The Egyptian pound recorded LE7.73 to the dollar at the foreign exchange auction on Tuesday, and the Central Bank seems to have stabilized it at this level after suddenly allowing it to depreciate over the past week. The pound has weakened by 2.5 percent since last Thursday, when it first fell to LE7.63 from LE7.53 where it had been for five months, followed by a drop of another LE0.10 on Sunday.
Earlier this year, the Central Bank took measures to tightly restrict the flow of dollars inside and outside the banking system, in an attempt to eliminate the rampant black market. Over the past few days, some analysts predicted the currency may further weaken to reach 8 pounds to the dollar.
While a weaker pound may spur investments and tourism, and boost exports, it creates a heavy burden on Egypt’s already large import bill for basic fuel and food supplies.
Citing a televised interview, Reuters quoted Central Bank Governor Hesham Ramez as saying, “There is nothing to worry about from the dollar’s rise (against the pound) … this is a normal movement. It only moved 2.5 percent and this happens a lot in markets.”
Why did the Central Bank allow the Egyptian pound to depreciate against the dollar?
The executive director of Multiples Group for Investment, Omar al-Shenaitty, says that this was an expected decision. In addition to boosting exports and tourism, and reducing imports, he believes that the decision was primarily aimed at encouraging foreign investment through providing a fair price for the dollar. He also points to the Central Bank’s previous reduction of the value of the Egyptian pound before the Sharm el-Sheikh Economic Development Conference to encourage foreign investment, which is a traditional way of managing exchange rates.
Assistant Professor at the Department of Economics at The American University in Cairo Samer Atallah disagrees with this argument. He believes that encouraging foreign investment and boosting exports as the two main sources for foreign currency requires clear and transparent monetary policies and structural, rather than procedural, amendments. For Atallah, financial decision-making remains random at best.
Meanwhile, Shenaitty says that the timing was a surprise, as most experts expected the government to take these measures by the end of this year or the beginning of next year. He speculates that the depreciation was timed to take advantage of the delay in raising fuel prices.
“There are main factors that lead to increasing inflation, including depreciation of the pound, raising fuel prices and printing money,” he explains. “The government has already delayed lifting subsidies and raising fuel prices, so this was the right moment to depreciate the pound to encourage foreign investment, especially as we approach the opening ceremony of the new Suez Canal, scheduled for next month.”
Shenaitty adds that the opposite happened last year in August, as well, when the government made the decision to cut back on fuel subsidies, which led to an increase in prices and inflation rates. Consequently, the government delayed depreciating the local currency.
“This is the government’s usual approach to avoid a major inflation crisis,” he elaborates. “Despite the fact that the current decision coincides with raising electricity prices and the prices of train tickets, the increase in fuel prices is the main factor that affects the prices of all commodities and services, so raising fuel prices is a deferred decision for the time being.”
Shenaitty believes that it is possible for the state to resumes its previous plans to lift fuel subsidies in a few months, which should be enough time to absorb the inflation shock resulting from the drop in the value of the Egyptian pound.
How is the exchange rate determined?
The exchange rate is determined through three basic mechanisms, the first of which is the government’s administrative decisions to stabilize the exchange rate of foreign currency, which is the method followed by Lebanon and China. Egypt employed this method before Atef Ebaid’s Cabinet’s decision in 2003 to float exchange rates.
The second method is floating foreign exchange rates, which means fully subordinating them to supply and demand. The third method, the managed float, is the policy Egypt currently uses.
In a managed float, the Central Bank intervenes through market mechanisms to adjust the foreign exchange rates without directly fixing them. This can happen through pumping or buying currency from the market to raise or lower exchange rates.
What are the factors affecting the value of local currency?
Many factors affect the value of local currency and in turn the inflation rate, including supply and demand both for the Egyptian pound and for locally manufactured products, as well as internal assets.
Atallah believes that at this moment, there is no demand for the Egyptian currency, nor for locally manufactured products, which has been exerting considerable pressure on the Egyptian pound since 2011.
At the same time, the market is suffering from a shortage of foreign currency due to weak tourism revenue and limited foreign investment. This reflects on the value of the Egyptian pound and increases inflation exponentially.
What is the role of the Central Bank with regard to stabilizing foreign exchange rates and managing inflation?
Business journalist Wael Gamal believes that in the past, the primary role of the Central Bank was ensuring the stability of the exchange rate through buying or infusing currency into the market. However, now the Bank’s role has theoretically changed to managing inflation. This role is tightly linked to local and foreign exchange rates.
He explains that “imported inflation,” which results from the rising dollar against the pound, leads to an increase in the prices of imported goods in the local market. This issue plays a major role in the Egyptian market due to dependence on imports for a large fraction of commodities. Thus, the Central Bank’s decision with respect to foreign exchange rates consequently affects inflation rates as well.