By Patrick Werr and Sujata Rao
CAIRO/LONDON, Jan 3 (Reuters) - Egypt dipped deeper into its rapidly shrinking currency reserves on Thursday, fighting to slow a sliding pound which is likely to push up inflation and risks reigniting popular unrest.
Economists warned that the central bank had little room left for manoeuvre with its readily available foreign currency reserves enough to cover just over two months of Egypt's import bill, well below levels in many of its emerging market peers.
The pound slid further on Thursday at the central bank's fourth auction of foreign currency, with $74.9 million sold to banks at a cut-off price of 6.386 pounds, weaker than Wednesday's 6.351 to the dollar.
Egypt's currency has lost about 10 percent against the dollar since the start of 2011, just before the Arab Spring unrest spread to the country. But about a third of that has come this week alone, since the central bank began auctioning $75 million a day out of its reserves on Sunday.
"The pound is extremely vulnerable," said Raza Agha, chief economist for the Middle East and Africa at VTB Capital.
"This auction system they should have done months ago to stem the decline in reserves rather than using them to defend an arbitrary level of the pound, which has gotten them to where they are now."
Egypt's once-booming economy was thrust into turmoil after the 2011 revolution that ousted Hosni Mubarak but weeks of renewed political unrest at the end of last year dealt it another heavy blow.
Egyptians began the new year in an atmosphere of growing anxiety, with few expecting any quick solutions as political infighting continues before a parliamentary election expected to get underway within two months.
With the crisis deepening and the pound hitting fresh record lows every day, economists believe more financial mess could be in store for the Arab world's most populous nation.
"This is the worst possible way of managing the devaluation, squandering $300 million a week to slow the decline," said one economist based outside of Egypt, who spoke on condition of anonymity due to the sensitivity of the matter.
Protracted political wrangling is bad news for President Mohamed Mursi who desperately needs consensus in order to introduce unpopular austerity measures, vital to securing a $4.8 billion loan from the International Monetary Fund.
To conserve reserves and restore confidence, Egypt has imposed new rules involving daily foreign currency auctions and has promised that the situation would soon stabilise.
FACTORING IN A FALL
Businesses say they are factoring in an even bigger decline in the pound's value and inevitable steep price rises in country which imports most of its food.
Unnerved by the events, Egyptians have rushed to buy dollars for fear of a messy devaluation, and banks have been forced to impose limits on dollar withdrawals to prevent a run on deposits.
The central bank alarmed Egyptians further when it announced last weekend its foreign reserves had fallen to what it said was a critical level, at around $15 billion as of late November. December figures are due out in the coming days.
This equates to about three months' worth of imports. However, one Cairo-based analyst said that if the gold bullion portion of reserves were subtracted, end-November reserves coverage were equivalent to 2.1 months of imports.
By contrast, Turkey holds reserves equal to about six months of imports, or five months when gold reserves are stripped out.
Whereas currency reserves can be used rapidly to fund imports, gold first has to be sold to raise cash and dumping large amounts on the bullion market can be disruptive.
Egypt's economy came under intense pressure in November when Mursi moved to grant himself additional powers and fast-track a new, contentious constitution, prompting a political crisis and a wave of sometimes violent protests.
Echoing this anxiety, the cost of insuring Egyptian debt against default has soared. Data from Markit showed Egypt's 5-year credit default swaps (CDS) jumped 27 basis points on Wednesday to 4-1/2 month highs from the previous close to 515 bps.
Adding to the uncertainty, it remains unclear when talks with the IMF - originally expected in January - would resume.
The IMF said on Wednesday no date had been set for the resumption but a day later an Egyptian government spokesman told Reuters that an IMF delegation would visit Cairo this month.
"January is a pretty critical month," said Richard Fox, head Of Middle East and Africa sovereigns at Fitch Ratings. " The important thing now is to build confidence to prevent capital flight and dollarization from gaining momentum. The ideal situation would be an agreement with the IMF as soon as possible."
VTB's Agha said however it would be hard for Egypt to invite the IMF for talks before the election as continued instability meant it had yet to build strong enough political consensus to be able to sell the IMF programme to its people.
Egypt has already committed to a reform plan in line with IMF recommendations but asked it to delay the loan agreement due to the political crisis over the new constitution.
Importers are finding their purchasing power curtailed because of the pound's declining value. Inflation is relatively low - urban consumer inflation declined to 4.25 percent in the 12 months to November from an annual 6.7 percent in October - giving limited leeway.
"Inflation will be an issue because in Egypt 25 percent of the currency shock is translated to the prices," Jean Michel Saliba, Middle East economist at Bank Of America/Merrill Lynch. "But inflation is low at the moment so they can take a bit of shock there."
Though the prices of state-subsidised basics will stay the same, the cost of other imported goods is about to go up, further stoking anger and resentment that is never far from the surface and increasing the potential for unrest.
"This could cause much more political instability, but it's hard to say how much it will take to push towards a new uprising," Hassan Nafaa, a professor of political science at Cairo University, said. "If there is no imagination for a solution to get out of this political polarisation, I think the government will face a deep economic crisis."