The year the pound sank
What started off as a floatation soon dragged the pound down to unprecedented levels, and pushed the economy into intensive care. Al-Ahram Weekly scans the ramifications of devaluation in 2003
This time last year, 'twas the season for congratulations on the manner in which the Egyptian economy had survived the year after 9/11.
But the ink had barely dried on those rosy reviews when the decision was taken to float the Egyptian pound. Addressing an unsuspecting audience at the American Chamber of Commerce in Egypt one afternoon, Prime Minister Atef Ebeid dropped the bombshell: the pound was to be free of government controls and its rate would be determined by the forces of supply and demand.
Out poured a torrent of government announcements on how a free foreign exchange market would benefit the economy: millions more in foreign investments, exports, tourism; the list went on. As it turned out, however, faced with an acute absence of foreign currency resources, those forces instead would pull the pound firmly downwards. Pegged to the dollar, which took a beating on international markets throughout the year, the pound further declined against the euro and the pound sterling.
Twelve months on, even the most optimistic of economists have been converted, as the anticipated benefits from the devaluation were offset by a range of negative effects. NDP Economic Committee Chairman Mahmoud Mohieddin, apparently disillusioned, called it a "managed float", blaming the "mess in the management" for the negative outcomes of the floatation.
The worst of the effects to hit the man in the street was the hike in prices of basic foodstuffs, which has increased by 30 to 50 per cent since January 2003. The effects on local prices were exacerbated by a marked increase in the prices of foodstuffs on international markets, on which Egypt depends heavily for basic food items.
According to Amr Bahaa, head of treasury for the Egyptian Commercial Bank, the decision to liberalise the value of the pound took the market by surprise, particularly the banking sector. Following the 29 January announcement, and for the first half of the year, the Central Bank of Egypt (CBE) attempted to encourage individuals to hold onto their pounds. Utilising market mechanisms, the CBE withdrew liquidity from the market pushing interest rates up. The CBE had hoped that, attracted by the interest rate differential, individuals would refrain from exchanging their pounds for dollars. But to no avail. According to CBE figures, the rate of foreign currency deposits as a percentage of total liquidity in the banks increased from 23 per cent in January to 28 per cent in July.
Pushing interest rates up also meant raising the cost of finance, giving investors one more reason to shy away from an economy in dire need of their funds. But it was not only investors who felt the pinch of the high interest rate, banks too were stung, said Bahaa. Suffering already from a defaulters' crisis, the increased interest rate was adding to the burden banks had to bear on behalf of those defaulters.
The floatation did not help with the backlog of requests to open letters of credit which had accumulated as a result of the shortage of dollars. That problem persisted, causing the government to issue decree 506 which stipulates that the exporter must pay 75 per cent of the value of the export transaction within 90 days of completing the export deal. Although that improved revenues, it is not enough. "How can there be a liberalisation when we force people to do something?" Bahaa asked.
Theoretically, the tourism sector should have benefited from the depreciation of the pound. However, the floatation gave rise to mixed results in the tourist sector in Egypt. According to Riad Qabil, secretary-general of the Egyptian Travel Agents Association, more tourists visited Egypt this year, encouraged by the devaluation of the Egyptian pound. "Egypt as a destination has become more than affordable to a wider category of tourists," said Qabil.
A greater number of tourists from Arab countries in particular chose to spend their holidays in Egypt. According to the Ministry of Tourism, the latest estimate of revenues generated by the tourism sector in Egypt in 2003 is US $4 billion. Normally, this would be interpreted as a thriving tourist year. However, Qabil claims that the increase in the number of tourists visiting Egypt this year did not translate into an increase in the income of the tourist-related businesses and industries.
"For the majority of tourist companies, the floatation of the pound was disastrous," he confirmed. The decision, he believes, has created many problems which are difficult for those in the tourist business to deal with.
Since devaluation, there has been a major scarcity in hard currency. Because the tourist sector relies heavily on imports for things like hotel equipment and promotion material, it has become more difficult for those in the tourist business to find the foreign currency to finance their activities.
Coming up with the goods, namely hard currency, has become a daily headache for those in the tourist industry, commented Qabil.
Many companies have had to resort to the black market. However, the situation became even worse for tourist companies when the government, in a quest for more foreign currency resources, decided that 75 per cent of dollar revenues should be automatically transferred through banks to the treasury at the "bank" rate, which is significantly lower than the black market rate.
"[The decision to float the pound] has given rise to technical difficulties; the floatation is considered a true violation of the principles of the constitution," said Qabil. He explained that tourist companies always maintain an open account with travel agents abroad, and in many cases the expenses are transferred three to six months after the tours are completed. "[This] means that tourist companies have to pay their 75 per cent share in any operation to the government before they actually collect their money. Does the government expect us to resort to the black market to pay in advance?" Qabil asked.
While tourist companies may recover some of their losses thanks to a genuine tourist boom, the situation with the small and medium-sized enterprises (SMEs) is even worse.
