The importance of 'long-term'

The market has welcomed the latest devaluation of the pound. But according to economists, more needs to be done. Aziza Sami reports
The Central Bank of Egypt's announcement of a new central rate for the pound, moving to LE4.15 to the dollar from the LE3.90 set last July, was welcomed by a market facing continued pressures on the exchange rate. The bank also widened the margin of fluctuation for the currency to three per cent.
Egypt first introduced a new "managed peg" exchange rate in January, which let the currency trade within a narrow margin, initially set at one per cent either side of the core rate (LE3.85 to the dollar at the time). Two subsequent changes followed before the latest change. On 28 May, the rate was set at LE3.86 to the dollar. On 3 July, the rate was changed to LE3.90 to the dollar, at which point the margin of fluctuation was increased to 1.5 per cent either side of the central rate for the dollar and Arab currencies, and two per cent either side of the central rate for other foreign currencies.
Ismail Hassan, governor of the Central Bank of Egypt (CBE), had asserted that measures would be taken to "completely eradicate illegitimate (currency) transactions outside banks and exchange firms." He also said that the new rate would be flexible and "take into account market conditions." Under the new regime, the pound is near to the price at which it has traded on the black market for the last three weeks. The step followed a 1 August cabinet meeting, chaired by President Hosni Mubarak, and his directives that the "economic group" (of ministers) and the CBE governor meet daily "to take clear measures and [establish] policies to ensure the exchange market's stability, and meet the demand for foreign currency."
Reactions to this week's measures reflected relief that action has been taken to meet the rising demand for the dollar, though some sources predict that the dollar rate will have to rise further.
Economists also cautioned that, while the step may resolve the market's short-term problems, longer-term solutions must be sought to prevent the pound falling into a spiral of devaluation, leading to severe inflationary pressures.
The latest decision "could not have been better," said Fayez El-Defrawi, chairman of the Gulf Exchange Company. He added that this step has "neutralised the black market. Why should anyone take a risk when they are being offered a good rate at the banks and forex companies? Had the government started out with a LE4 central rate, instead of the LE3.86 last January, things would not have deteriorated to this extent."
According to El-Defrawi, the new rate has already affected transactions positively. "We are getting 10 times the number of people selling dollars than we have had in a long time," he said.
But it is still an open question whether this will be enough for banks to meet the rising dollar demands needed for capital imports. The dearth of available dollars has been the major factor propelling importers to the black market to meet their hard currency needs.
Over the past months, banks have been short over $1 billion. Now they will have to face the burden of import needs while also shouldering the new central rate increase. The CBE, banking sources say, will inject anything between $200 million and $500 million into the market. Until now, it has been reluctant to resort to this measure which will reduce its foreign currency reserves. Until July, those reserves stood at $14.2 billion. Proceeds from a recent Eurobond issue bolstered them by $1.5 billion.
A director with a major financial multinational told Al- Ahram Weekly, "I doubt whether the government will allow the currency to rise to its realistic level which, I predict, will reach LE6 or LE7 for the dollar. Even at the new exchange rate, exporters are phenomenally shortchanged and are made seriously uncompetitive, because the currency rate is not set by the market." In a statement, HSBC in London told its investors that the move was "surprisingly positive," and suggested a more "bullish" approach from the government. It also said the change has broken the important LE4 barrier, which was "mainly psychological." But it cautioned that investors should wait to see if the black market aligns with the official rate, and added, "theoretically, we are uncertain how easy the government will find it to make a [managed exchange rate] regime work."
While the impact of devaluation will not be immediately apparent, the rising demand for the dollar is bound to raise the bill of imports and widen the already huge trade deficit of over $12 billion, unless export performance improves dramatically and foreign currency revenues increase.
Long-term structural factors have put downward pressures on the pound, and have been manifest in a poor export performance. The crisis has also emphasised the dangers of depending solely for hard currency on four traditional sources: oil, the Suez Canal, tourism and expatriate remittances.
Exporters want to tie the pound to a basket of currencies in order to promote the competitiveness of Egyptian exports and ease demands for the dollar.
Mahmoud Abdel-Fadil, a professor of economics at Cairo University, said, "Liquidity shortages, market stagnation etc, are all part of the economy's short-term problems, and have partially resulted from a misallocation (of resources) among sectors. But rationalisation of the demand for hard currency must also be supported by developing the sources of hard currency revenues, and adopting expansionary policies boosting growth, employment and exports. This must happen, even if it means that the government allows for more inflation and for a widening of the budget deficit."
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