It was marketed as inevitable, a necessary step to seal the deal with the International Monetary Fund. What choice did Egypt have, economists and analysts said. The nation had no choice but to hike interest rates and float its currency. Yet the country surprised the market, economists and investors with an almost 50 percent devaluation.
Egypt’s economy, one of the most critical, simmering issues in the region, is again in flux. The country’s fiscal situation, which has a direct bearing on the security and livelihood of an already endangered population, was sent into a tailspin when a new currency regime was announced this week. “There will inevitably be fresh pain for the economy in the near term,” said Jason Turvey, economist at Capital Economics in a note. The decision is already having reverberations across one of the most fragile countries in the Middle East and North Africa, with prices of staple commodities expected to balloon. Mohamed El Dahshan, non-resident fellow with Tahrir Institute for Middle East Policy told Middle East Eye:
“We are now in hell and the only way out is through.”
The IMF predictably championed the move, saying the new system better prepared people to sell dollars as well as buy them, injecting more money into the economy. The move would eliminate a thriving black market for dollars and secure, after five years of on-again off-again negotiations, that much-needed IMF loan. Without this, there was chaos and economic armageddon on the horizon.
There is a price to pay for Egypt’s complicity with the IMF at such a late stage attempt at economic recovery. Like most regimes with troubled economies, Egypt has a history of hiding the true extent of its inflationary woes. In many cases, governments fabricate inflation statistics to hide their economic problems, and Egypt is no exception. Steve Hanke, a professor of Applied Economics at Johns Hopkins and director of the Troubled Currencies Project at the Cato Institute had this to say to Rebel Economy:
“Inflation is an enormous problem and my estimate is inflation is considerably higher than official numbers and between 105 percent and 110 percent.”
The IMF, Hanke said, has provided “incredibly bad advice,” that serves predominantly to provide false hope and delay any real solution. “They [the IMF] did this just a few months ago in Nigeria, and they have not stabilized the naira [Nigeria’s local currency] and they’re not going to stabilize the pound,” Hanke said. Nigeria is experiencing an eerily similar problem to Egypt. It managed to sharply devalue its currency but only worsened the very problem that devaluation was meant to solve. Read this Quartz piece for a scary window into Nigeria’s present situation and Egypt’s future.
The underlying issue that no one wants to talk about, said Hanke, is this:
“The IMF wants a monopoly on giving advice, and the governments it advises are afraid to get a second opinion because they’re worried they won’t get money from other governments. It’s a false hope and it allows them to kick the can down a little further.”
But there is another way. Hanke suggests Egypt’s solution could be the implementation of a currency board system, which effectively combines a fixed exchange rate between a country’s currency and an “anchor currency” (which would be the U.S. dollar), automatic convertibility, and a long-term commitment to the system. “The rule is you have to back the local currency,” he said. The system has been tried and tested in several countries, including Bulgaria, where Hanke was an advisor to the government that implemented the program in 1997. The key is disciplining the fiscal authorities, says Hanke.
And guess Egypt’s primary problem is? Discipline. “In Egypt, the government can borrow from the Central Bank any time they want,” Hanke said. Bulgaria was in the midst of a banking crisis and entering a period of hyperinflation. The currency board system reduced Bulgaria’s annual inflation to 13 percent by mid-1998 and to 1 percent by the end of 1998 while rebuilding foreign exchange reserves from less than $800 million to more than $3 billion—more than six months of imports.
So why hasn’t Egypt taken this step? Why hasn’t it been put on the table? Because the military, who controls vast swathes of the economy, might find it hard to swallow.
Inflation is at the highest level in at least seven years, and the president and his team will have to satisfy the IMF through hard measures, including adequately reducing energy subsidies. And Egypt doesn’t seem too far from Bulgaria’s situation today.
Emad Mostaque, a strategist for Ecstrat, an emerging markets consultancy, says Egypt was just shy of hyperinflationary collapse before this week’s currency regime changes, with the deficit, tax base and interest payments all hovering around the 12 percent-of-GDP mark, not to mention debt-to-GDP exceeding 100 percent. (If you want to see what hyperinflationary collapse looks like, just check out Venezuela). Mostaque says:
“Nasty things happen when your entire tax base is barely enough to cover your interest costs and you have less than 3 months of import cover.”
Yesterday, the Egyptian pound slid to a new record low of around LE6.51 to the dollar, as demand for dollars remained strong.
It was despite Qatar providing the nation with an economic lifeline by sending $2.5 billion in aid to help it tackle a currency crisis.
The central bank has allowed the pound to slide by about 0.5% a day against the dollar since it introduced a new currency regime on December 30, according to data from Reuters.
Until the new regime was imposed, the currency had lost just 6% in the two years since Egypt’s revolution that overthrew president Hosni Mubarak. But in last past 11 days the fall has accelerated, with the pound losing 5% on the interbank market.
But what does this mean in the long-term?
Using interviews I did with two former Egypt Central Bank governors (part of this appeared in a story I published today in the International Herald Tribune), Rebel Economy looks at two different perspectives on the new currency regime:
1. Mahmoud Abul Eyun, Central Bank governor until 2003, and oversaw Egypt’s historic flotation of the pound and eradication of the black market:
He criticized the timing of the new measures, saying they should have been adopted at least a year ago and that the late reaction will hit vulnerable people the hardest.
“We have been waiting for this for a long time, at least two years. The bank has unfortunately lost a lot of foreign currency, and this is the price that has been paid for the late decision.”
“This is going to add a lot to the fiscal burden if the government continues to have subsidies,” Mr. Abul Eyoun said.
Abul Eyoun predicts a 20 percent jump in the price of staple goods if the government cannot finance its deficit and if the pound continues to slide.
“It is a dilemma, and I feel that this government and central bank will have to go through hard times,” he said.
Ismail Hassan, Central Bank governor in the 1990s and now heads Misr Iran Development Bank in Egypt:
He welcomed the Central Bank’s move and said it heralds a new era of currency management.
“I don’t think there is room for the word devaluation. Devaluation was used in the past when we had a fixed price, and now the alternative is the central bank not interfering heavily in the market,” Hassan said.
The new regime means devaluation, a product of central bank measures, would be replaced by market forces of natural depreciation where the real value of the pound would be discovered.