2011-2020: The Egyptian economy - All eyes on the dollar

Niveen Wahish , Tuesday 29 Dec 2020

The availability of hard currency will always be a make-or-break question for the Egyptian economy


The value of the Egyptian pound against the US dollar has always been a sensitive issue for all Egyptians, as it defines how much their savings are worth and is a key indicator of price direction.

Over the last 10 years, the pound has gone from being artificially supported to being floated, losing half of its value overnight. While the move was shocking at the time, it was seen as one of the factors that have helped the Egyptian economy to withstand major shocks like the emerging markets crisis in 2018 and this year’s fallout from the Covid-19 pandemic.

The decision to float the pound in November 2016 as part of an International Monetary Fund (IMF)-backed package of reforms was much-needed to tackle a build-up of significant imbalances including a widening budget deficit.

Egypt’s overall budget deficit stood at 12.5 per cent of GDP in fiscal year 2015-16, according to Ministry of Finance data. That deficit fell to 10.9 per cent in fiscal year 2016-17. The reforms included the gradual lifting of fuel subsidies and an increase in the value-added tax (VAT).

Christine Kamel, an economist at Dcode Economic and Financial Consulting, described the economic reforms implemented since 2016 as “the boldest in Egypt’s modern history”. After a long history of controlling the foreign-exchange market to hedge against imported inflation, the Central Bank of Egypt (CBE) had finally realised it cannot beat market fundamentals, she said.

“It was definitely one of the crucial measures that had to be taken for the economy to go in the right direction,” said Dalya Mokhtar, head of research at N Gage Consulting, a government relations and public-policy consultancy. The CBE’s prior monetary policy had resulted in the bank expending a considerable portion of its foreign reserves, she added.

Egypt’s foreign reserves stood at a low of $13.4 billion at the end of March 2016, covering 3.5 months of imports, Ministry of Finance data showed. Following the floatation, the reserves rose to $26.4 billion at the end of January 2017, covering 5.6 months of imports and increased to $38.2 billion during January 2018, covering 8.2 months of imports, surpassing the $36 million of the international reserves in January 2011.

According to Mokhtar, before the floatation in 2016 it had been difficult for importers to meet their dollar invoices and for foreign investors to repatriate their profits because of the dollar shortage caused by a significant drop in tourism numbers and a slowdown in foreign investment.

The decision to float was important to strengthen investors’ confidence in the economy, reroute foreign-currency trading to the formal banking sector, and end the currency black market, which was trading the dollar at double the price set by the CBE at the time of the floatation, Mokhtar said. Less than a month after the floatation, the CBE reported that the banking sector had pulled in more than $3 billion, she pointed out.

Moreover, she added, companies had benefited from the floatation as foreign-exchange losses were recognised by the Tax Authority, when previously foreign currency purchases from the parallel market had created a burden of foreign-exchange losses not supported by receipts. As a result, only a certain portion has been allowed as expenses during tax investigations.

But the reform has been costly to ordinary Egyptians. While the reforms as a whole have helped to accelerate and rebalance growth, eliminate the parallel market and replenish net international reserves, Kamel said, they had also resulted in a higher cost of living, eroded purchasing power, increased poverty rates, depleted household savings, elevated the cost of borrowing, and more than doubled external debt.

Since the currency floatation in 2016, the CBE has raised key interest rates by 700 basis points in three phases to dry up liquidity from the market and defend against speculative attacks on the pound as well as to anchor inflationary expectations.

Higher prices and interest rates have pushed some companies to halt their expansion plans, said Mokhtar, adding that firms that have foreign-currency debt were also left exposed after the pound lost half its value, and manufacturers who relied on imported inputs saw their working capital fall by as much as half.

Nevertheless, the government eventually managed to control inflation rates, added Alaa Abdel-Aziz, an economic researcher at N Gage Consulting. Inflation came down from a peak of 33 per cent in July 2017 to 3.4 per cent in August 2020, marking its lowest level since 2005, according to data from the Central Authority for Public Mobilisation and Statistics (CAPMAS).

For years monetary policy was about keeping the currency stable. However, it gradually shifted focus to price stability with an eye on eventually targeting inflation. In its country report for Egypt issued in August 2020, the IMF praised the CBE’s data-driven policy approach to anchoring inflation expectations, which has so far delivered low and stable inflation, DCode’s Kamel pointed out.  

The CBE intends to adopt a fully-fledged inflation-targeting regime once the fundamental prerequisites are met, said Abdel-Aziz. These prerequisites include the independence of the CBE, price stability as the main monetary policy goal, and the country’s capability to forecast inflation targeting. The CBE needs “to explicitly announce that its mandate is to achieve price stability as a primary goal for monetary policy,” Abdel-Aziz said.

TOWARDS 2021: Going forward, it is crucial for the government to cement these hard-won gains by continuing its efforts in stabilising the economy and accelerating reforms to unleash the economy’s potential, said Mokhtar.

Public-private partnerships need to be deepened so that the private sector becomes the engine of growth, in addition to granting a special focus to it and conducting continuous assessment on sectoral growth to garner further economic gains. This also entails ensuring that the current cushion of foreign-exchange reserves is preserved by maintaining a flexible exchange rate and that inflation remains on the decline, along with public debt, which will create further room for investment in health, education, and public infrastructure, she stressed.

