The pound and dollar drama: Is there an exit?

Ahmed El-Sayed Al-Naggar
Wednesday 2 Nov 2016

Egypt can still achieve comprehensive development, but it needs immediate action to stabilise its currency and balance its deficit

While the Egyptian pound was devalued officially months ago, talk has surfaced about further devaluations or a full-fledged currency flotation that leaves it at the mercy of both the regular and black markets.

Ambiguity launched a frenzied rush to buy dollars and store them, considering the dollar a commodity in itself, coupled with feverish activity in the foreign currency black market.

Consequently, the real economy worsened in a way that required urgent measures in order to deal with this unbearable situation through accurately specifying the reasons for the crisis, its consequences and the mechanisms of exiting through real structural reform, rather than embracing financial and fiscal treatments that only have a temporary effect.

External balance deficit: the root of the crisis

The root of the problem of the exchange rate of the Egyptian pound against the dollar and other major currencies lies in the huge deficit in the external balances of Egypt. The deficit in the trade balance reached about $39.1 billion in the fiscal year 2014/2015, and reached $29.3 billion in the first nine months of 2015/2016.

As for the current account balance deficit, it has worsened rapidly, reaching $18.7 billion in the fiscal year 2015/2016 in comparison with $12.1 billion in 2014/2015, about $2.8 billion in 2013/2014, around $6.4 billion in 2012/2013 and $10.2 billion in 2011/2012.

In light of this deficit, there is an objective reason for the decline of the local currency for a country that produces and exports far less than what it consumes and imports.

It is necessary to point out that the Egyptian pound is estimated originally less than its real value according to World Bank data. The World Bank Database mentions that Egyptian Gross Domestic Product reached $330.8 billion in 2015 if calculated in dollars according to the prevailing exchange rate. But if calculated in dollars according to purchasing power parity, it would reach $996.6 billion.

That means that the dollar would be equivalent to 2.6 Egyptian pounds, according to the purchasing power parity between the pound in its market and the dollar in its market.

In addition to the official deficit in the trade balance and the current account balance, the Egyptian pound is suffering heavily from speculation in the black market economy — from money accumulated through crimes of corruption, or the illegal trade in arms, narcotics and money smuggling — outside the country after converting it into foreign currencies.

The Egyptian pound is also suffering from the real interest rate, which is considered negative at present and does not encourage saving or possessing it in comparison to other currencies.

The real interest rate is the nominal interest rate announced by the bank subtracted from the inflation rate. The interest rate announced by the bank is less than the inflation rate announced in September by about 5 percent, where the inflation reached 14.1 percent.

Estimations of the International Monetary Fund in its World Economic Outlook Report are that inflation in Egypt in the current fiscal year, 2016/2017, will reach 18.2 percent.

Some see that the interest rate on the American dollar, at 1.75 percent, is evidence of the necessity of decreasing interest on the pound for the benefit of borrowers among businessmen in order to revitalise borrowing for the sake of establishing new businesses. They ignore that the inflation rate in the US is currently only 1.1 percent (i.e., there is a 0.65 percent positive benefit for the dollar and even the Japanese yen, on which the interest rate is 0.05 percent. The real interest for it is positive and is +0.45 percent, because the inflation rate in Japan is -0.5 percent).

The Egyptian pound is also suffering from speculation with the complicity of exchange companies, which were basically established in order to absorb speculators in the foreign currency black market.

The basic reason for the existence and growth of the business of exchange companies is the absence of the currency’s sovereignty in its market, because if such sovereignty existed, the free currencies' entrance into Egypt should have been done through banks.

It would have been impossible to withdraw any foreign currency from bank accounts to be used locally. At that stage, there would be no point in having exchange companies in the first place except on a minimum level, which can be carried out by banks.

Absolute exchange rate fixation and complete flotation: two evils to stay away from

There are several systems for determining the exchange rate of any currency. The first system is the fixed arbitrary pricing of the currency. This system does not take into account the economy’s needs and leads to its rigidity, calcification and the loss of any flexibility in mobility and its competitive edge in the long run.

There is the floating system based on the central bank fixing a basic exchange rate with commercial banks allowed to move above it and below it within certain percentages specified by the central bank.

As for absolute liberalisation of the exchange rate (full-fledged flotation), this leaves the exchange rate to be determined according to the interaction between supply and demand (i.e., the regular and black markets together).

This system is an absolute evil for a country like Egypt — one that has a huge trade deficit, lacks any effective policy to ration imports, and has a large illegal trade in narcotics, arms and money smuggling.

In light of Egypt’s special circumstances, this system will lead to the Egyptian pound becoming a plaything in the hands of speculators in a way that will surely ignite inflation and destroy the economy’s stability.

The conditions under which such a system can be applied include the availability of large reserves, enough to cover nine months of imports, a rational trade policy that implements regulations on imports and helps in achieving a balance in the current account balance, stability and increasing sources of free currencies (such as exports, tourism and expatriate remittances) accompanied with strong confrontation of illegal activities that drain the state’s stock of free currencies, such as the secret importing of narcotics and arms.

