Devaluation has always been the Egyptian economist's greatest fear. However, this is no longer the case, since it is already happening. The Egyptian pound lost almost three per cent of its value during the first two days of this week to reach LE6.39 against the US dollar on Monday. This was after it had survived a post-revolutionary drain of foreign currency resources that had stripped it of six per cent of its value to the beginning of December. The unprecedented decline in the value of the pound comes as the Central Bank of Egypt (CBE) introduced a set of new policies aiming at rationalising demand for dollars and determining the dollar/pound exchange rate according to force of supply and demand. A daily auction will be held between the CBE and the banks in which the CBE will either buy or sell dollars according to market needs. Bankers have described the new system as a move toward establishing a free-market value for the pound, which has been tightly controlled since a managed devaluation that ended in 2004. On Sunday and Monday, the CBE sold a total of $150 million to the banks to cover their needs, with the latter covering the needs of foreign-exchange offices to tame fiercely rising demand for dollars. “What is pushing the dollar high right now is overheated demand. This will subside now that more dollars are being made available to the banks through auctions,” said a banker at one of Egypt's leading private banks. The pressure on the pound started soon after the 25 January Revolution, when a drain on foreign currency reserves led its losing some 60 per cent of its value. The politically driven street violence between the allies of Islamist President Mohamed Morsi and representatives of the more secular opposition last month pushed many people to buy dollars and to sell pounds, fearing that the latter could lose more ground due to the political instability. The decline in the value of the pound against the dollar in the first two auctions held by the Central Bank may have increased demand further, according to Emad Fathi, manager of the Crown Foreign Exchange Bureau, who put the hike in demand during the first days of the week at 50 per cent. Under the new CBE regulations, local banks will not be able to hold more than one per cent of their capital in dollars, down from the previous 10 per cent. Corporate clients will be limited to daily cash withdrawals of $30,000, and individuals who purchase foreign currencies will be charged a one-to-two per cent administration fee. All transactions will be monitored to make sure they are for “legitimate” needs and do not involve speculation, bankers said. “It represents a kind of pooling of the dollar holdings in the banking sector, so that a bank which has a surplus of dollars today can sell it, covering any deficit another has. This way, the demand on the dollar by corporate clients and individuals will be met,” the banker said. Ahmed Adam, a banking expert, had reservations about the new system, however. “Making the results of these auctions publicly known will exacerbate the problem. When currency dealers or even ordinary people know that the dollar's price is increasing due to increasing demand, they will either hoard their holdings or sell them on the black market at higher prices,” he said. Market observers believe the coming period will witness volatility, with the pound experiencing more losses before stabilising. A Pharos Holdings research note expects volatility in the days to come as the CBE tries to manage expectations. “At the moment, most Egyptians assign close to 100 per cent probability that the pound will continue to weaken versus the dollar. In response, the CBE will aim to reduce this probability to 50 per cent, which is the level sufficient to make investors/individuals indifferent to buying or selling foreign currency, “said the note, issued on Monday. Most projections put the expected value of the dollar in the short term at hovering around LE6.5. While not wanting to put an exact figure on the expected price of the dollar, Samer Attallah, an assistant professor of economics at the American University in Cairo, said he expected it to increase in value before falling again soon. “In similar experiences, an overshoot takes place in the price due to speculation, but after reaching a certain value speculators start selling again to make profits. The supply then increases, and the price goes down,” he said. However, this does not mean prices will not go up again in the future. “As long as we have pressure on our balance of payments, leading to continuous withdrawals from the reserves, there will be pressure on the pound,” Attallah said. The CBE statement announcing the new rules noted that the current level of foreign currency reserves represented “the minimum and critical limit. This requires their being conserved for critical uses, as represented in fulfilling foreign debt obligations to preserve Egypt's reputation in the international financial markets and to cover imports of strategic commodities.” Meanwhile, the government is placing its hopes on finally receiving a $4.8 billion loan from the IMF to relieve some of the pressure on the reserves. The deal was put on ice last month after political unrest made it impossible to pass an IMF-prescribed reform programme including increasing taxes on a wide variety of commodities. Prime Minister Hisham Kandil said on Sunday that talks with the IMF would resume this month. An IMF statement on Monday praised the CBE's new policy as a means to “maintain a level of international reserves that can support its international trade and payments.” Many observers believe the CBE's move is linked to an IMF condition that forces the government to execute austerity measures via setting a floor to reserves. The IMF put a similar condition on Jordan when negotiating a loan with the Jordanian government two months ago. Devaluation of the pound has long been feared because of the knock-on effects it could have on the economy. Since Egypt is a net importer of food and fuel, any increase in the value of the dollar against the pound will lead to inflationary pressures at home. According to the CBE, Egypt has withdrawn $14 billion from its reserves since the Revolution to cover imports of food and fuel. “The problem is that the Egyptian market is not a free market in the classic meaning of the word, as there are a lot of sectors governed by monopolies that dictate the price of commodities and thus add to already inflated prices,” Attallah said. “Imagine the cost hike for a producer who depends on imported inputs and needs fuel for his factory to work,” he added. Egypt's imports bill ballooned to $59 billion during the fiscal year 2011-2012 ending in June, compared to $49 billion the previous year. “If Egypt imports goods worth $59 billion, this means that each one piastre increase in the value of the dollar versus the pound adds $590 million to the import bill,” Adam said. Trading at LE6.35 on Monday, the dollar has gained 20 piastres on the pound since the beginning of the week. The increase in the dollar will also increase the burden of foreign debt and the cost of its servicing. Attallah said that with the debt currently standing at around $35 billion and its annual servicing coming to around $3 billion a year, the effect of the increase could overload government finances. On another front, the depreciation of the pound will burden foreign investors with currency losses and perhaps encourage more capital flight in the short term. However, the Egyptian stock market fared pretty well on Sunday and Monday, ending both sessions in the green. Market observers attributed this resilience to investors having already factored a weaker currency amid other bad economic news into their calculations.
