Sustainable reforms

Niveen Wahish , Tuesday 12 Mar 2024

With devaluation off the to-do list, what next for policy-makers, asks Niveen Wahish

Egyptian pound
photo: AP


Hala Ali, 55, has seen plenty of devaluations in her lifetime. She remembers when the pound was devalued in 2003 from around LE3 per dollar to LE5.5. Fast forward two decades and the pound is now trading at LE50 to the dollar following the 6 March decision by the Central Bank of Egypt (CBE) — inevitable given the chronic shortage of hard currency over the last two years — to allow market forces to determine the exchange rate.

Ali’s income, like that of the vast majority of Egyptians, has not kept up with the devaluations and her spending power has been severely eroded, especially over the last two years. People who keep old supermarket receipts have been sharing them on social media. One such post showed a 2008 supermarket receipt for LE145. “This receipt has items on it for which you would need to take out a loan if you were to buy them today,” the post joked bitterly.

 “How many devaluations can we survive,” asks Ali. “And what guarantees that this will not happen again? It’s been happening at ever shorter intervals over the past two years.”

The exchange rate crisis is a symptom of Egypt’s chronic macroeconomic problems, says Sarah El-Khishin, associate professor of economics at the British University in Egypt. Dependence on hot money as a major source of reserves and delays in applying shock absorber mechanisms have cost Egypt dearly, she told Al-Ahram Weekly.

Some $20 billion in hot money fled Egypt in early 2022 following the start of the war in Ukraine.

Egypt recently concluded a deal with UAE-based ADQ to develop the Ras Al-Hekma area on the North Coast for $35 billion, $10 billion of which have already been received by Egypt. Securing foreign funds before the floatation to act as a buffer against further sharp devaluations in the Egyptian pound was a good step, says El-Khishin, and will help keep the pound-dollar rate stable. But while the market is currently witnessing relative stability in the exchange rate due to the cash injection, such stability could prove temporary in the absence of additional steps to stabilise the market.

The exchange rate must be allowed to move freely to reflect supply and demand and build confidence among market players that it is not being controlled. Only then will Egypt be able to attract foreign exchange flows back into the official system and absorb movements in the balance of payments, says economic and strategy consultant Reham ElDesoki.

Following previous devaluations, the exchange rate was closely managed and the mismatch between supply and demand continued.

A free trading exchange rate was a precondition for the agreement of Egypt’s latest International Monetary Fund (IMF) deal. Following the CBE’s announcement last week, the IMF announced it had reached a staff-level agreement with the Egyptian authorities on the economic policies needed to complete the first and second reviews of the loan deal reached in December 2022. It also said funding will be increased from the $3 billion agreed 2022 to around $8 billion.

While the IMF agreement is important in restoring confidence in the Egyptian economy and rebuilding investor sentiment, Egypt still needs to ensure there is sustainable implementation of reforms, including restoring the private sector’s role as an engine of growth, to ensure that confidence continues beyond the IMF agreement.

In the long-run positive outcomes are possible, says El-Khishin, but they remain conditional on serious action being taken to implement corrective macroeconomic policies. Such action must include the development of stable sources of foreign exchange based on exports and FDI growth rather than debt or hot money.

The government also needs to ensure that its spending decisions remain in line with the budget to prevent overruns that lead to higher inflation and public debt, adds ElDesoki.

It must also press ahead with investment reforms to ease the costs and time needed to do business in Egypt, including, ElDesoki insists, full implementation of the State Ownership Policy so that the private sector can replace the state across a range of economic activities, a process that needs to be conducted transparently and made public for future accountability.

In a press conference this week, Minister of Finance Mohamed Maait said the government was limiting public investment in the coming fiscal year to allow for more private sector investments.

Another priority is for the CBE to operationalise its inflation targeting mechanism, as promised by its governor, says El-Khishin. Experience has shown that opting to use the exchange rate as a monetary policy anchor is the wrong approach for Egypt’s economy, and depending on hot money as a major source of foreign currency is very dangerous, particularly given Egypt’s vulnerable external environment.

“Proper policy coordination and restoring monetary policy credibility are key to containing inflation and protecting the economy from forex market distortions,” stresses El-Khishin. Hopefully, she says, a flexible exchange rate will operate as shock absorber.

Implementation of the needed reforms will shorten the response time to shocks and allow private sector activity to rebound and economic growth to rise again, agrees ElDesoki.

It is also important not to repeat the mistakes of the past. “The government needs to be very cautious about the inflated debt burden, particularly in light of hiked interest rates,” warns El-Khishin. The CBE raised interest rates by six per cent as part of its 6 March decisions.

In the past, points out ElDesoki, there has been a tendency to allow public debt to rise on the back of spending on projects that do not generate revenues to pay back the debt in a timely manner, a pattern that needs to be avoided in the future.

Egypt’s external debt stood at around $165 billion in September 2023, amounting to 40 per cent of GDP, compared to 30 per cent of GDP in January 2022.

Hard-pressed housewife Hala Ali does not expect an immediate reversal of inflation.

Egypt’s annual urban inflation reached 35.7 per cent in February and according to El-Khishin, prices are unlikely to decline soon even if economic conditions get better.

The key issue, ElDesoki argues, is to regulate markets and prevent the hoarding and manipulation of supply and prices by traders. She also advocates that the government reduce custom rates on essential goods that experience high inflation until their prices decline.

In the meantime, says El-Khishin, expanding social safety nets for the most vulnerable groups negatively affected by the recent measures is essential.

* A version of this article appears in print in the 14 March, 2024 edition of Al-Ahram Weekly

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