Despite potential short-term inflationary pressures and a likely rise in the cost of imports, economists say the inevitable decline in the value of the Egyptian pound should help to encourage foreign direct investment and revive the flagging economy. ‘Essentially it takes the currency to the level of the black market, and quite frankly this foreign exchange market was behaving reasonably well beforehand,’ says Al-Haque. ‘But there will of course be some testing of the market until the currency settles in.’

Prior to liberalisation, the currency was trading in a 3 per cent band around a core rate of $1=£E 4.51. Following the announcement, the pound tumbled by about 15 per cent on 29 January to trade between $1=£E 5.35 and $1=£E 5.37 in local foreign exchange bureaus by the end of the day – equivalent to the levels at which it had been traded on the black market previously.

The announcement brings an end to the managed peg system, which has seen the value of the pound fall by 24.6 per cent against the dollar in four successive devaluations since late 2000. The decline has accompanied a period of flat economic growth and a recession in the tourist industry, the country’s main foreign currency earner. Foreign currency reserves fell to $14,000 million in October 2002, from their peak of $20,000 million in 1997.

Local bankers say the announcement has not come entirely as a surprise, as the 57 banks licensed to deal in foreign currency had recently been permitted by the Central Bank of Egypt to charge commissions that effectively gave them the parallel black market rate.

London-based rating agency Fitchhas welcomed the decision to float the currency, saying the initiative ‘alleviates a major concern with respect to the management of economic policy’, which had previously placed a constraint on the country’s sovereign rating. Fitch also said official fears regarding inflation had been overstated, as previous devaluations had no apparent effect on consumer price inflation in the period 1997-2001, when inflation remained at or below 3 per cent. The agency in August 2002 downgraded Egypt’s long-term foreign currency rating to BB+ from BBB-, effectively taking the country out of the investment grade category (MEED 23:8:02).

‘We have seen the Egyptian economy progressively close in the last ten years … so it’s very early days to say whether floating the currency will have any positive effect on external credit ratings,’ James McCormack, senior director for sovereigns ratings at Fitch, told MEED on 30 January. ‘But it’s definitely a step forward.’

Rating agency Standard & Poor’s (S&P’s)has also reaffirmed its BB+ foreign currency rating, but cautioned the government to continue to exercise fiscal discipline. The economy should benefit from a return of liquidity to the foreign exchange market, allowing the central bank to further lower interest rates,’ said Alaa al-Yousef, S&P director for sovereign ratings in the Middle East. ‘This should stimulate growth, provided fiscal policy is not loosened at the same time. Otherwise, the exchange rate will be destabilised, inflation will rise and growth will be jeopardised.’

A further depreciation of the pound was widely expected in the run-up to a possible war in Iraq, but the decision to free-float the pound came as a surprise to many. Local bankers say the timing of the of the decision coincided with the build-up to the annual hajj, when demand for foreign currency is at its highest point, but that it would also provide the central bank with a certain amount of flexibility to respond to any external knocks to the economy.