Forex in free fall
Economic policy-makers are desperately fighting the black market and inflation, but perhaps the foreign exchange regime itself needs to be reconsidered. Salah El-Amrousi reports
In a sudden and successful blow to the black market, the Central Bank of Egypt (CBE) has pumped dollars into the banking system. This was a necessary move, coming at a time when the margin between the black and official markets had become perilously large. Judging by past experience, black market rates have a tendency to eventually dictate the official exchange rate. But, has this ended the black market problem? Is the floating policy successful or is it going to be so any time soon?
In my opinion, the black market problem is still there and may even get worse. It may force the CBE to intervene again and again, at a great risk to its own reserves. This is a problem that needs to be addressed right away. We also need to re-evaluate the floating policy and find out why it left us into a position where the CBE has to fight so hard and at such a high cost to protect the flagging pound.
The problems began soon after the decision was taken, on 28 January 2003, to float -- or free -- the Egyptian pound. The black market sprang into action, first tentatively and then with a vengeance. Interestingly, the crisis happened at a time when the balance of payments was recovering by anywhere between $0.5 billion and $1.1 billion, according to variable figures. So, what exactly occasioned the crisis in the pound?
Some speak of psychological reasons, citing the lack of confidence in the pound, which is exacerbated by speculators messing about in the market. Some blame our banking culture, or lack of it, which keeps savings outside of the banking system. Some accuse black market dealers of hoarding foreign currency in order to sell it later at a greater profit. Some newspapers even accused the banks themselves of hoarding foreign currencies.
None of these excuses are good enough. Although psychological factors are relevant to the phenomenon, they are not divorced from reality. The banking culture alone cannot explain the current crisis. As for black market dealers, they may not be above hoarding -- neither are the banks -- but I imagine they would prefer a small margin of profit on a large volume of transactions to a larger margin on a very limited volume.
The real trouble is elsewhere. To start with, we do not have a money market in the real sense of the word. Either in the supply side or the demand side, the calculated surplus in the balance of payment is little more than a figure in the books. In the supply side, the resources of the money market consist mainly of revenues from the big four foreign exchange earners: oil exports, tourism, expatriate remittances, and Suez Canal revenues.
The state had freed the current account even before freeing the exchange rate. This gave the exporters of goods and services (primarily the tourism industry) the right to hold on to foreign currency revenues and transfer them abroad at will. Foreigners working in Egypt have the same right. The state also freed the capital account, allowing capital owned by Egyptians to be transferred abroad without impediments. And the state allows the repatriation of foreign capital from Egypt, including direct investment and stocks.
In a high-growth economy, with a solid industrial base and good exporting capabilities, foreign currency would flow naturally into the economy, creating a functional money market. In the Egyptian case, foreign currency does not flow completely into the banking channel. This is why the monetary figures fail to match those of the balance of payments.
On the demand side, there is an extra type of demand that the balance of payments hardly takes into consideration. This is the demand by small savers, particularly those working abroad. The wave of inflation that accompanied the recent policy of floatation has discouraged them from transferring their earnings into Egyptian pounds. The balance of payments surplus was reason in part to a drop in the imports of intermediate, capital and basic consumption goods.
This drop in imports constitutes a frustrated demand, for the products in question have neither been replaced with local ones or become unnecessary. The only reason that these products were not bought is that they have been priced out of Egyptians' means. This frustrated demand is not without pressure on the currency market. By adding $700 million to its reserves at such a critical time, the CBE has contributed to the shortage of foreign currncy.
In brief, the currency crisis happened due to a conflux of factors -- because the revenues from exports and tourism were often not transferred into Egyptian pounds, savers kept their money in dollars, and frustrated demand exerted pressure on the market.
The government seems to think that free market rules are as applicable to Egypt as elsewhere. It has, therefore, wagered on the possibility of creating a free money market in Egypt, one free from administrative impediments. Just after the pound was floated last January, Prime Minister Atef Ebeid boasted of the "full freedom of exporters to do what they want with their foreign currency revenues", denying that the government had any intention to force exporters to deposit their revenues within the banks. Similar reassurances came from the minister of foreign trade, who specifically mentioned that any constraints imposed on the exporters with regard to their revenues would be a "step backwards". Exporters receiving financial subsidies from the state were the only exception to this rule.
Still, foreign currency did not flow into the banking system at the expected rates. Within less than a month, the government began pressuring exporters to deposit their revenues into Egyptian banks. Leading exporters' groups responded with lip service, but no real change in their banking patterns. Exporters promised the minister of foreign trade that they would deposit $500 million with the banks in March, but no such thing was done.
Dismayed at the expansion of the black market and growing inflation, the government began expressing itself with a martial tone that contrasted totally with its supposed liberalism. Speaking at the People's Assembly, Prime Minister Ebeid threatened "to strike with an iron hand against those who tamper with the currency market or fiddle with the prices of goods" (Al-Ahram, 11 March 2003). In late March, the government issued decree 506, forcing exporters and tourist companies to deliver 75 per cent of their foreign currency earnings into the banks. Business responded with resentment and a fair amount of evasive measures. The government and the CBE now hope that the new inter- bank system they are putting together would resolve much of the exchange rate problems. This is unlikely to say the least.
The aforementioned decree was nothing if not a practical admission of the failure of the currency floatation. Foreign Trade Minister Youssef Boutros- Ghali has already described the decree as a "step backwards", for it undermines the policy of freeing the current account and constitutes a relapse into currency regulations. The government now recognises the problem, but has yet to formulate a new policy. The current policy is a far cry from the much-hyped "freeing of the exchange rate", but is also nowhere near a comprehensive system of "currency regulations". Caught in the middle, it is both unstable and ineffective. Eventually, the CBE may be forced to intervene repeatedly in the market at a high risk to foreign reserves. What can be done?
Some people call for further measures to be taken, such as decreasing the deficit, selecting a target inflation level, or increasing interest rates -- any of which measures may actually worsen the current recession through discouraging investment, especially industrial investment. Others call for pressing ahead with the current liberal reforms and the privatisation programme. This latter group urge the privatisation of the four major public sector banks, and call for further liberalisation of trade, revision of taxes, and removal of impediments to foreign investment.
In my opinion, the strengthening of liberal reforms at this point of time would only exacerbate matters. To argue that liberal policies are going to succeed anytime soon, one has to be either a dyed-in-the-wool optimist or totally immune to reality. Some people have suggested scrapping the freeing of the exchange rate altogether. This daring proposal was put forward by none other than former Minister Sultan Abu Ali -- not quite your typical adversary of liberal reforms. This, and other proposals, will remain of no consequence, however, until an alternative monetary policy is in place, one designed to fortify the current industrial structure by combining export industries with import- substitution industries. Only such a strategy, designed to eliminate the trade deficit, can provide the basis for a successful monetary policy.
