The government has been actively negotiating with the International Monetary Fund (IMF) to adjust the timeline of implementing reforms under its current Extended Fund Facility (EFF) programme.
Official statements have emphasised the need to revisit the programme in order to reduce the strain on Egyptian households, and the government has sought to extend the implementation period for some of the reforms rather than abandon them altogether.
Although the IMF appears open to such discussions, it insists that the “macroeconomic conditions today show that the programme, in its design and finance, is still appropriate,” according to the IMF director for the Middle East and Central Asia.
Statements on both sides show that while no final agreement has been reached, both parties are committed to maintaining the programme’s objectives. In the meantime, it is important to evaluate whether a slowing down of the pace of the required measures is what Egypt needs.
From the IMF’s point of view, structural challenges call for thecontinued implementation of the programme’scommitments, including maintaining a flexible exchange-rate regime, putting inflation and debt on a downward path, increasing the role of the private sector and accelerating the privatisationprogramme.
To meet its obligations, the Central Bank of Egypt (CBE) is giving more space for the Egyptian pound to move against the dollar, aligning with the principle of a flexible exchange rate. The greenback’s price increased to almost LE51 earlier this week compared to an average of LE48 since its devaluation in March.
The rationale is that while a cheaper pound would increase demand for exports, costlier imports would discourage relying on goods purchased abroad.
The principle is fundamentally sound but only within specific limitations and under particular conditions related to the ability of the balance of payments to adjust to changes in the exchange rate, or what is scientifically known as the “Marshall-Lerner condition”. In simpler terms, this means that for a currency devaluation to positively impact the trade balance of a particular country,the combined price elasticityof demand for imports and exports is greater than one (elastic). Also, the economy of that country should be able to increase the volume of its exportable production and secure local substitutes for its costlier imports.
Without this elasticity, the benefits of currency depreciation will be limited or not attained at all.
The Egyptian economy does not meet this elasticity criterion due to structural factors. Egypt’s imports are highly inelastic, meaning that the demand for these goods is hardly affected by price changes and people will continue to purchase them even as prices rise. This inelasticity stems from the essential nature of many imported goods, such as food, medicine, and fuel.
Some imported goods, though non-essential for society at large, are also primarily consumed by high-income groups. For this segment, price increases, such as those resulting from currency depreciation, have a negligible impact due to their greater purchasing power.
Additionally, there is a limited capacity to expand exports in response to price changes as exporters cannot scale up production to meet increased foreign demand. This explains why repeated devaluations of the pound have failed to deliver the intended benefits as contemplated by the IMF deals.
It should come as no surprise, therefore, if Egypt liberalises its foreign-exchange system following IMF recommendations and does not achieve the expected outcomes. Moreover, several potential impacts on the exchange rate and the broader economy could occur.
The first of these is the continuation of the depreciation, as the market perceives the currency as overvalued. For example, the pound would lose ground to the dollar if there was a sudden increase in demand for the latter as businesses and individuals rush to convert their local currency holdings into dollars anticipating further depreciation.
Without proper controls, the exchange rate is going to become more and more volatile, with fluctuations driven by market speculation, uncertainty, and a lack of liquidity in the foreign-exchange market.
The repercussions of depreciation extend to the fiscal level as well. As the country has significant external debt denominated in foreign currencies, the depreciation will increase the volume of external debt when translated to the Egyptian pound, as well as the cost of servicing this debt. This will further strain public finances and aggravate the public debt problem.
Inflation in Egypt is primarily supply-side, although there are some demand-driven factors as well. Supply-side inflation occurs when the cost of producing goods and services rises, leading to higher prices, even if demand stays the same. This type of inflation is often caused by higher production costs, higher raw material prices, and supply-chain disruptions.
This kind of inflation should not, as is the case in Egypt, be addressed by increasing interest to tighten demand. This cannot address its root causes, such as rising import costs or disrupted supply chains. It also increases the cost of borrowing for businesses and thus limits economic growth and increases unemployment.
Without addressing the core issue of the trade deficit and production inefficiencies, liberalising the foreign-exchange system and raising interest rates will only provide temporary fixes at the most. High interest rates fall short of addressing the root causes of the imbalances and push the authorities to acquire more foreign-currency denominated loans, which results in a cycle of borrowing and repayment that puts the brakes on independent economic progress.
The local currency will remain under pressure as long as the underlying structural issues (mainly the trade deficit) persist. With the continuous inability to address the root causes, there remains only one option left, which is following structural reforms that are not aligned with the country’s specific economic realities. For example, the privatisation of certain state-owned enterprises, especially those in strategic sectors.
The lessons of Egypt’s recent currency crises highlight the need for sustainable economic management rooted in self-reliance rather than dependence on external loans and devaluations.
The government and CBE need to adjust their policies by taking measures like introducing capital controls. There is also a need to mobilise domestic resources and implement a sustainable, inclusive growth model.
In other words, the deficiencies in Egypt’s current economic policies highlight the need for more than extending the timetable of the IMF programme. Instead, they need a paradigm shift.
The writer is a banking consultant.
* A version of this article appears in print in the 19 December, 2024 edition of Al-Ahram Weekly
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