Saturday,18 August, 2018
Current issue | Issue 1287, (17 - 23 March 2016)
Saturday,18 August, 2018
Issue 1287, (17 - 23 March 2016)

Ahram Weekly

The dollar for dummies

Compiled by Sherine Abdel-Razek

Al-Ahram Weekly

What determines the value of the pound against the dollar?
It is largely a matter of supply and demand. However, the Central Bank of Egypt (CBE) controls the value of the pound via tri-weekly foreign currency auctions at which it provides dollars to the banks. The banks are allowed to trade dollars among themselves within a 10-piastre premium on the price at the auctions. Exchange bureaus are also allowed to trade dollars at a price that is five piastres higher than that of the bank they are registered with.

Why has the dollar rate been increasing since the 2011 Revolution?
The turmoil following the 2011 Revolution has adversely affected the country’s sources of foreign currency, as has been reflected in the severe decline in tourist numbers and foreign investment figures. The slowdown in international trade due to the drop in Chinese economic growth rates, together with the decline in the price of oil, has pushed down revenues from the Suez Canal and led to a drop in the value of remittances from Egyptian expatriates.

Meanwhile, the fact that Egypt is a net importer of food, energy and raw materials and machinery has meant that it has an inflated imports bill, adding to excess demand for the dollar. The total value of imports was estimated at $61 billion in the fiscal year ending on 30 June 2015, almost three times the value of the country’s exports.

The CBE’s foreign currency reserves have declined to almost half their value prior to the 25 January Revolution, settling at $16.8 billion, or just enough to cover three months of imports. With downward pressures persisting, the CBE has been allowing incremental devaluations every few months.

What has exacerbated the problem over the last year?
The scarcity of dollars increased after Gulf aid to Egypt slowed down at the end of 2014 due to the decline in oil prices. Foreign investment promised at the Egypt Economic Development Conference last year has not materialised due to the shaky political and economic situation. Then came the emerging markets currency crisis, which left the pound as one of the most overvalued among its peers. This was followed by a strong blow last November with the crash of the Russian plane in Sinai, further hitting tourism.

The former Central Bank governor channelled money into keeping the pound afloat, but he eventually devalued it three times in 2015. He also introduced ceilings on daily and monthly dollar deposits at the banks, a move that while it helped in limiting demand for dollars in the black market raised complaints from importers and manufacturers who were not able to open letters of credit. They eventually resorted to the black market and to currency changers who trade dollars acquired by Egyptian expatriates who use them to benefit from the price differences between the official and parallel markets.

Why has the black market flourished in recent months?
Imposing a ceiling on dollar deposits conveyed the message that the CBE was unable to defend the pound, a perception that led to speculative trading in dollars. Meanwhile, when the current governor of the CBE, Tarek Amer, increased the cap on dollar deposits last month this resulted in people obtaining dollars from the black market and then depositing them in dollar accounts, adding upward pressure on the parallel market rate.

Restrictions on withdrawals and measures taken to rationalise imports were read by some as the CBE not being able to provide needed dollars, pushing investors and importers to look for their needs through illegal forex traders. Leaked information that the government was calculating its expenses and revenues for next year’s budget on the assumption that the exchange rate would be LE8.25 compared to the official rate of LE7.73 also triggered speculation that the pound would be devalued. The price then increased until it reached LE9.8 to the dollar.

Why has the official price remained at LE7.83, while the black market price has risen to LE9.80?
As a part of a policy to rationalise imports the banks only provide dollars to importers of basic commodities (food, energy and pharmaceuticals). Thus, the banks only accept bids on dollars from those who need to import these supplies so that the supply of dollars is equal to their demand and, therefore, the rate can be maintained at LE 7.83 at the auctions.

Meanwhile, importers of non-essential goods can get as much currency as they want from the black market as long as they are offering a premium over the official rate. The problem here is that importing non-strategic commodities is a waste of much-needed dollars, which if injected into the banking system at the official rate would help finance more necessary imports.

Why did the CBE devalue the pound this week?
Simply because the available dollars are limited and the Central Bank cannot afford to maintain its support for the pound by injecting dollars into the system on a regular basis.

In theory, the devaluation will encourage foreign investors to start pumping money into the country. Foreign direct investment as well as portfolio investment slowed down over the last year as investors abstained from investing in an overvalued currency as there was a risk of incurring losses as the currency depreciated.

Meanwhile, more needs to be done to reform economic regulations and the bureaucracy of doing business in Egypt in order to attract investors. While in theory the devaluation should improve the competitiveness of Egyptian exports, the fact that most of the raw materials used in manufacturing are imported means that the cost of these imports and with them the price of exports will increase.

Is this a devaluation or a floatation?
A devaluation is a lowering of the value of the currency to a certain level where the Central Bank intervenes to stabilise it. A floatation leaves the value of the currency to be determined solely by supply and demand. What happened this week was something in between, being a “managed floatation” that gives space for the rate to move up and down but within limits to avoid sharp fluctuations.

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