The Central Bank of Egypt froze the exchange rate of the pound on Tuesday at LE8.78 to the dollar, having sold US$120 million during its weekly auction of foreign currency. The pound fell on the black market to LE15 per dollar.
The decision to keep the pound at the current rate comes on the heels of comments made by the International Monetary Fund’s Managing Director Christine Lagarde. On Saturday, Lagarde said there were still some issues related to exchange rates and subsidies that needed to be resolved before the IMF board would review its $12 billion loan agreement with Egypt, fueling speculation that the pound would be imminently devalued.
After the Central Bank’s unexpected decision not to devalue the pound at the beginning of October, many analysts continue to claim it is now inevitable and imminent. Assuming the devaluation could reach LE15 per dollar, what are the possible ramifications for Egypt’s economy?
According to the managing director and head of global research for Mubasher Financial Services Amr Hussein al-Alfy, devaluing the pound to such a level is similar to floating the currency. This, he argues, would result in the currency dropping to more sensible levels over time, to somewhere between LE10.7 and LE11.6 per dollar. He compares the trajectory Egypt is currently on to Argentina in 2015.
The devaluation of the pound will have an impact on the prices of regulated goods, Alfy says, which were previously set based on the exchange rate. Although, with the black market rate currently at 13-14 pounds to the dollar, devaluation will not affect unregulated goods and services much, as long as dollars are available.
Professor of economics at Cairo University, Omneia Helmy, says the devaluation of the pound is guaranteed to affect the prices of basic commodities. The government must find a way to ration imports and increase capital flows in order to offset the hardships Egyptian citizens already face, she argues.
Mohamed Abu Basha, an economist working for EFG Hermes, says the effect of currency devaluation on Egyptian citizens depends on their reliance on subsidies. “If you are a family that has access to and depends on subsidized goods, these costs won’t increase, but other families that do not have such access will find that their costs will increase quite a bit,” he explains.
Egypt also faces many shortages in essential medicines, which has been closely linked to the dollar crisis. While Alfy maintains the accessibility of medicine and food are governmental priorities, Helmy argues the state must establish mechanisms to foster healthy competition from the private sector. “If the government allows the private sector to contribute, it can ensure shortages in medicine are averted,” she says.
Egypt currently subsidizes a lot of essential medicines, keeping their cost affordable for the general public. While this means many medicines are sold at below production cost, creating a more competitive private sector could further increase the cost of many essential and basic medicines, increasing the burden on those that rely on the subsidy. Pharmaceutical companies have said that the price of production in many instances does not match market rates and has led to a large profit losses.
With an effective safety net, Alfy believes the impact of the pound’s devaluation will not necessarily translate into social unrest.
Generally speaking, currency devaluation can contribute to higher export rates, as goods become more economically competitive in international markets, but purchasing power often diminishes as international goods become more expensive.
Alfy warns devaluation or floatation of the pound will not be a positive move for Egypt, as it is a net importer that relies on substantial food imports, such as grain, to feed the population. “Egypt must turn from being a consuming to a producing nation,” he says, adding that, “exports will not increase much with devaluation unless high-quality goods are produced that are competitive with other countries.” Given the ever-widening deficit, Helmy stresses the state must curb unnecessary imports.
“If there is a significant increase in the purchasing costs of imported goods such as wheat, it would have a noticeable impact on the cost of subsidies,” Alfy says. “Food is the most important commodity for the Egyptian people, accounting for an average of 40 percent of expenditure,” he adds, speculating that, if energy subsidies are further deregulated in the coming period, this could also shift excess savings into other areas, such as food.
Helmy believes the state must undertake many economic reforms as soon as possible in order to limit the impact of currency devaluation. “The state must create a better business environment that can attract investors, and at the same time tackle ongoing corruption,” she says.
In order to diminish the impact of currency devaluation on the economy and the lives of Egyptians, a concerted effort must be made by both the Central Bank and the state. According to Alfy, state expenditure on wages has gone up significantly since the revolution in 2011, and many sectors could face cuts to balance out the budget. “Not the wages of the average worker, but the wages of advisors and consultants that get paid a lot of money,” he clarifies. “We have understandably been increasing salaries in Egypt because government employees were not paid very well, but we have reached a point where lots of people are being paid well enough without necessarily being more productive.”
With the recent introduction of the civil service law, Alfy believes wages can be better distributed. “Overall the wages of civil servants may fall slightly, but this does not mean that the average wage will drop. What will probably happen is that the salaries of certain people as mentioned before may drop, but other salaries will be increased to make up for the differences.”
That a currency devaluation will bring increased hardship for many people is no surprise, but Abu Basha believes it will also create room for growth. “According to our models, the economy could experience 4-5 percent growth in the next two years if the currency adjustment is successful,” he says. “The industrial sector, for example, will have to import resources and machinery at higher prices.”
Inflation reached 10.2 percent on average in the 2014/15 Financial Year. Forecasts by EFG Hermes predict inflation will likely hit 14.2 percent on average for 2016, but their models do not account for the possibility of an increase in fuel prices.