Tarek Amer began work as governor of the Central Bank of Egypt (CBE) on November 27, following the resignation of Hisham Ramez on October 21. His appointment represents a dramatic and much-needed change in Egypt’s monetary policy and a tacit admission by the government that the relative strength of the pound (EGP) is no longer sustainable. The move has been lauded by Egyptian businessmen and investors, who have been suffering from a shortage of foreign currency in recent years. Despite Amer’s economic credentials—he served as deputy governor of the CBE from 2003 to 2008 and then turned the failing National Bank of Egypt around in the four years that followed—the severity of the foreign currency crisis and the dire conditions afflicting the rest of the economy put him in an exceptionally difficult situation.
Egypt’s net international reserves dwindled to $16.3 billion as of September 2015, roughly $20 billion less than it had prior to the 2011 revolution. This has largely been due to the CBE’s efforts to defend the value of the pound in the face of falling demand for Egypt’s exports. Despite receiving more than $40 billion in loans and grants from Gulf countries and issuing a $1.5 billion Eurobond, Egypt has not had enough foreign currency to successfully bolster the Egyptian pound. Attempts to eliminate the black market for U.S. dollars through limits on dollar deposits only exacerbated the shortage of U.S. dollars available to importers.
In addition to the central bank’s policy, a number of external factors have also worsened Egypt’s macroeconomic position. First, in the wake of two popular uprisings and, more recently the bombing of Metrojet Flight 9268, which killed 224 people, there has been a sustained drop-off in the tourism sector, an important source of foreign currency. Second, the depreciation of the euro and the yen against the dollar, to which the Egyptian pound is pegged, has erased much of the depreciation the pound has thus far seen over the past two years. Under normal circumstances, this would be a positive development, but given that the Egyptian pound is overvalued and Egypt is trying to boost exports, a relative appreciation (or lack of depreciation) eliminates any export-boosting advantages Egypt would otherwise gain from depreciation. Third, the government is still working to repay a number of international oil companies for appropriating natural gas intended for the international market that was instead pumped into the Egyptian national gas grid, planning to pay down another $500 million in arrears before the end of the year.
In short, Amer’s options to address Egypt’s foreign exchange crisis are limited. While his precise steps will depend on dynamic, on-the-ground conditions, there are three major policy actions that Amer can make in the coming months, all of which will have major impacts on the economy and investment environment.
First is to lift domestic banks’ limits on dollar deposits—a move for which the private sector has been clamoring. The policy of limiting dollar deposits was originally implemented in February 2015 as part of a plan to eliminate the foreign exchange black market, which was thought to have encouraged speculation and hoarding, putting depreciative pressure on the pound and reducing dollar liquidity. While the deposit limits did initially reduce the volume of the black market and close the gap between the official and black-market pound-to-dollar conversion rates, the gap has reemerged. On the black market, the dollar is now trading at EGP 8.60, 0.77 pounds more than the official rate of EGP 7.83 to the dollar.
Instead, the move dramatically limited the amount of dollars available to importers, who relied on dollars to buy their goods on the international market. To address the growing shortage, the government prioritized imports of basic goods, such as food and medicine, at the expense of more sophisticated imports, such as computers and specialized machine parts. While Egypt has been fairly successful in staving off starvation and plague, the limited availability of dollars has had a deleterious effect on the private sector—and, ironically enough, has limited exports due to the difficulty exporters have had in importing intermediate goods.
The second option is to depreciate the pound. This is more complicated than it may seem. The pound is certainly overvalued, and a downward slide in its value is inevitable, but the CBE also has an interest in allowing some short-term appreciation. By creating “two-way risk” in allowing the value of the pound to fluctuate within a small range, the CBE can encourage traders to take both long and short positions, offsetting the disproportionate number of short sales of the pound that can push down its value, and also help importers clear out backlogged imports. In the weeks prior to Amer’s appointment, the CBE made its first appreciative move on November 10, pushing the value of the pound up by 20 piasters, from EGP 8.03 to the dollar to EGP 7.83 to the dollar.
But the effectiveness of this short-term move to increase the value of the pound is highly limited. The CBE gains little from burning short-term speculators, and according to a report issued by Pharos, a Cairo-based investment bank, many importers are already basing their 2016 budgets on an eventual depreciation to EGP 9.00 or more to the dollar.
Instead, Egypt’s long-term concerns regarding depreciation are more closely related to increases in the price level for imports. However, these concerns are largely overblown. While there will be some increase in prices, due partially to the fact that importers are already budgeting for depreciation, external inflationary pressures are at a minimum. Both international energy prices and international food prices are at their lowest levels in five years. Additionally, core inflation in the Egyptian economy has averaged 7.12 percent over the first eight months of 2015—the lowest level since 2012. While this could offer the CBE an opportunity to defer the inevitable pain of depreciation, the pressure on the pound will only increase if the U.S. Federal Reserve opts to raise interest rates later this month. Depreciation of the pound needs to come at some point, and now is an ideal time given the relative lows in import prices.
If these first two measures are executed with minimal economic or political disruption, the third major policy decision Amer could make is to take a loan from the IMF. Egypt has taken loans from a number of international organizations recently, including $4.5 billion over three years from the World Bank and African Development Bank. However, IMF loans typically come with more stringent conditions and are meant to help countries that have already made some progress on implementing structural reforms. Because of these conditions and required reforms, IMF loans are unique in their ability to attract international investors. In a 2012 interview with Al-Ahram, Amer himself stated that an IMF loan can “boost the confidence of the world's investors in Egypt [encouraging them] to start doing business in the country.”
These three policy decisions are not inevitable. Any number of factors, emanating from within Egypt and from the broader global economy could throw these reforms off course. However, if Tarek Amer, who has a reputation as a pragmatist and a reformer, is serious about attracting foreign investment, the Egyptian government’s route forward will almost certainly follow this path. A depreciation of the pound and a freeing up of the foreign exchange market will reduce uncertainty in the investment environment, allowing foreign investors more confidence in their ability to import needed inputs and repatriate profits abroad.
Brendan Meighan is an economic researcher at the American Chamber of Commerce in Egypt.