Ups and downs
The recent drop in dollar rates was preceded by an eventful year in the forex market. Pierre Loza traces the effects of the flotation thus far
The flotation of the Egyptian pound in January 2003 has spurred a wide debate on the decision's timing, effects and overall economic soundness. With average prices rising steadily since, and the budget deficit swelling to unprecedented levels, the pinch of the flotation has been felt at all levels.
Although the float was praised by international rating agencies, the year prior to the float witnessed a downgrading trend as a result of Egypt's rigid dollar peg regime, which did not represent true market conditions. The flotation itself has been bitterly attacked, due to a lack of hard currency availability and a general public sentiment that the government did not make good on its promises.
When Prime Minister Atef Ebeid said "starting tomorrow there will be a free market for foreign exchange," the public expected a relative ease in obtaining hard currency, giving the black market a fatal blow and putting an end to speculation and market instability. Contrary to expectations, this was not the case.
The pound tumbled down the day following the announced float by 17.96 per cent, from LE4.64 to the dollar, to LE5.32 to the dollar, with a few short-lived upturns gradually reaching an official LE6.15 below the black market's LE7 price range.
Even with rising prices of necessities, softened by a burdensome jump in subsidies, the market is showing signs that the worst part of the storm is passing.
In recent months currency earning sectors have seen improved performance. Suez Canal dues are at record levels, tourism numbers have recovered swiftly and export receipts are up, bolstered by higher oil prices.
The Hermes stock index has also rebounded rising 60 per cent above pre-flotation levels. With this newfound optimism many believe the economy is on the road to recovery. However the harsh reality prevails that exports form too small a portion of GDP to push the economy to sustainable growth levels. Instability in foreign exchange also tends to deter foreign investment, something Egypt desperately needs in order to reach targeted growth levels. The word from experts is that Egypt's currency crisis has more to do with speculation than any single factor.
Economist Samir Makary of the American University in Cairo explained the current currency crunch as a direct result of speculation. "When you fix an exchange rate in the market for a year or longer, and then you float, people start to speculate on future value, which means you go and demand foreign exchange not to use it, but to store it, and this will lead to much higher demand than actual demand under normal conditions." Makary believes that variations in foreign exchange rates are expected after any flotation, but in the Egyptian case variations were above the norm.
The textbook solution for such instability comes in two parts: firstly, the raising of the interest rate on the Egyptian pound to encourage people to deposit their money in pounds; and secondly, for the central bank to make foreign exchange available, in order to counter increasing demand.
This was done publicly when the government announced that it would pump $400 million into the market during the term of previous Central Bank of Egypt (CBE) Governor Mahmoud Abul-Oyoun. Experts say the same policy is being followed by the recently appointed Central Bank Governor Farouk El- Okda, but in a much more discrete manner.
The new CBE governor has cut down his public announcements considerably, giving himself a much more low profile persona. Economists such as Ahmed Ghoneim of Cairo University believe that this more discrete role of the governor has helped the market stabilise. "I think the new management of the Central Bank is doing fine in the sense of not making a lot of announcements that disturb the market and give the wrong signals to people," he said.
An important indication that the market is indeed settling is that the black market premium has decreased from LE7 to the dollar to LE6.85 to the dollar. Even with the market showing signs of improvement, one cannot help but ask the question: What would have happened if the pound had been floated during the boom years of the late 1990s?
Ghoneim believes that the present currency crisis represents the cost of not seizing the opportunity of floating during the late 1990s. "It's like any disease you have. The more time you leave it, the cost of curing it increases. What has really affected the problem negatively is the credibility of what is being announced by the government."
Ghoneim believes that the announced float did not fall under the definition of a free float, due to the presence of a black market price that satisfies market conditions. Other government decisions that followed the flotation may have backfired, exacerbating the shortage of forex and fuelling the black market. Decree 506, which forced tourist companies and exporters to relinquish 75 per cent of their dollars to banks at the LE6.15 official rate, limited the freedom and flexibility of the most dynamic market players, in effect forcing them to dodge regulations by operating under the table.
