the scenario (of a disorderly devaluation) could yet
happen if people perceive the government is unlikely to get the
funding needed to avert a crisis."
($1 = 6.4484 Egyptian pounds)
(Additional reporting by Nadia El Gowely in Cairo. Editing by