The devaluation of Egyptian pound: tough test for Sisi

The devaluation of Egyptian pound: tough test for Sisi
Comment: Ibrahim AlSahary
5 min read
15 Mar, 2016
On Monday, the central bank devalued the pound by 14.5 per cent [Reuters]

"Absolutely not," said Tarek Amer, govenor of Egypt's central bank when asked if he would float the Egyptian pound.

He said that the central bank was aware of the needs of society - of the importance of keeping prices stable and the interests of poor, in addition to the need create an environment conducive for business.

"When foreign reserves reach US$25 or $30 billion (from the current $16.48 billion) then maybe we can think about it," he said.

On Monday, the central bank devalued the pound by 14.5 per cent to 8.85 per dollar from 7.73.

Dire straits

Now the question is: Has the country's foreign reserves increased during the past three weeks to $25 billion or came close that level? The answer is absolutely not.

On the contrary, statistics available show a slight monthly increase in foreign reserves of around $40 million over the past five months.   

More so, the central bank managed "Operation Makeup to maintain the widely monitored foreign reserves figure at or above the $16 billion mark," a research note by Cairo-based investment bank Beltone Financial read.

The central bank used "Operation Makeup" - the biggest face-lift in recent history, according to Beltone - to "conceal an otherwise steep contraction in official foreign reserves assets".

They did this by making commercial banks place $3.6 billion worth of foreign currency customer deposits into the central bank during the second quarter of the fiscal year 2015/2016.  

"If we exclude these 'rescue' deposits, foreign reserves would have probably plunged to $12.5 billion."

Egypt's total imports bill is estimated at $5 billion per month, which means that current reserves are hardly sufficient to cover two-and-a-half months of imports.

On Monday, the central bank devalued the pound by 14.5 per cent to 8.85 per dollar.

So, why did the central bank depreciate the pound despite declining reserves, and even though this will likely lead to price rises and therefore harm the poor who are already suffering from high inflation?

Egypt has received loans and grants worth tens of billions of dollars from Gulf state during the past five years. Yet the country's reserves have dropped by 50 per cent from $36 billion at the end of 2010. Due to permanent shortages in reserves, the central bank depreciated the local currency 20 times since January 2011. So, the official exchange rate climbed by 60 per cent from EGP 5.62 to the dollar at the of 2010.

Obviously, the flotation will not stop the rise of dollar in the coming weeks. The green currency will keep on climbing, just not as fast as before, because the central bank does not have a realistic, long-term plan for shoring up reserves.
Recently the government said that it will depend on a recovery in tourism revenues and remittances in the second half of the fiscal year 2016, but it is questionable if this recovery can be achieved.

Hot summer

It seems that the central bank has run out of solutions. In fact, it has recently come under extreme pressure from local and foreign investors, and importers, to float the pound, as a way out of the crisis caused by a dollar shortage.  

It is clear that investors are the main gainers from Monday's decision as Egypt abides to the conditions of the international financial institutions.

In a swift response, Egypt's stock market gained 14.9 billion Egyptian pounds ($1.6 billion) on Monday's session, with the EGX30 Index soaring 6.7 per cent. It was its biggest jump since President Mohamed Morsi's ouster in 3 July 2013. Trading volume was the heaviest since the global financial crisis between 2008-2009, boosted by the speedy shift in investors' sentiment that turned from an "over pessimism" to "extreme optimism", according to securities brokerage company, Sigma Capital.  

But not everyone is optimistic. The 14.5 per cent devaluation coupled with a sales tax will drive the price of imports up 35-40 percent, the head of importers division in Cairo's chamber of commerce told media. He described the central bank's move as "catastrophic".

More than 70 percent of Egypt's imports are raw materials, machinery, basic food goods, such as wheat, sugar, meat and cooking oil, and pharmaceuticals.

When the IMF and the World Bank lend money it comes with tough conditions.

This makes it appear that an IMF loan is looming for Egypt. The timing of the flotation decision is significant; it came days after a IMF delegation visited Cairo with discussions about the exchange rate and monetary policies. The IMF has made it clear more than once that it is ready to engage with Egypt once it shows more commitment to the fund's financial reforms programme.

In a Reuters report on Monday, American Bank, JPMorgan said that "it expected Egypt to agree with the IMF on a loan programme before the end of the fiscal year in June". The report pointed out that "this would be a politically difficult step for the government; for this reason, Egypt has not committed itself to an IMF programme in the last several years".

When the IMF and the World Bank lend money it comes with tough conditions. For Egypt, the currency devaluation will be one of these conditions as well as privatisation, sharp austerity measures - such as cutting subsidies for goods and services - and reducing the wage bill for civil servants.

Last month, Prime Minister Sherif Ismail said that the government will soon announce "tough economic measures". This means more measues that attack the poor are due.

There's no doubt that the dramatic soaring of prices and no hope that better days are to come will make summer in Egypt a very hot one, and will give "General" Abdel Fattah al-Sisi one of the toughest tests in his rule.

Ibrahim AlSahary is an economist and former executive chief editor of Egypt Independent.

Opinions expressed in this article remain those of the author and do not necessarily represent those of The New Arab, its editorial board or staff.