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Pound jittersby Sherine Abdel-Razek
For the second time in less than six months, the status of the Egyptian pound and its declining exchange rate versus the dollar have again become a hot issue.
Two weeks ago a dollar crunch pushed the Egyptian pound exchange rate to LE3.50 in some exchange companies.
This happened in spite of the government's intervention last November which took the form of pumping dollars into the banking sector and issuing decrees restricting imports which have been consuming huge sums of dollars.
The jitters over the pound have ignited a war of accusations and counter-accusations among exchange market players. The Central Bank of Egypt (CBE) launched numerous raids on exchange companies to investigate their compliance with trading rules. In some cases, penalties resulted in the closure of companies for months.
In response to the turmoil, and with the intention of calming the situation, the Foreign Exchange Division of the Federation of Chambers of Commerce last week agreed to lower the exchange rate to LE3.45, a step which resulted in stabilisation of the exchange rate.
But the question remains, how long can the pound hold its own in the face of the spiralling dollar? Another question is whether abolishing the current non-official peg between the pound and the dollar is the solution.
According to some economists the Southeast Asian financial crisis, which began in late 1997, showed how detrimental a fixed exchange rate regime can be, on occasion.
But what of the causes behind the latest dollar crunch?
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The CBE accuses exchange companies of engaging in malpractices such as trading the dollar at prices other than those which they announce. But the list of accusations directed by financial circles against the CBE is even longer.
Deutsche Bank's country report on Egypt issued last January criticises the CBE's long-standing adherence to a fixed exchange rate regime. Restricted by its policy of maintaining a stable exchange rate, the CBE had no choice but to loosen its grip over its foreign exchange reserves which declined from $20 billion last year to $18.5 billion in the first quarter of 1999. "With its current muddle-along approach, the CBE is putting the credibility of the [government's] economic policy to the test," the report said.
Another accusation directed against the CBE is that it has not provided sufficient dollar reserves to the commercial banks, which has led to a sizable dollar shortage in the inter-bank market and delays in currency exchange operations.
But there are those who defend the CBE's policies. Rejecting the view that the CBE is responsible for the problem, Mohamed Noureddin, head of the Arab Bank's research department, said that the Central Bank has always intervened in times of crisis in order to regulate the market by pumping dollar reserves into the banking sector. "These accusations stem from the tendency by foreign institutions to show that the CBE is inefficiently managing its reserves, with a view to promoting the idea that foreign institutions should manage the reserves instead of the CBE. But the reality is that CBE policies have for a long time succeeded in maintaining a stable exchange rate," said Noureddin.
Both Noureddin and Professor of Economics at the American University in Cairo Medhat Hassanein attribute the shortage in dollar reserves to a depletion in the country's main foreign exchange resources due to declining oil export earnings, flagging tourism revenues still affected by the Luxor tourist attack of 1997, and dwindling remittances from Egyptian expatriates in the Gulf economies which are badly affected by the decline in world oil prices.
Another factor compounding the problem was the increased demand for dollars by Egyptian pilgrims travelling during the Hajj season. All of this coincided with a general decline in capital inflows to the world's emerging markets in the aftermath of the Asian crisis.
"The situation has been made worse by Egypt's rising import bill because importers wanted to profit from the declining prices of Asian exports," said Noureddin.
However, according to Hassanein, the CBE still must bear partial responsibility for the currency situation. As the authority responsible for monetary policy, it should have predicted the problem and hedged against it by adopting certain procedures such as tightening regulations governing imports.
"The CBE's recently issued regulations, which require importers to deposit the value of their imports in dollars before opening letters of credit, will lead to a tightening of imports," said Noureddin.
Another way to resolve the situation would be to devalue the pound and end its non-official peg to the dollar. (The pound is pegged to the dollar since most of Egypt's foreign reserves are denominated in dollars.) "A five to 10 per cent devaluation of the Egyptian pound is not a big deal, as long as we have a sufficient level of foreign reserves covering more than a year of imports, and as long as we follow a sound monetary policy," said Hassanein.
International reserves declined from 18.8 months of imports in 1993/94 to 14.3 months of imports in 1997/98. At the same time, depositors seem to be more attracted to the Egyptian pound for which interest rates are five per cent higher than those on dollar deposits. This has resulted in a situation in which the dollarisation rate as a per cent of total liquidity has declined to 17.9 per cent currently compared to 25.1 per cent in 1994/95.
Deutsche Bank's report suggested raising the interest rates on pound deposits to levels sufficient to attract foreign portfolio investment inflows, so as to balance the current account deficit. This idea stems from the fact that maintaining a fixed exchange rate with a high current account deficit exerts pressure on the pound and decreases its real value.
Noureddin, however, expressed reservations about Deutsche Bank's interest rate proposal on the grounds that it is a "thorny issue" requiring more study before being implemented. "Using the interest rate can be a double-edged weapon. The interest rate was one of the main instruments used by the Egyptian government to stabilise the pound for many years. A considerable difference was maintained between the interest rates for pound deposits and those on other currencies. Resorting once again to a policy of raising interest rates will have a negative effect on investment and economic growth," Noureddin concluded.