Overburdened by high taxation, bureaucracy and a slow market, SMEs represent almost 90 per cent of the overall number of projects in Egypt employing 75 per cent of Egypt's total labour force.
"SMEs can no longer afford to buy the imported materials and machinery which they need to keep their factories going," said Ahmed Abdel-Salam, chairman of the Credit Guarantee Corporation for Small and Medium-Sized Enterprises.
"Based on small investments, these enterprises do not have any lending tools and banks refuse to extend loans because they usually fail to provide banks with adequate guarantees," he continued.
As a result, 3,000 factories reportedly shut down in 2003. "This is either because there is insufficient demand, or the costs of production are too high to make a profit. To export to international markets is out of the question," said Abdel- Salam.
The least fortunate of all, perhaps, is the government. As the dollar leapt to LE7, while the Egyptian pound almost lost 35 per cent of its value, the volume of Egypt's external debts, estimated at some $29 billion, has grown at an alarming rate. "This simply means that Egypt is obliged to provide more funds to reimburse its debts. However, there are no new sources of hard currency to cover for the increases in the external debt," said a source in the Ministry of Finance who preferred to remain anonymous.
It is worth noting that the country's main sources of hard currency come from oil exports, the Suez Canal, tourism and remittances.
Egypt seeks international loans for capital-intensive projects, which include infrastructure, health, education and mega- projects. The interest rate on these loans is determined according to bilateral protocols. "So far, Egypt has been struggling to pay back the interest on the loans with its limited hard currency resources. The loans themselves have not yet been addressed," the source commented.
Estimates of the extent the external debt has grown since the devaluation of the Egyptian pound have not yet been confirmed. The actual figure will be officially issued in the annual budget report for 2003, which will be submitted to the People's Assembly next June.
Struggling to maintain control over prices, the government is facing an even more unpleasant situation internally. For food security reasons, the government recently placed an LE1,400 billion subsidy on main household commodities such as table oil, sugar and bread.
To cover the increasing budget deficit, estimated at LE44 billion this year, and to address the accumulating internal debt, which is almost approaching LE190 billion, the government this year issued more treasury bills worth LE3,400 billion with a 10 per cent interest rate. "Once again the government is trapped in the same vicious circle. The government thinks that issuing more treasury bills to eliminate the budget deficit and the internal debts is the solution. It is not," commented the Ministry of Finance source. This is coupled with the fact that covering the interest on bills issued previously becomes a problem, he added.
According to Alaa Ezz, chief advisor to the chairman of the Federation of Egyptian Industries, the floatation of the pound brought increased interest in the acquisition of Egyptian companies by foreign investors. "[This year] we have received 350 queries expressing interest in Egyptian companies [whereas] during the past two years, we received an average of only 120 queries," Ezz said.
Egyptian products dominated the market for home appliances, cars and food products, as the difference in the price between the imported and the local became astronomical.
Ezz argues that the positive effects of the devaluation in the exports sector was not significant, except in 100 per cent local products, such as foods and agro products, and textiles and garments.
Exports of engineering products, he said, did not benefit from the devaluation " because they are lower in quality and they are expensive due to the fact that their imported input is above 50 per cent".
In sharp contrast to the opinions of most people, Ezz believes that devaluation has had a positive effect on the manufacturing industry. "Because of the depreciation of the pound and the lack of foreign currency, manufacturers were forced to localise, which increased local investments in the food industry," he explains. He went on to explain that sales are increasing, which will lead to further production and result in a drop in prices. "This is the survival instinct," said Ezz.
Economists and businessmen have mixed feelings about the floatation. Mona El-Garf, assistant professor of economics at Cairo University, said that although the floatation decision itself was awaited with anticipation, it has led to increased prices. Salaries, however, have remained the same, so the overall cost of living has risen dramatically.
"The black market still exists, with a considerable gap between its price and the official price," El-Garf said. She explained that when people are convinced that the value of the pound will drop, they are likely to speculate; this exacerbates the problem. She argues that the government's continual announcements that the foreign reserves will not be touched does not help. "It indicates that those reserves are not continually fed and are not growing. And it leads people to question why they should give up their dollars if the government is holding onto its own," she concludes.
Decree 506 was definitely needed, but with certain conditions. El-Garf said exporters who transfer their dollars though the banks "should be given guarantees that they will get their dollars when they need them and at the same rate for which they sold them".
El-Garf is cautious about the effects of the devaluation of the pound on exports in the long run. "Any increase in exports as a result of the devaluation is only temporary because sustaining exports in the long run requires solving the other problems which hamper exporters in the first place," she said. "The devaluation has only helped some exporters who are already well established in their export markets and who have overcome the age-old export problems and who export certain products."
Khaled Abu Ismail, chairman of the Egyptian Federation for Chambers of Commerce (EFCC) said that the devaluation of the Egyptian pound has reinforced the already existing state of recession in the market. One of the few sectors which benefited from the devaluation, according to Abu Ismail, was the real estate sector since sales increased due to a growing demand from Egyptian expatriates, Arabs and foreigners.
