Wednesday,22 November, 2017
Current issue | Issue 1319, (10 - 16 November 2016)
Wednesday,22 November, 2017
Issue 1319, (10 - 16 November 2016)

Ahram Weekly

Maximising reform gains

What should be done to guarantee that the benefits of the government’s bold reforms exceed their costs, asks Sherine Abdel-Razek

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eco
Al-Ahram Weekly

“Politically sensitive” is how commentators are describing the government’s moves to float the pound and cut the subsidies on fuel.

Fears of the repercussions of the two moves on the cost of living of millions of Egyptians have made them seem risky, to say the least. Even with IMF Managing Director Christine Lagarde saying that the decisions were needed before the extension of the $12 billion loan agreement that Egypt needs, observers were still convinced that the government would only take one of the two steps.

However, the government took everyone by surprise when it opted for the complete floatation of the pound rather than a managed devaluation, followed several hours later by a reduction in fuel subsidies that ranges between seven and 87.5 per cent on different kinds of fuel.

The most conservative estimate of the resulting inflation puts the rate at 18 to 20 per cent by the end of this year, with some putting it as high as 25 to 30 per cent. The timing of the steps also could not have come at a more sensitive time, coming a week before expected demonstrations on 11 November to protest against an increase in prices of around 14 per cent.

However, the steps gained the praise of many economists and the IMF, World Bank and the European Bank for Reconstruction and Development (EBRD), which consider them the best way for Egypt’s ailing economy to deal with the ballooning budget deficit and the dollar shortage.

The floatation scenario used is the recommended technique of the Central Bank of Egypt (CBE) taking LE13 as a starting rate, very close to the LE15 that was the market rate a day earlier, and coupling this with an interest rate hike of three per cent to attract portfolio investments and lifting foreign exchange restrictions on the value of dollar deposits.

New certificates of deposit with rates as high as 16 and 20 per cent were also introduced by state owned banks.

CBE keeping hands off the market: The banks are now required to operate the interbank market in a way that clears the existing backlog and investors’ open positions, securing enough foreign currency availability for the market without depleting CBE reserves.

Attending a meeting with CBE officials and investment bankers after the floatation decision, Reham Al-Dessouki, a senior economist at Arqaam Capital, said the officials had indicated that the banks were well-capitalised and that open positions did not exceed two per cent of their capital base.

The banks could absorb any foreign exchange losses that they needed to incur, and it was stated at the meeting that the CBE had run stress tests on the banking sector and concluded that it would be able to absorb any foreign exchange losses.

“The banks having enough dollars to clear the backlogs is the only guarantee that customers won’t resort to the black market to get them,” commented Sherif Othman, head of foreign exchange transactions at a private-sector bank.

However, transactions have been subdued as the banks do not have enough dollars to finance them and many customers are still holding US dollars in anticipation that prices will increase. The CBE should inject further dollars into the system through auctions during the coming weeks, Othman said.

A report by Bloomberg earlier this week presented the experiences of five emerging economies with free floating currencies, concluding that the success of the floatation in easing the dollar crunch and quashing the parallel market in Egypt would “depend on how committed the CBE is to staying hands-off when the currency swings ensue.”

After floating the ruble, Russia spent about $90 billion defending the currency against short-sellers in 2014 before ultimately giving up in November of the same year. However, the strategy paid off in the longer term, with inflation expectations down, net capital outflows slowed, and households keeping 60 per cent of their savings in rubles.

Satisfying customers’ dollar demand: “It is true that the CBE has said it won’t use its foreign reserves in rebalancing the foreign exchange market, but I assume it meant that it won’t interfere unless it has enough reserves to cover imports and the open positions of the banks,” Othman added.

CBE governor Tarek Amer said earlier this year that the CBE would not devalue the pound unless it had at least $25 billion in foreign reserves. This should cover three months of imports to a total value of $15 billion, with $9 to $10 billion being the total value of open positions in the banks.

The last announced figure for Egypt’s foreign reserves was $19 billion, but Amer has noted that a currency swap agreement with China should be signed within a few days, giving Egypt access to a further $2.7 billion.

After the floatation and the cuts in fuel subsidies Egypt is ready to cash in the first tranche of the IMF loan, equivalent to $2.5 billion within weeks. These inflows, together with the revenues of the $2-3 billion in Eurobonds slated at the end of this month, mean that the reserves could reach, if not surpass, $25 billion by year end.

“When the banks have enough liquidity to cover their needs at an exchange rate around which most of the banks are implementing their transactions and this rate is lower than what we are seeing now, we can say that the new system has succeeded,” Othman said.

“This could take a year at least, as in January 2003 when we devalued the pound it took a year and a half for things to settle down and the dollar settling to a fair price,” he added.

