US dollar.
Taking the plunge on August 5, the Central Bank of
Egypt (CBE) announced its new official exchange rate: £E 4.15 to
the dollar. Along with the new rate came a widening of the “band”
of legally permitted fluctuation, within which currency prices now
have room to maneuver 6 percent – 3 percent up or 3 percent down.
The band allows for greater flexibility than its 1.5-percent
predecessor and permits the legal sale of dollars, at the new
rate, within a range spreading from £E 4.03 to an upper limit of
£E 4.27.
The new central rate represents a 6.4-percent
devaluation from the previous central rate of £E 3.9, and makes
the pound an approximate 22 percent less valuable than it was a
year ago. Given that most legal currency trading is still
happening at the top end of the band, the devaluation is arguably
even greater.
According to the August 6 edition of business daily
Al Alam Al Youm, Minister of Economy Youssef Boutros Ghali assured
that “the new system for the exchange market will be able to
satisfy all requests for dollars with flexibility and the
immediate availability of real dollar resources.” He added that
the move would help whittle down the gap in Egypt’s balance of
trade by making Egyptian exports cheaper, as well as diverting the
flow of dollars – hoarded until now by private forex bureaus and
the black market – into legal channels.
The decision followed a series of earlier
devaluations. The first came in January of this year, with the
slaying of the sacred £E 3.4 cow to which the dollar exchange
rate, as part of the Economic Reform and Structural Adjustment
Program, had been firmly lashed since 1991. The January
devaluation, representing a switch to what economics boffins
dubbed a “managed peg” regime, lopped about 13 percent off the
value of the pound, bringing the official dollar rate to £E 3.85,
from which it could deviate, legally, a mere one percent either up
or down.
At the time, Prime Minister Atef Ebeid was quoted as
saying that the Central Bank wouldn’t let the currency fall into a
free float. Nor, he added, would it “resort to [artificially]
stabilizing the pound, because adopting an unrealistic fixed
exchange rate for the pound has proved to be detrimental to
national development purposes.”
But despite the prime minister’s seemingly
enlightened take on the evils of intervention, the pound, at its
new rate of £E 3.85, was still being artificially held in check by
the government, with stiff penalties meted out to anyone selling
dollars at more than the official price.
In May, the Central Bank announced a further
exchange-rate adjustment – a none-too-radical jump of one piastre
– to £E 3.86. This was followed by another mini-devaluation in
early July, to £E 3.90, with an accompanying enlargement of the
“fluctuation band” to 1.5 percent up or down on US dollars and
Arab currencies and 2 percent on other foreign currencies.
What’s new?
At a conference held by the Egyptian Center for
Economic Studies last November, some economists argued that Egypt
should adopt a variant of the “band, basket and crawl system”
which had proved effective in other developing markets in recent
years. Not long after, the CBE adopted the band – albeit an
absurdly tight one. But Egypt continues to lack a “basket,” as
foreign reserves continue to be held entirely in US dollars. More
problematically, the central rate has been “crawling” not in
direct response to market pressure, but rather in accordance with
CBE decisions.
In spite of the slow crawl seen since the start of
this year, the values assigned to the Egyptian pound continued to
smack of unreality, and the black market has continued to thrive,
selling dollars at prices closer to £E 4.3. “All the recent
devaluations over the course of the last nine months were
considered unrealistic,” said Nourhan Galal, head of research at
the Commercial International Brokerage Company (CIBC). “But it had
to be done in gradual steps. They couldn’t cut the value from 3.4
to 4.15 overnight.”
What makes this latest devaluation different is that
it has actually approximated the pound’s market value against the
dollar. The 4.0 level, described in the past by bankers and
analysts as a “red line” or a “psychological barrier” was finally
transcended – an indication perhaps of a more forward-thinking
monetary policy. “No doubt, this was a step in the right
direction,” said Alaa El Seesi, executive director of investment
banking at HC Securities. “The question is now whether this is the
right price or not. But if it’s not the right rate, then it is
very close.”
The new system also allows for future devaluations,
if the new rate proves inadequate. In order to “restore order to
the foreign-exchange market,” the CBE intends to review the
central rate once a week, and adjust it up or down based on the
average of the market rates within the previous week. Could this
latest monetary development represent a first, tentative step to
creating a real, transparent crawl mechanism?
Another major difference between the latest
adjustment and those of the past – and a major indication that the
new rate is at least close to the “real” one – is that this latest
devaluation has actually resulted in the availability of dollars
via legal means. Forex dealers are finally selling at the official
rate – something they weren’t willing to do at the previous rate
of £E 3.9. In the weeks ahead, said Mohamed Fahmy, senior research
analyst at Prime Securities, “we shall see whether dollars are
available in the forex market or not, and whether there is real
demand-supply equilibrium. If this happens, then there will be no
need for another devaluation.”
Fighting the forex phantoms
Whether the adjustment will prove sufficient to
abolish the black, or “parallel,” market is still uncertain, and
some analysts did not exclude the possibility that black-market
rates would resurface immediately if the government refused to
take account of the pound’s real market value. “The new exchange
rate should eliminate the black-market rates,” said El Seesi. “But
after the devaluation, we should still be flexible, in line with
real market rates. If such rates were to go up, then we should
follow them.”