The currency’s arbitrary variable pricing: the best solution in the face of the “canned” IMF model

The currency’s arbitrary variable and flexible pricing is the best solution and the most suitable for Egypt’s circumstances, if managed in a highly efficient and flexible way in light of the economy’s performance and indicators in comparison with other economies and the needs of commercial and investment policy and the economy in general.

This policy involves a high degree of stability that helps local and foreign investors take investment decisions on clear foundations. It is considered one of the wisest and most objective monetary policies.

As for the IMF and the World Bank’s theoretical model, it posits that devaluation of the local currency’s exchange rate in any country economically stumbling vis-a-vis the dollar and the major free currencies leads to a drop in its export prices when evaluated against the free currencies.

Thus, its competitive edge abroad is elevated in a way that helps increase of its exports and helps revitalise incoming foreign investment flows and foreign tourism, since devaluing the local currency increases the purchasing power of foreign currencies in that country.

However, this theoretical outcome may not be achieved. Reality is more complicated. Exports will not increase if there is no production capable of competing globally with regard to quality, price and being surplus to local consumption and hence exportable, or as a production directed to export within an economy that grows, develops and has new and effective investment that produces those commodities.

The reality of the Egyptian economy points to a horrendous deficit in producing essential commodities. Thus, the trade deficit increased in the fiscal year 2014/2015 to $39.1 billion and the deficit reached $29.3 billion in the first nine months of the fiscal year 2015/2016, according to official statements.

As for the rate of investment, which can be a reliable index when seeking to increase production and exports, it reached 14.4 percent of GDP in the year 2014/2015 and reached 14 percent in the first nine months of the fiscal year 2015/2016, in comparison to a 22 percent global average and a 32 percent median in average income countries, and around 40 percent in the Far East and Pacific countries.

This low rate of investment will not respond to external demand and does not even meet local market needs.

Investments in Egypt are concentrated on oil, natural gas, real estate and infrastructure in a way that is directed basically to domestic consumption. Consequently, the advantages presented by the devaluation of the pound against the dollar won’t be effective due to low exportable production.

Imports will not be reduced if necessary because consumption cannot be decreased, even after prices jumped higher due to local currency pressures.

Meanwhile, non-essential imports are consumed by certain segments of society that are ready to pay the price, due to their possession of a large amount of the income and wealth in Egypt. There is no way to reduce these imports in a substantial way except through presidential measures or through a clear agreement with the chambers of commerce that can be applied to importers on an equal basis.

Reducing luxury goods, waiting for sovereign decisions

The Global Wealth Report mentions that the wealthiest 10 percent of adults in Egypt used to possess 61 percent of its wealth in the year 2000 and that their share rose to 65.3 percent in the year 2007, then to 73.3 percent in 2014.

This pattern of possession of wealth places Egypt among the worst countries concerning wealth distribution, nearing the American model in which 10 percent of adults possess approximately 75 percent of American wealth, and the Turkish model in which the wealthiest 10 percent of adults possess 77.7 percent of Turkish wealth.

Consequently, this wealthy segment won’t bother about the prices of luxury goods and will continue to consume no matter their price, thus negating the effectiveness of devaluating the pound against the dollar in reducing imports.

Inflation is the only certain effect of the pound’s decline

The only certain effect of devaluation of the Egyptian pound is the increase in imported commodities causing a general price rise wave in all commodities, wherein the inflation rate rose to 14.1 percent last month.

IMF estimations based on official Egyptian statements suggest that the inflation rate will reach 18.2 percent in the current fiscal year (IMF, World Economic Outlook, October 2016, p. 238). We should put into consideration that estimations, based on official statements, mentioned in April that the inflation rate would reach 9.6 percent in 2016 and about 9.5 percent in 2017.

However, the rapid decline of the pound against the dollar led to revision of official and international estimations, which point to much a higher rise in the inflation rate in a way that the poor and the middle classes, especially labour rights holders (i.e., those gainfully employed where their wages rise at a rate less than price rates; thus, their salaries’ purchasing power erodes and their standards of living decline), will struggle to endure.

As for increasing foreign tourism, that is connected with other decisive factors, such as safety, freedom, the country’s image abroad and the touristic infrastructure. Currently, the problem of diminished tourism to Egypt has nothing to do with price rises.

Egypt remains extremely cheap in comparison with the sweeping majority of touristic destinations of a lower value than Egypt. The problem, as I have mentioned, is linked to Egypt's global image on safety, freedom and openness.

As for the flow of foreign investment into the country, it is connected with the existence of an attractive and appealing investment map, security and political stability, and administrative efficiency, speed and integrity in providing licenses and all necessary instruments for setting up investments, as well as flexibility in following-up on foreign investments and the management of public and private local partnerships on fair and balanced bases.

Generally, this means that devaluing the exchange rate of the Egyptian pound will lead to a price rise and the erosion of real salaries and won’t be effective in rationalising imports and revitalising exports, tourism and investment.

