* Repos outstanding jumped to almost 38 bln EGP in June

* Govt needs for finance making liquidity tight

* Banks profit by reinvesting repo funds in T-bills

By Patrick Werr

CAIRO, Sept 5 (Reuters) - Demand for the Egyptian central bank's repurchasing agreement (repo) facility has fallen back after shooting up in June, indicating that short-term pressure on the banking system may be easing as more money flows into the country.

The government introduced the facility in March last year to boost liquidity in Egypt's turbulent financial markets a month after President Hosni Mubarak resigned in the wake of a popular uprising.

The flight of foreign investors after the uprising forced the government to fund its burgeoning deficit - now running at about 8 percent of gross domestic product - b y relying mainly on local banks, whose lending capacity was rapidly stretched to its limit.

In June, repos outstanding surged to almost 38 billion Egyptian pounds ($6.23 billion), equivalent to more than a quarter of the government's annual budget deficit. They have since fallen back to about 12 billion pounds.

The repo facility pumped more money into the banking system. But it also increased the government's already high cost of financing its deficit by allowing banks to temporarily sell treasury bills that yield 12.75 percent or more to the central bank at only 9.75 percent interest.

Over the last few months, liquidity problems have eased, particularly after the government received loans and pledges from Gulf states of more than $5 billion. Tourism has also improved and oil prices have fallen.

This appears to have taken some of the pressure off banks, although deposit figures for the period are not yet available, analysts and traders say.

"Liquidity is improving at the margins. You've seen a little bit of foreign interest in local T-bills and a little bit more liquidity showing up in the stock market," said Simon Kitchen, an analyst at EFG Hermes. "How sustainable it is, I don't know."

"Plus, the political outlook is clearer, which may have encouraged foreign investors to take the plunge as well," he said.

LIQUIDITY IMPROVES

The amount of repo transactions peaked at 37.9 billion pounds on June 12 and remained above 30 billion for the rest of the month, apparently caused in part by a squeeze on the resources of both the government and state banks ahead of the close of the fiscal year on June 30.

Immediately into the new fiscal year, the size of repo transactions began decreasing, falling to 22.3 billion pounds on July 3. This week the amount had fallen to 12 billion pounds.

Liquidity was further improved by a two percentage point decrease in the reserve requirement on local currency deposits that took effect on June 26.

The central bank also transferred about 3 billion pounds to the finance ministry after it sold $526 million in dollar-denominated T-bills in mid-June, the head of a bank dealing room said. It may have transferred more money after Qatar deposited $500 million with the central bank in August.

A $1 billion Eurobond denominated in Egyptian pounds matured in July, adding further liquidity to the market. Local banks, mainly state-owned, held 70 percent of the bonds, said the dealing room head, who asked not to be named.

"There is more liquidity in banks so less pressure to borrow," he said.

Traders say the repos have allowed some banks to make a killing by securing cheap funds at the central bank's repo auctions then buying treasury bills with much higher yields on the secondary market.

The average yield on 91-day T-bills at an auction on Sunday was 14.227 percent. That translates into an 11.4 percent effective yield after allowing for Egypt's 20 percent income tax. The effective average yield on 364-day T-bills is 12.75 percent.

DANGER FOR BANKS ? Despite Egypt's faltering economy - which the finance ministry projects grew by only 2 percent in 2011/12 - l ocal banks have reported strong profits for the first half of this year, partly on higher interest income. Bankers say much of this has been due to the high interest rates they have been collecting on government securities, including the repo facility.

The danger for banks, however, is that the central bank reduces the size of its weekly repo offerings, leaving them overexposed.

Until now the central bank has seemed content to keep the system going, probably to take pressure off interest rates in the interbank market. On July 10, it expanded the seven-day repo facility to include 28-day repos as well.

Under its corridor system, the central bank lends money to banks overnight at 10.25 percent and borrows at 9.25 percent.

If the central bank were to allow the yield on T-bill repos to rise in order to eliminate the difference with T-bill prices, it might have to increase its corridor rate as well, one analyst said.

If T-bill yields rise much higher, then banks would be tempted to use their funds to buy short-term T-bills in the secondary securities market, shrinking funds available on the interbank market.

"You would have short-term paper trading at higher yields, which would discourage banks from lending to each other," said a securities analyst at a Cairo investment bank. He did not wish to be named because of the sensitivities in discussing central bank policy.

($1 = 6.0873 Egyptian pounds)

(Reporting by Patrick Werr; Editing by Susan Fenton)

((patrick.werr@thomsonreuters.com)(+20-2-2578-3290)(Reuters Messaging: patrick.werr.thomsonreuters.com@thomsonreuters.net))

Keywords: EGYPT REPOS/