Because of the country’s lack of foreign currency resources, Egypt has been forced to devalue its currency repeatedly in recent years, worsening its economic woes. The country now finds itself caught in a trap, as it will likely need to devalue again in the near future given the unfavourable conditions for the success of its previous devaluation efforts.
Egypt’s inability to secure adequate amounts of foreign currency has forced it to rely heavily on borrowing from abroad. The gap in Egypt’s external trade balance can only be closed by reducing imports and/or increasing exports. However, the means of achieving this is a subject of ongoing debate among economists. One common approach in different countries is to let the central bank use monetary policy tools to make the local currency depreciate against other currencies. This, in turn, raises the prices of imported goods and services, which reduces demand for them and lowers the prices of exported goods and services. This then increases the demand for them, ultimately improving the balance of payments.
However, the success of this method depends on certain conditions, namely sufficient elasticity of demand for both imported and exported goods, meaning that the demand for them responds to changes in prices (the price elasticity of demand). Additionally, the country’s production capacity must be able to meet the increased demand for its exports. If either of these conditions is not met, devaluing the currency will not help the situation. For instance, external demand may not be high enough, or the country may not be able to increase its exports due to production limitations. Similarly, raising import prices may not be effective, as the demand for imported goods tends to be less responsive to price changes (inelastic).
The case of Egypt is a typical example of the lack of sufficient elasticity of demand for imported goods and sufficient production capacity. This might be one reason why many countries that have devalued their national currencies, including Egypt, have not seen an improvement in their external balances despite several devaluations. The experience of the latest devaluations of the Egyptian pound and the subsequent decline in its value show that they are unlikely to be the last, as the country is still struggling to close the gap in the external trade balance.
The current problem is particularly severe because for the first time the value of loans payable in the short term, i.e. within a year, exceeds the total value of the country’s international reserves. This is an alarming indicator that warns of highly undesirable consequences, and it explains why there was a strong push to finalise an agreement with the International Monetary Fund (IMF) this year.
The significance of the IMF loan is not its monetary value, which amounts to about $3 billion, but rather the message of confidence in the economy that the agreement sends, making the country eligible for new loans. Yet, while the loan may provide temporary relief to the current economic crisis, it does not address the root cause of the problem. If the current economic policies continue unchanged, the economy will continue facing the same challenges.
The agreement with the IMF enabled the country to receive some of the amount badly needed to bridge the external trade gap, but the amount received is also “hot money”. By its very nature “hot money” is volatile short-term capital that can be quickly withdrawn from the country, and there are several reasons why this might happen.
One possibility is that investors might find better investment opportunities elsewhere and decide to withdraw their funds. Alternatively, if a country’s economic situation deteriorates further, investors might fear that their investments will be at higher risk and will withdraw their funds as a result. Such a withdrawal of hot money adds more pressure to the economy. The sudden withdrawal of funds creates a funding gap, leading to the further deterioration of the country’s external balances and its economic situation as a whole.
Egypt’s economy therefore faces a complex and daunting challenge. The toxic mix of borrowing and currency devaluation has created a dangerous situation and one that threatens to worsen over time. The country risks becoming trapped in a downward spiral of debt, currency devaluation, and economic decline. Overcoming these challenges is possible only by focusing on structural reforms to enhance the country’s exports and reduce its dependence on imports.
However, this is a medium or long-term solution the results of which will materialise after a period of (say) three to five years. Until that happens, there is an urgent need for a “surgical intervention” by imposing restrictions on the imports of non-essential goods for a temporary period until conditions improve. This is compatible with General Agreement on Tariffs and Trade (GATT) and the World Trade Organisation (WTO) agreements, since these give countries whose balance of payments are exposed to difficulties the right to impose restrictive import measures.
Articles XII and XVIII:B of the GATT 1994 Agreement and the Understanding on Balance-of-Payments Provisions are intended to safeguard the external financial position and balance of payments of countries facing such difficulties by allowing them to restrict the quantity or value of the merchandise that is permitted to be imported. Imposing such restrictive measures is not expected to give rise to possible retaliatory measures by affected trading partners, simply because it is meant to deal with genuine balance of payment difficulties and is applied on a non-selective basis.
Despite the increasing challenges confronting the economy, it is imperative that we remain optimistic and steadfast in our efforts to find solutions. While the situation may seem daunting, we must not lose faith in our ability to overcome these obstacles. It is crucial to recognise that there are still options available to us, and we must be proactive in pursuing them.
* The writer is a banking consultant in Cairo.
* A version of this article appears in print in the 18 May, 2023 edition of Al-Ahram Weekly
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