It is necessary to point out that the exchange rate of the local currency against foreign currencies is not an idol sacred to a pagan group, but it is a tool that can be employed to achieve various economic goals.

Whether the exchange rate of the local currency against foreign currencies is estimated by a real value or is above or below it, according to the choice of monetary authorities, what is important is that this rate is characterised by relative stability and slow mobility in any direction, in a way that allows future investment accounts or foreign currency borrowing.

Moreover, specifying the exchange rate should be based upon certain goals by which this specification must be evaluated.

Possible mechanisms for exiting Egypt's foreign exchange market crisis

Treating the pound crisis is impossible except through treating the current account balance with several short, medium and long term measures.

First and foremost comes strict and immediate regulation of imports via presidential measures and friendly agreements with the chambers of commerce in order to minimise consumption, imports and associated components, temporarily stopping the import of certain luxury goods in order to decrease total imports at least by a quarter.

This decrease in imported commodities would be enough to regain balance in the current account, similar to what the South East Asian countries did in the years 1997 and 1998, in confronting their crises. Imported services — and especially the travel and tourism item, for different purposes — should also be rationalised through administrative decisions.

Tourism payments abroad reached around $3.338 billion in the year 2014/2015 and reached $2.914 billion in the first nine months of the fiscal year 2015/2016.

It must be clear that vibrant countries and peoples can be rallied to address their pitfalls. In order not to be in total submission to those handing out poisonous assistance packages that are always conditional to implementing policies that serve outside interests.

Sometimes these assistance packages are met with the most serious concessions, affecting the holiest parts of the homeland. Rallying the Egyptian people should be based on fairness and burden distribution according to income levels.

It is also necessary that the Egyptian pound be respected in its own market, in which no financial operation within the Egyptian market can be carried out except by using it.

There shouldn’t be accounts in any other currency except those of importers, exporters, expatriates and those receiving remittances, provided that they convert their balances into the Egyptian pound if they wish to withdraw and use these remittances in the local market.

Depositors’ rights should be respected regarding the reception of a positive real interest rate that exceeds the inflation rate in order to encourage citizens to keep their national currency and have savings in it.

Before all this, public and private investment must be concentrated in the productive sectors (i.e., agriculture, agricultural industries and all kinds of manufacturing industries) in order to enhance the Egyptian economy’s capability to produce commodities and services society needs.

This should be done in order to minimise the need for imports and to reduce the big deficit associated with them, and also to create real job opportunities, leading to hiring the unemployed, enabling them to earn their living with dignity, and get out of the cycle of poverty.

This matter might require postponing some infrastructure and real estate projects, as Malaysia did in its big crisis in 1997. It was able, without borrowing from the IMF and without implementing its adjustment programmes, to get out of its crisis more rapidly than all the South East Asian countries.

If the state budget deficit, which amounts to around 11 percent of GDP, is the real reason for inflation and exacerbation of internal and external debts, reforming the Egyptian economy requires taking strong measures in order to address this deficit and the historical failure of consecutive fiscal policies that made Egypt reach these horrible levels of debt.

Internal debt reached around EGP2,497 billion at the end of March while external debts was about $53.4 billion in the same period.

On the other hand, vigorous and swift work should be done to raise the rate of local investment in productive sectors and attract foreign investment, especially in manufacturing industries, aimed at increasing production and exportable commodities.

Utmost efforts should also be exerted to regain the momentum of foreign tourism in Egypt, expanding and enhancing transport services through the Suez Canal, maintaining and supplying vessels passing through it and organising short trips for the vessels’ crews with the aim of doubling Suez Canal revenues.  

What’s happening now on the pound and dollar front reflects the buidup of sins of the financial, monetary and macroeconomic policies accumulated long years ago.

This buildup calls for essential changes that champion the necessities of growth and social justice, which constitute the main lever for sustainable growth through stimulating an investment multiplier, being the essence of any economic growth and prosperity cycle.

We must perceive that Egypt with its real GDP amounting to $996.6 billion in 2015, according to purchasing power parity between the pound and the dollar, ranking 22nd globally, with its GDP amounting to $330.8 billion according to the prevalent exchange rate, which puts it in 32nd rank globally (according to the World Bank Database), and with its large market comprising 90 million consumers, possess strong foundations to achieve economic development.

Moreover, Egypt’s economic openness to the world and its links with free trade zones with the EU, Arab and African countries, represents a gate to gigantic markets before any local or foreign investment. Thus, this constitute an attractive factor for investment, if properly utilised.

Egypt with its enormous workforce, nearing 30 million across different skill levels, and with its agricultural, maritime, mineral and quarry wealth, its exceptional location in the heart of the world, and being on the borders of large markets, main sources of raw materials, and energy, is capable of recovering and achieving comprehensive development.

This is possible provided it makes substantial changes in directives and stays away entirely from Mubarak era policies. Those policies yielded nothing but economic slowdown, the predominance of parasitic sectors over productive ones, bad income distribution, poverty and unemployment.

The writer is chairman of the board of Al-Ahram Establishment.

Short link: