- The central banks interventions and policies that focus on the dollar is what many are saying caused the overvaluation of the Egyptian pound
- IMF says central bank needs to adopt a more flexible exchange rate policy
- It is difficult to see how Egypt will be able to offer the local market a free supply of dollars at prices dictated by market forces without negatively affecting local industries
When Egypts investment minister Ashraf Salman called for the devaluation of the Egyptian pound, it once again ignited the debate inside the country about the value of the currency against the US dollar.
Salmans calls were also echoed by the finance minister as Egypt continues its efforts to boost foreign direct investment (FDI).
Most analysts across Egypt will say the Egyptian pound is overvalued. The pound has even increased in value against the euro over the past year, as the euro and other currencies dropped against the dollar. The central banks interventions and policies that focus on the dollar is what many are saying caused the overvaluation of the pound, making Egypts products, services, investments and tourism less competitive.
Following a recent visit by the Washington-based IMF, the concluding statement said Egypts central bank needs to adopt a more flexible exchange rate policy to improve the availability of foreign exchange in order to strengthen competitiveness and support exports and tourism.
Egypts central bank has a history of interventionist policies towards foreign exchange.
Prior to the 2011 uprisings, when Egypts foreign reserves sat at about $40bn, the bank was applying what is referred to as a dirty float.
The central bank would supply the market freely, but control the price, as it only sold dollars to two local banks Suez Canal Bank and the Arab African Bank which would then sell on to the other 38 banks operating in Egypt.
This method worked relatively well for Egypt, as the banks foreign reserves were sitting at a healthy number because of a stable economic climate and a booming tourism sector that brought in hard cash, says a Cairo-based analyst.
After 2011, Egypt watched its international reserves dwindle and, as a consequence, the central bank applied a much more protectionist policy. The bank created an auction system by which dollars can be traded. All 40 banks were invited to bid as the central bank limited the supply into the market.
What most people will not realise is that the central bank very quickly changed its stance and became very aggressive in its setting of the price, says the analyst. The central bank was essentially controlling the starting bidding price and controlling the supply. Egypt was left with a currency that was valued in accordance to a policy that protected its international reserves.
As a result, the Egyptian pound continued to increase in value against the dollar and over the past few years, the country has become a much more expensive place to visit and invest in.
Since December 2011, foreign reserves have fluctuated without exceeding $20bn, which is where its net international reserves sat in June this year.
|Annual performance||Jun 2010||Jun 2011||Jun 2012||Jun 2013||Jun 2014||Jun 2015|
|Net international reserves||35,221||26,564||15,534||14,936||16,687||20,080|
|Net foreign assets*||24,295||18,798||9,713||1,907||4,775||2,715|
|*=Excludes loans. Source: Central Bank of Egypt|
|Performance over the past eight months||2014||2015|
|Net international reserves||15,333||15,429||15,456||15,291||20,525||19,560||20,080||18,534|
|Net foreign assets*||4,646||4,140||4,434||566||4,379||3,635||2,715||3,214|
|*=Excludes loans. Source: Central Bank of Egypt|
Analysts claim another reason behind Egypts dwindling reserves is the breakdown in the trade balance, with imports outweighing exports by $29.6bn, or 23 per cent, in the first nine months of the past fiscal year, according to central bank data.
It is also important to note that the countrys reserves are predominately made up of international loans from Gulf states and the IMF.
As such, with Egypt it is essential to look at the net foreign assets figure, which excludes central bank loans and therefore provides a more accurate picture of the central banks reserve capacity.
Egypts net foreign assets sat at $2.7bn in June this year despite net foreign reserves being $19bn. In June 2010, there was only a $1bn deficit between net reserves and net foreign assets, indicating a drastic change in the nature of reserves.
Simply put, the central banks foreign reserves capacity is now dominated by loans, therefore posing a problematic situation where Egypt is actually only left with its gold reserves, which are about $2bn.
The central banks policy towards exchange rates seems like a desperate attempt to ration foreign currency, and it was no surprise the bank has gone as far as putting a cap on dollar deposits at banks.
The combination of the central banks control over the supply of currency, the setting of prices and limiting of dollar deposits has depressed Egypt as an attractive investment destination.
Foreign investors want a guarantee that they can come in and come out, says Omer Essa, a derivatives analyst for a London-based bank focusing on Egypt. Egypt doesnt offer that and if it does, investors will find that an overvalued currency means they are making a loss before even entering the country.
Considering that Egypts development plans, championed by President Abdul Fattah al-Sisi, are often solely focused around the boosting of FDI, the central banks approach seems contradictory.
But Egypt cannot simply devalue its currency for as long as it has an importing economy, says Essa.
Egypt is left with a complex challenge.
Devaluing the currency will strain the countrys foreign reserves and offer a major blow to importing industries as the Egyptian pound weakens. At the same time, an overvaluation of the currency will continue to deter foreign investors and tourists while the central bank carries on with dogmatic exchange rate policies.
The devaluation of the Egyptian pound is inevitable and the central bank will be sure to do so in a managed manner to avoid hyperinflation. But while the central banks foreign reserves remain at dramatically low levels, it is difficult to see how the Egyptians will be able to offer the local market a free supply of dollars at prices dictated by market forces without negatively affecting local industries.
Although the argument for devaluing the pound will highlight the long-term benefits, the current state of the Egyptian economy means many import-based industries could find that they do not recover from a weakening currency.