Devaluation brings short-term pains and long-term gains

14 March 2016

Central bank currency will improve balance of payments

Egypt’s decision to devalue its currency by 14.5 per cent is another positive move taken by the central bank.

Pressure had been mounting in recent months over the devaluation of the currency with investors reluctant to enter the market amid what has been described as an artificially overvalued local currency, damaging the country’s international competitiveness.

The move will help Egypt adopt a more flexible exchange rate and allow the country to improve its balance of payments position.

The move is also part of a wider policy championed by Tarek Amer who was appointed as the central bank governor in late 2015 to ease Egypt’s historically protectionist approach towards foreign currency.

The devaluation of the pound has been coupled with a recent easing of deposit and withdrawal restrictions that had stifled economic activity. The central bank has also said further devaluations are expected in recent weeks.

Several analysts have suggested the central bank must continue with a depreciation of the pound with many believing the organic level is closer to E£9.5, roughly where it is trading on the black market.

But for ordinary Egyptians there will be some short-term troubles that could cause problems for Al-Sisi’s government. From a fiscal and wider economic point of view, the devaluation is a move that the Egyptians must take. But as living costs increase and inflation inevitably rises, the government should look at ways to alleviate the pressures on the cost of imported goods, savings and pensions.

A 10 per cent drop in the currency is expected to cause inflation to jump by 1.5-2 percentage points. Higher inflation will damage disposable incomes and put pressure on consumer spending, which has been a key driver for growth over the past few years.

The devaluation of the currency therefore could cause more damage than good if it is not backed-up with further economic reform in order to position the country as an attractive destination for foreign investors.

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