Even though the devaluation was substantially larger
than expected, dollar trades immediately rushed up to the higher
end of the widened trading band (£E 4.25) at most banks and
foreign-exchange bureaus, suggesting that the adjustment may not
have been large enough to deal a final deathblow to speculative
pressure on the pound.
Mohamed Hassan Al Abyad, president of an association
of exchange companies, also quoted by Al Alam Al Youm the day
after the devaluation, said that “the new price will exceed the
one found on the black market, which moved in previous days from
4.18 to 4.19 to the dollar.” He insisted that there was no longer
a niche for a parallel currency market.
However, despite official assurances that dollars
were now flowing freely in and out of Egyptian banks, the market
reality looked different. Some banks initially refused to part
with their US currency, and others were selling it only in very
limited amounts and under specific conditions – if, for example, a
client can prove that he or she needs foreign currency in order to
travel abroad.
As one exchange-bureau trader complained, “It is
unfair that we have to continue buying and selling dollars while
banks only buy dollars from people and refuse to sell any back.”
The banks, he added, “don’t contribute to the circulation of
dollars in the market; they only continue to accumulate them.”
The government, meanwhile, has threatened to
withdraw the license of any exchange bureau that is found hoarding
dollars. Several times in recent years, the minister of economy
has ordered certain exchange bureaus shut down for violating the
official rate. “There is no confidence between the exchange
bureaus and the government,” the trader said. “The same harsh
restrictions and regulations that they impose on us are not
carried out against banks that still refuse to sell dollars.”
Unleashing export potential
While the government exacts retribution on shadowy
forex dealers, the currency’s devaluation should boost the
country’s competitiveness in the global marketplace and hopefully
lead to an improvement in export-based economic growth. Egypt has
witnessed a gradual erosion of its balance of payments for several
years, going from a $7.3 billion deficit in 1994 to one of $11.4
billion in 2000, with an import bill – £E 17 billion for the
calendar year 2000 – rising in tandem with a decline in
exports.
In the face of such circumstances, the devaluation
“was a very good decision,” according to Ahmed El Wakil, president
of the Wakalex Import/Export Company and vice president of the
Alexandria Chamber of Commerce. “It will promote our exports and
give more power to Egyptian products to compete in the global
market.” Even the inevitable increase in the cost of imported
goods has its silver lining, he added, as “people will buy fewer
imports, thus giving Egyptian products a chance to compete in the
local market as well.”
Automotive assemblers are more circumspect.
“Although we have high local-content percentages, we also have
high imports,” said Dan McCarthy, chairman and managing director
of General Motors Egypt. “Even our local suppliers, who make
components here in Egypt, are importers. So it does put pressure
on us from the standpoint of our returns.”
Other local auto manufacturers would be affected in
the same way, he added.
General Motors Egypt operates in Egyptian pounds,
but pays for its imported parts in dollars. Even so, McCarthy
called devaluation “the right thing to do” in terms of improving
the Egyptian economy as a whole. “In the context of other
structural changes, we need to get a proper valuation for the
pound,” he said.
And the currency devaluation can only help a tourism
industry hard hit by regional tension and violence in neighboring
Palestine. True, the operating costs for hotels and tour companies
might rise, but tourists will find their hard currency going
further in Egypt. “The devaluation will have an [negative] effect
on the tourism industry in the sense that costs for imports like
furniture and machinery will go up,” said Mohamed Sakr, professor
of economics at Cairo University and economic adviser to the
tourism ministry. “But in terms of tourist companies, it will make
Egypt cheaper and more competitive vis-à-vis other tourist
destinations.”
The overvalued pound has contributed to the
depletion of foreign reserves, which, according to official
statistics, currently stand at $14 billion. At the end of 1998,
state coffers boasted an even $20 billion, before two years of a
clumsy – not to mention expensive – policy of using cash reserves
to prop up the local currency. “The CBE couldn’t satisfy the local
demand [for dollars] on its own, when most of the dollars were in
the hands of forex bureaus and the black market,” said Galal at
CIBC. “It couldn’t afford to just keep throwing money at the
problem. But now that dollars are readily available from banks,
people will be more inclined to keep their assets in Egyptian
currency.”
Galal added that she didn’t expect to see much
further deterioration of reserves.
The Central Bank will continue to manipulate
interest rates in an effort to tempt those with substantial
savings accounts to keep their funds in Egyptian pounds. In April,
the CBE cut interest rates for the pound twice, in two increments
of 50 basis points each, after having left them unchanged for more
than two years. The result was a one-percent decrease from 12 to
11 percent. But now there are rumors of a possible hike to 14
percent, in a bid to keep people from dollarizing their assets.
The current interest rate for dollars is a mere 3.5 percent.