Egypt’s main sources of hard currency are, traditionally, tourism, Suez Canal revenues, remittances from abroad, and exports.

The crash of a Russian passenger jet near the Red Sea resort of Sharm El-Sheikh late in 2015 was one of the major factors affecting hard-currency income. Egypt only began recovering from the crash in 2019, and 2020 would likely have been a bumper year for tourism had it not been for the coronavirus. Nonetheless, the sector’s activities are expected to pick up, especially with the expected opening of the Grand Egyptian Museum (GEM) on the Pyramids Plateau in 2021, said Abdel-Aziz.

As for remittances, although they have been increasing in recent years, Abdel-Aziz believes they are the least sustainable form of revenue, as they easily fluctuate with any changes in the situation of Egyptian expatriates working in Gulf countries.

Though in 2020 remittances beat expectations, reaching more than $27 billion in fiscal year 2019-20, their highest ever, compared to around $25 billion during the previous fiscal year, they are forecast to decline as the Gulf Cooperation Countries (GCC) increasingly replace expats with national labour.

DCode expects remittances to decline by an average of five per cent annually starting in fiscal year 2021-22 due to consolidation in the GCC.

According to DCode research, the increase in remittances in recent months is likely due to Egyptian expatriates in the GCC countries either sending their families back to Egypt, as they can no longer afford the cost of living there, thereby transferring money to them at home, or sending the bulk of their savings home as they prepare to return to Egypt due to job losses abroad.

Another reason, Kamel said, could be their inability to informally transfer their money by hand due to lockdowns, causing them to make greater use of the banks. It could also be attributed to Egyptian expatriates wanting to increase their support for their families in Egypt during the economic downturn to compensate for the loss of other sources of income and employment, she added.

As for hard currency earnings from Suez Canal receipts, which amounted to $5.7 billion in fiscal year 2018-19, these are unlikely to increase significantly, said Abdel-Aziz, largely due to sluggish global trade and demand, in addition to the fall in oil prices, which had made longer shipping routes less costly for vessels than the canal’s passage fees.

He said that according to the United Nations Conference on Trade and Development (UNCTAD), the Covid-19 shock to the world economy is estimated to potentially shrink global trade by 20 per cent in 2020. Fewer ships transiting the Canal would essentially lead to fewer paid tolls, which could constrict the country’s foreign-currency earnings, he explained.

FUTURE PLANS: The answer to boosting Egypt’s hard-currency earnings, experts say, lies in greater exports.

President Abdel-Fattah Al-Sisi has called for a drive to boost Egypt’s exports to $100 billion annually within three years. Structural factors such as low productivity, a poorly diversified export base, and quality issues have so far impeded the further penetration of Egyptian exports abroad despite competitiveness gains brought about by the currency floatation, Kamel said.

According to the World Bank, other factors include the concentration of exports in traditional areas of comparative advantage and weak relatedness to globally traded goods, significant barriers to trade including administrative, technical, and sanitary measures, as well as connectivity and infrastructure challenges, she added.

“Incentivising more investments into export-related industries, improving the quality, complexity, technological advancement and diversity of Egypt’s exports, as well as entering new markets with high potential such as Africa, would help get us closer to that target,” she said.

Another area where more work is needed is in attracting foreign direct investment (FDI). Despite the competitiveness gains brought about by the cheaper currency following the floatation and the country’s unprecedented macroeconomic and legislative reform measures implemented over the past few years, foreign direct investment in Egypt remains lacklustre, well below its potential, stressed Kamel.

According to UNCTAD’s 2020 World Investment Report, inward investment flows stood at $9 billion in 2019. That was a far cry from the situation following 2011 and an improvement on 2017 when FDI came to around $7.5 billion.

Egypt has recently adopted a new investment law that grants incentives based on the labour-intensity of a project or its geographical location. Investment in the poorer Upper Egypt region has been very much encouraged. The government has also set up special business-friendly economic zones with more efficient administration, tax incentives, facilitation of registration and customs procedures and better infrastructure.

However, a significant boost to FDI will likely only come about with structural reforms as well as deeper reforms to the business environment. According to the World Bank’s Doing Business report, Egypt still lags behind when it comes to trading across borders, reflecting lengthy time and procedures to import, export, or clear commodities across borders, said Kamel.

She added that Egypt did not perform well on issues such as the enforcement of contracts, including lengthy periods to resolve business disputes and a relatively poor standing on the judicial processes index.

With the country’s main hard-currency earners largely hostage to external shocks or awaiting development, the government will rely to a large extent on borrowing. As Kamel pointed out, since March 2020 Egypt has been able to secure some $20.3 billion in foreign financing.

Prior to the Covid-19 crisis, Egypt’s external debt ratio had declined from 37 per cent of GDP in June 2018 to 30.8 per cent of GDP in March 2020. With increased foreign debt in recent months, as well as slower economic growth, the ratio has increased to stand at 34.1 per cent of GDP in June, Kamel pointed out.

Nonetheless, she added, despite the build-up of debt, it still remains within sustainable levels. The international ratings agency S&P Global Ratings has affirmed Egypt’s B sovereign credit rating with a stable outlook, despite the elevated external risks from Covid-19.

*A version of this article appears in print in the 24 December, 2020 edition of Al-Ahram Weekly


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