Guaranteeing steady dollar inflows: Securing enough foreign currency resources is a prerequisite for the success of the foreign exchange reform package. Talking the day after the floatation, Minister of Investment Dalia Khorshid said Egypt was targeting $10 to $15 billion of foreign direct investment (FDI) in addition to $5 billion in portfolio investments.

She did not specify the time frame, but said the ministry planned to achieve this through a set of 17 incentives decided by the Supreme Investment Council headed by President Abdel-Fattah Al-Sisi last week.

In addition to postponing the new capital gains tax for another three years, the measures provide tax exemptions for the producers of the agricultural crops and strategic goods that Egypt imports or exports.

Agriculture and industrial investment in Upper Egypt have five-year tax exemptions. This is in addition to a 25 per cent discount on land in the New Capital, East Port Said and other new urban developments for three months.

The Egyptian Rural Development Company, which manages a 1.5 million feddan project, the New Administrative Capital Company, the New Al-Alamein Development Company and the companies managing the Siemens combined-cycle power plants have been added to the roster of state-owned companies that could go for initial public offerings (IPOs) in the coming three years.

Commenting on these decisions, Eman Negm, a senior analyst at Prime Securities, said they were positive signals, though no date had been given for implementation. They were credible signals that serious steps were being taken to put the Egyptian economy on the right track and encourage the business environment, she said.

But Negm said the effect of boosting investments with their foreign component would not be seen immediately, especially with the current high interest rates, and it was a short-term policy to increase portfolio and treasury investments after the decision to go ahead with the floatation.

“FDI is supposed to step in after the forex risk is contained and after the current fluctuations in the exchange rate are stabilised by the fourth quarter of 2016/2017,” she said, adding that FDI of $8 billion was expected by the end of 2016/2017 compared to $6.8 billion in 2015/2016.

As for tourism revenues, while the floatation has made Egypt a cheap tourist destination, security conditions are still a concern. Prime expects tourism revenues to increase to $4.8 billion by the end of this year, compared to $3.77 billion in the current year.

While the earlier March devaluation helped to increase oil and non-oil exports in the fourth quarter of 2015/2016 by 37 and 20 per cent, respectively, the floatation now is expected to result in an increase in non-oil exports to reach $15.6 billion, up from $13 billion in 2016.

Another important source of foreign currency, remittances, which declined by 11 per cent last year, is expected to start circulating back through formal banking channels after leaking out of them last year due to the widening spread between the official and the parallel exchange rates to more than 70 per cent, Negm noted.

Egypt is also considering new ways of collecting Suez Canal fees by taking them three years in advance to secure foreign currency. Several major shipping lines have asked for an eight to nine per cent discount, while the Suez Canal Authority (SCA) has offered three per cent for a period extending from three to five years.

Reuters has reported that the SCA is expecting a decision this week from the three major shipping lines.

Keeping interest rates high for now: Parallel to the floatation decision, the CBE hiked its corridor interest rates by three per cent to 15.75 per cent for the overnight interbank lending rate and 14.75 per cent for the overnight interbank deposit rate. The state-owned banks are also offering investment certificates at exceptionally high yields of 16 and 20 per cent.

“Raising interest rates is a classic technique used when devaluing the currency to maintain demand. However, there is a negative side as the sharp increase in interest rates pushes up the cost of borrowing to new highs, adversely affecting economic growth,” Othman said.

He said that the rates should be lowered early next year to help investment.

The reduction in fuel subsidies has added a heavy burden to consumers, but it will not help in tightening the budget deficit. With the pound losing around 60 per cent of its value and fuel prices increasing by 30 per cent, fuel subsidies have increased and are expected to be LE65 billion in the current fiscal year, compared to the projected LE35 billion.

With the subsidies mainly benefiting those who use more fuel and the better-off, the system has been waiting for reforms. The new smartcard system for fuel purchases could help here, but more vehicles still need to be registered in the system, a process that minister of petroleum Tarek Al-Molla believes will take until the end of this year.

A decision on when it will be implemented will come next year.

Commenting on the decision to reduce the fuel subsidies, Ziad Bahaaeddin, former head of the General Authority for Investments, wrote in Al-Shorouk this week that while fuel prices needed to be reduced the government had had better alternatives for the timing and for the percentage increase in the different kinds of fuel.

The government could have taken measures to guarantee equality and fairness in distributing the burden resulting from such a step by supporting those hard hit in the agricultural, industrial and transportation sectors in order to protect those with limited incomes, he said.

He concluded by saying that the economic situation Egypt was facing was due to economic policies that must be addressed rather than pointing the finger at measures that aim at limiting the effect of these policies.

“We have to revise the priorities of government spending, especially on the mega-projects, as well as the extent of government involvement in economic activity, investment climate reforms, taxation policy to limit tax evasion, and the political reforms needed for economic revival,” Bahaaeddin wrote.

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