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.”
As the months drag on and the prospect of a recovery for Egypt’s economy seem to slip further away, the key question on most investors’ minds is whether the government can push through reforms.
But while it is clear that successive governments have failed to ease hardship, it’s worth addressing whether Egyptians are ready for reforms.
The loudest opposition to the International Monetary Fund loan, energy subsidy reforms and higher taxes was from Egyptian citizens. That’s not surprising considering Egypt’s rocky history with the IMF and the (inaccurate) perception that reforms will make life worse for the poorest.
But perhaps its time for an attitude change. Indeed, it is the very real fear of a popular backlash to reforms that has so far stopped any government imposing anything too harsh.
But as Rebel Economy argued earlier this week, a dose of austerity with some stimulus is better than no austerity at all.
Take Latvia, which has provided “a rare boost to champions of the proposition that pain pays”, where it is perceived as shameful for people who earn any salary, no matter how small, to go on strike, New York Times reporter Andrew Higgins writes:
When a credit-fueled economic boom turned to bust in this tiny Baltic nation in 2008, Didzis Krumins, who ran a small architectural company, fired his staff one by one and then shut down the business. He watched in dismay as Latvia’s misery deepened under a harsh austerity drive that scythed wages, jobs and state financing for schools and hospitals.
Then there was light:
But instead of taking to the streets to protest the cuts, Mr. Krumins, whose newborn child, in the meantime, needed major surgery, bought a tractor and began hauling wood to heating plants that needed fuel. Then, as Latvia’s economy began to pull out of its nose-dive, he returned to architecture and today employs 15 people — five more than he had before. “We have a different mentality here,” he said.
Does Egypt need to change its mentality? Rather than protest dislikes (which is all too easy) what about focusing energy into lobbying organisations to work harder for job creation and inclusive growth?
It worked for Latvia.
The Baltic tiger’s economy grew by 50% during 2004 and 2007, but the global financial crisis of 2008-09 hit the country hard and it endured one of the worst recessions of the European Union. Deep public spending cuts introduced by the new government led to discontent and protests at home, but impressed international lenders enough to earn Latvia an IMF/European Union $10 billion bailout.
Rather than cause uproar, the cuts (including slashed wages, wide-scale sackings of public sector workers and reduced welfare) calmed fears in the international markets and rather than throw the government out of office, Prime Minister Valdis Dombrovskis, who presided over the austerity, was re-elected.
Of course it would be short-sighted to suggest that if there were no protests then life would improve for the neediest. Demonstrations have been a key tool for Egyptians to communicate their grievances. However, persistent political instability, labour strikes and violent street confrontations are only delaying a recovery.
To be sure, economists have estimated that the military’s overthrow of Islamist president Mohammed Morsi led to losses of around $3 billion to $5 billion. That mostly reflects a sharp fall in foreign investment, declining production as factories and production facilities stopped working and a major reduction in tourism revenue as security concerns mount.
But is it naive to consider Latvia’s recovery, dubbed a “neo-liberal success story”, a model for Egypt, a country that recoils at the mere mention of “neo-liberal”?
Not necessarily. The reason why the military was so welcomed in its power-grab last month was partly because Egyptians want a return to normality. Few people want Mubarak to return but they are viewing his regime a little softer and moaning that life has gotten worse since the 2011 revolution.
At one point, Egyptians will have to recognise that there must be hardship to reach the desired result. Not everyone will get what they want, but protesting every time you don’t get it won’t make any difference either.
Of course, Latvia and Egypt are hardly comparable. While Latvia was reeling from the global recession, Egypt experienced one of the fastest growth rates in the Middle East under reforms that began in 2004 to increase trade, promote growth and facilitate doing business. But as wealth accumulated, this did not trickle down to the poorest and soon stirred the discontent that ultimately led to the 2011 uprising.
Though the January 25 revolution was the harbinger of growth for Egypt, that day cannot be replicated as we have seen with Morsi’s rule and now the military’s caretaker government.
Egyptians must accept reforms and approach these with the mentality that the country won’t recover unless people are willing to try to fulfil their ambitions for a better future, rather than undermine their opponents or protect their own interests at whatever cost.
CORRECTION: This article originally linked to a story by Middle East Monitor that suggested Egypt was hit by losses of $17.1 billion after the military overthrew the former Islamist President Mohammed Morsi. The article has been corrected to reflect losses of around $3 to $5 billion, according to economists Rebel Economy consulted.