Saturday,23 June, 2018
Current issue | Issue 1344, (11 - 17 May 2017)
Saturday,23 June, 2018
Issue 1344, (11 - 17 May 2017)

Ahram Weekly

Could have been done differently?

Last year’s floatation of the Egyptian pound might not have been the best way out of Egypt’s economic crisis, say economists in a recent report, writes Sherine Abdel-Razek

The stock exchange attracted most of the post-devaluation investments
The stock exchange attracted most of the post-devaluation investments

Six months after the devaluation of the Egyptian pound, two economic experts have challenged the main arguments supporting it and the agreement with the International Monetary Fund (IMF) of which it was a part.

The 2016 Economic Strategic Trends Report, an annual report issued by the Al-Ahram Centre for Strategic and Economic Studies, came out this month and includes analysis of political and economic changes in Egypt and the wider world. It includes two papers focusing on the economic situation in Egypt after the IMF agreement and devaluation by economics expert and former Al-Ahram chairman Ahmed Al-Naggar and Magdi Sobhi, editor-in-chief of the report.

The IMF approved a $12 billion three-year loan programme to Egypt in November last year to jump-start the economy after years of economic and political upheaval that had driven away investors and tourists. It came as Egypt promised to embark on reforms starting with the devaluation of the pound, introducing a new value-added tax (VAT), and slashing energy subsidies.

In his article in the report, Sobhi criticises IMF reform programmes in general, pointing out that they are based on “Washington Consensus” rules that promote reducing subsidies, tax reforms, reductions in inflation, trade liberalisation, and lifting impediments to foreign direct investment (FDI) as policy prescriptions.

He says that these rules, aiming to open up markets and narrow the role of the government in the economy, were put in place in the 1980s when many Latin American countries faced hyperinflation and ballooning foreign debt. However, since then they have been imposed by the World Bank and IMF on other countries with different economic ailments as a means to open up developing countries to the international economy and to rein in inflation.  

According to Sobhi, for a developing economy like Egypt, adopting Washington Consensus policies will not end its economic problems as it needs policies that guarantee equality and sustainable development and more employment.

In his article in the report, Al-Naggar says that IMF recommendations are “ideological prescriptions that do not take into consideration the circumstances of each individual country and have been failures in countries aiming to kick-start their economies”. The recommendations are applied at the expense of the poor, he says.

Sobhi also challenges the theory, promoted by the IMF and repeated by mainstream economists, that devaluation will increase FDI and improve the competitiveness of Egyptian exports.

In November, Egypt abandoned all controls on the foreign-exchange market, leaving the price of the pound to be determined according to the laws of supply and demand. This resulted in the currency losing more than 50 per cent of its value and leaving it hovering around LE18 to the US dollar compared to the official rate of LE8.8 to the dollar before devaluation.

The possibility of attracting more investment has not been realised, according to Sobhi, who says in the report that what has happened since the floatation has been an increase in the influx of investment to the stock market as well as to treasury bills and bonds.

This has been justified by a hike in interest rates, which has enabled investors in the so-called “hot money” market to realise high profits, he says.

Investments in Egyptian treasuries in the two-and-a-half months following devaluation reached $1 billion, and the stock market hit its highest levels since 1999 on the back of foreign purchases.

Sobhi notes in his article that economic history in general and that of Egypt in particular shows that the government should not be fooled by such inflows, as they could exit the market at any moment. Egypt witnessed the highest outflow of such monies after the 25 January Revolution in 2011.

As for the “myth” that exports would increase after the devaluation, the fact that Egyptian exports mainly depend on imported raw materials and machinery, more expensive after the devaluation, tends to negate it, the authors say. Added to this has been the slowdown in international trade growth rates to reach 1.7 per cent in 2016, the lowest since 2009 and undermining the possibility of increased exports.

World Bank projections for the international economy in 2017 do not give much hope either because of a recession in global trade and a slowdown in FDI, the authors say, both things that will make it hard for Egypt to increase its exports.

“The theoretical paradigm underpinning the work of the IMF is based on the belief that the devaluation of any currency versus the dollar makes a country’s exports more attractively priced, but that is only the case if local prices stabilise,” Al-Naggar writes.

Egypt’s annual inflation rate has been on the rise since the floatation, hitting its highest level in 30 years in March to reach 30.9 per cent.

Al-Naggar also challenges IMF assumptions that the devaluation would improve the country’s trade deficit. “Imports will not decrease as the consumption of necessary items will not go down even if prices go up. As for unnecessary items, well-off consumers are willing to pay more for them,” he notes.

Al-Naggar is highlighting the fact that according to the Credit Suisse Investment Banking Global Wealth Report, the richest 10 per cent of people in Egypt own 77.7 per cent of the country’s wealth.  

Furthermore, investment that should be used in increasing production and boosting exports did not exceed 14 per cent of GDP in the first nine months of 2015/2016, according to Al-Naggar. “This low investment rate makes the economy’s ability to cover any increase in foreign demand for exports limited,” he says.

He points out that increasing the savings rate to have more money available to finance needed investment is crucial. This rate stood at 4.9 per cent of GDP during the first nine months of 2015/2016, compared to a global average of 22 per cent and 24 per cent in low-income countries.

On the positive side, the low savings rate translates into a consumption rate of 94.1 per cent, equivalent to $938 if calculated according to purchasing power parity (PPP), Al-Naggar says. “Such a huge market with gigantic demand should entice investors to tap it,” he adds.

Al-Naggar sees positive aspects in high imports as he considers them to be an indicator that there are many opportunities for foreign investors in Egypt to invest in import-substitution industries.

Sobhi adds in his article that a local economic plan based on import-substitution industries, expanding the manufacture of items that are currently imported, is the only way out of the current crisis. “A stable economy focusing on creating job opportunities and realising growth is more important than IMF policies concentrating on lowering inflation and adopting the right fiscal policies,” he says.

To reach this goal, both Al-Naggar and Sobhi call for upgrading Egypt’s transformative industries sector, which now represents only 13 per cent of GDP and employs 10 per cent of the workforce.

Betting on import-substitution policies is also justified by examples from other countries, the authors say, as those countries which originally benefited from the Industrial Revolution did so by opting to keep their raw materials and transform them locally into end products rather than exporting the raw materials and importing the end products.

Sobhi gives the example of the British wool industry, which thrived after a decision was taken to process the wool locally and to impose tariffs to protect the industry, creating one that is now one of the oldest in the world.

In more modern history, Sobhi points out that both South Korea and Taiwan embarked on import-substitution policies, including imposing protective measures against imports, at the start of their economic development before moving to a production-for-exports paradigm.

He points out that the total liberalisation of trade, another Washington Consensus rule the IMF follows, would have harmed these countries and quotes a Korean economist as saying that “had South Korea adopted free-trade rules and not protected its fledgling industries it would not have been today’s giant economy and would have remained an exporter of raw materials and low-end technology”.

However, the costs of importing after devaluation have the same effect as imposing high tariffs on imports to protect local industries, according to Sobhi, who adds that this represents an opportunity for local industries in Egypt to grow without competition.   

“We should start planning for expansion in a number of industries according to surveys of demand, starting with profit-making industries whose products can be promoted locally,” he writes.

According to Al-Naggar, there should be plans to narrow the current account deficit through stopping luxury imports as well as finalising agreements with the various chambers of commerce to reduce imports by one-quarter. 

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