Patrick Werr: Sweet wrappings for the bitter pill of Egypt devaluation

Egypt’s currency crisis could spiral out of control if the government does not devalue quickly, a measure that although unpalatable is the best medicine for an ailing economy. The longer it waits, the more acute the crisis will grow.

I offer a few ideas that might make the bitter pill easier to swallow.

People are reluctant to buy the Egyptian pound because it is pegged artificially high against the US dollar. This has led to an acute shortage of dollars, which, in turn, has weakened the economy, creating a downwards spiral.

The crisis has been growing. In the past few days, British Airways stopped selling tickets in Egyptian pounds because it has not been able to obtain dollars to repatriate revenue, Al Mal newspaper reported yesterday. The airline also threatened to halt all flights to Egypt if the problem is not resolved. Other airlines have similarly warned they may stop selling tickets in Egypt.

The electronics maker LG Egypt said this week the currency shortage had forced it to stop production for seven days because it could not import components. Volvo’s distributor in Egypt, Ezz Elarab, said it had stopped importing cars.

Tourism, already in dire shape, collapsed after the Russian airline crash over Sinai on October 31, the result, it is believed, of a bomb. Egypt has lost about US$1.3 billion in tourism receipts since the plane’s downing, the prime minister said this week.

Demand for the pound plunged after the 2011 uprising. Successive governments since then have sought to weather the crisis until tourists and investors return and demand rebounds. But if that was ever a realistic option, it certainly isn’t now. The currency is fundamentally overvalued, whether the economy improves or not.

This implacable determination not to devalue has been dragging the economy to the ground. Growth slowed significantly starting in January 2015, when the central bank restricted the ability of importers to buy dollars on the black market. As a result, non-petroleum imports in the first nine months of last year fell by an annual 5.63 per cent. The overvalued pound, meanwhile, has made Egyptian products less attractive, causing non-pet­roleum exports to tumble 16.5 per cent in 2015.

In the third quarter of last year, GDP slowed to a tepid 3 per cent annually. In the 12 months until June 2015, it grew by 4.2 per cent, but with most of that growth occurring in the six months before the January currency restrictions. The situation is only getting worse. Despite the stagnation, money supply rose by more than 18 per cent in 2015, which means the pound should continue to lose value against foreign currencies.

To avert a full-blown crisis, it’s urgent that the exchange rate accurately reflects market demand.

On the black market, the pound has weakened to 9.32 to the dollar from 8.68 only a month ago, creating a yawning gap between the official rate of 7.83.

One danger with devaluation is that it can trigger dollarisation, where a panicky public converts out of pounds, sending the currency even lower. The central bank needs a cushion of cash to prevent this. One idea might be to devalue to 9.00 or 9.50, then offer to sell $5bn to $7bn worth of Egyptian pound treasury bills to Egypt’s Arabian Gulf friends at 10 per cent interest rate or more.

After that it could maintain currency controls for a year to minimise depreciation pressure before moving to a managed float.

A last resort would be the IMF if its Gulf allies do not accept.

Once the pound is devalued, more measures may be needed to reassure the public and the global community. Many Egyptians have an amazing fear of a devaluation that in some cases verges on panic. I propose the government consider topping up its smart card, known as the family card, with an extra sum for a lim­ited transition period to keep people calm.

Currently, most Egyptians are given 15 pounds a month to spend on a wide range of commodities.

The government should also launch a campaign to explain why it needed to devalue, perhaps stressing that it would make Egypt’s exports competitive and encourage consumption of local goods at home.

Finally, the government needs to establish credibility with investors, both foreign and Egyptian, by rapidly pushing through a package of reforms in tandem. These could include widening the tax base with tighter enforcement, a more transparent way of allocating land to firms, improved customs procedures, faster approval for operating licences, espe­cially for manufacturers, and a rewrite of the awkward investment law the government recently introduced.

It might then seek a seal of approval from the IMF to reassure global investors its reforms are serious.

Patrick Werr has worked as a financial writer in Egypt for 25 years.

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