Luring foreign investors
Another – and certainly not the least important –
perk of the devaluation is the greater confidence that Egypt will
enjoy among foreign investors, who will hopefully jump at the
relatively cheaper valuations of Egyptian stocks dollar-wise. “The
devaluation will have a positive impact on foreign investors as it
will encourage them to enter the market,” said Reem Mansour,
economic analyst at Sigma Security Brokerage. And cheaper, more
realistic asking prices for state assets could further serve to
jump-start the privatization process, which has lagged
conspicuously for the past couple of years.
By bringing the pound more in line with its real
value vis-à-vis the rest of the world, Egypt can display its
readiness to bite the bullet and become a serious contender in the
global economy. The devaluation, said Galal, “sent a signal to the
investment community at large that Egypt is coming to terms with
its monetary policy.” To take a recent case, “the exchange-rate
issue was raised by practically every investor at the roadshow for
the recently launched Eurobond.”
According to Galal, the decision to devalue the
pound was prompted by fears of a downgrade of Egypt’s
foreign-currency ranking by ratings agency Standard & Poor’s.
The country’s local-currency ranking was lowered in June.
“Time will tell,” stated an August 10 report
prepared by international finance house Morgan Stanley Dean
Witter, entitled Is Devaluation the Savior?, “but a more flexible
exchange-rate regime is wise in the face of a major global
slowdown that has increased the risk aversion against emerging
markets around the world.”
Still, the effects of the devaluation obviously
aren’t all positive, or the government would have done it ages
ago. One of the inevitable drawbacks is that those institutions
with dollar-denominated debt – foremost among which is the
government – will suddenly owe that much more in terms of Egyptian
currency. The state’s public debt, which currently stands at 95
percent of GDP, continues to rise as the currency devalues, making
Egypt’s dollar debts more difficult to repay.
The Morgan Stanley Dean Witter report calls the
adjustment a “bold step in the right direction” and states that
even if the devaluation initially worsens debt-to-GDP ratios, this
is a small price to pay for the correction of an overvalued
currency. The unrealistic value assigned to the pound “was
undermining the competitiveness of the entire Egyptian economy,”
the report contends, adding that “fiscal policy is key to overall
macroeconomic stability.”
Shoring up the local bourse
On the Cairo stock market, the news of the
devaluation immediately drove up share prices, which had been
plunging during the two weeks prior as the Hermes blue-chip
financial index fell to its weakest levels in seven years.
“Before, people were afraid to enter the market – would they be
able to exit later or not, and at what cost?” said El Seesi. But
as long as the pound is tradeable at a realistic value, he added,
investors don’t have to worry about heavy forex losses in the
event that they want to cash out. “Now, there is more transparency
as investors can enter or exit the market whenever they want.”
Market analysts, however, cautioned that the
devaluation would hurt some local companies burdened with foreign
debts, like those of the telecom sector, which depend mainly on
loans denominated in foreign currency to finance their expansion
activities. MobiNil, for example, which has dollar-denominated
loans amounting to $220 million, might be exposed to considerable
risk, as every piastre of devaluation translates into forex losses
of £E 2.2 million.
Orascom Telecom (OT), in contrast, “is exposed to
minimal forex risk, as it has already paid off the bulk of its
dollar loans,” said Amr El-Alfy, assistant manager of research at
CIBC. However, for OT to take advantage of its recently acquired
Algerian GSM license, “equipment and network expansion will need
to be financed in dollars.”
The impact of devaluation depends on the nature of
the industry. The cement sector is expected to enjoy substantially
improved market conditions post-devaluation, since imports are not
vital to the industry and because Egyptian cement exports will
become more competitive in foreign markets. “Generally, the cement
sector is not expected to be negatively affected from the
devaluation, since the inputs to production are locally procured,”
said Yasmine Al Ebiary, senior investment analyst at CIBC. “But
there is risk for some cement companies, such as Suez, which is
loaded with a $50 million loan.”
The banking sector, meanwhile, will suffer few
negative effects, according to analysts. Central Bank governor
Ismail Hassan has assured banks that the CBE will reimburse them
for any forex losses incurred based on the new exchange rate, as
well as fulfilling all their requests for dollars. The first week
under the new rate saw the Central Bank pump close to $150 million
(apparently supplied by the CBE’s “internal resources,” not its
forex reserves) into the banking sector. This money was in turn
lent to clients.
In banking, as elsewhere, the effect depends on the
financial structure of each company. “With the recent devaluation,
some banks, like CIB, will be positively affected as they have
part of their capital and positions in dollars,” said Fahmy. “So,
those banks will actually be posting gains.”
As of press time
So far, the center seems to be holding.
As of August 13, Hassan was declaring, according to
HC Securities, that there was “no need this week to change the
official exchange rate based on market forces,” even though
exchange rates the week before had hovered around the weaker end
of the band, between £E 4.20 and £E 4.24.
But three days later, on August 16, shortly before
Business Monthly went to press, the headlines splashed across Al
Alam Al Youm’s front page read ominously: “Forex Bureau Dollar
Prices Jump to 427.45 Piastres” – a figure which represented the
furthest extremes of the fluctuation band and therefore intimated
a possible need for further devaluation.
