Between a rock and a hard place

A six per cent devaluation of the pound is the latest measure taken by the government to try to revive the flagging economy. Sherine Abdel-Razek reviews Egypt's economic fundamentals
Following a week of intensive meetings by the cabinet economic group, yet another forex regime was unveiled earlier this week. The Central Bank of Egypt (CBE) announced that it has devalued its core pound- dollar rate to LE4.15 from the LE3.90 level it set less than a month ago. It has also widened the margin in which it allows the currency to fluctuate to three per cent above or below the central rate from the earlier margin of 1.5 per cent.
With this latest measure, the government has reduced the value of the local currency against the dollar by about six percent. Under the new regime the minimum price for the dollar is LE4.2745 -- about the same price it has been traded at on the black market during the last three weeks.
Prior to the announcement of the new regime, the forex market had all but come to a standstill as banks and exchange bureaus were unable to provide the liquidity demanded by customers due to tight restrictions imposed on banks for dollar sales. The purchase of dollars from banks has been limited to a maximum of $1,000 per person and buyers had to present travel ticket, valid visas and passports to obtain this. Some exchange bureaus closed out of frustration with the restrictions, which have been stringently enforced by the CBE and the Ministry of Economy.
Observers had predicted that the government would announce a new forex regime following President Hosni Mubarak's directives to the cabinet economic group for clear policies to ensure stability in the foreign exchange market.
Egypt introduced a new "managed peg" exchange rate in January that allowed the currency to trade within a narrow margin, initially set at one per cent either side of the core rate, which was at that time set at LE3.85 to the dollar. Subsequent changes followed on 28 May, when 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 also increased to plus or minus 1.5 per cent for the dollar and Arab currencies, and two per cent above or below the central rate for other foreign currencies.
These successive measures represent a 22 per cent devaluation of the pound since May 2000 when the government abandoned the LE3.9 level. These steps were necessary to give the pound a price based in market realities. While the new rate places a heavy burden on many businesses, deferring the devaluation indefinitely was not an option as maintaining the pound at such an artificially high rate probably would have brought the economy to a standstill within a month from now.
Economically, Egypt has long been said to enjoy sound fundamentals. It has a fast-growing population, a burgeoning middle class with growing spending power, GDP growth rates of six per cent or more, a diversified industrial base and a host of firms ripe for privatisation.
However, a closer look reveals the fragile state of the economy. For the past two years, Egypt has been in the throes of an economic crisis, which has been clearly manifested in a decline in economic activity and a liquidity shortfall. Analysts blame this state of affairs on an array of factors, which include insufficient export trade, an increase in state expenditures, limited foreign investment and capital flight.
The state's budget deficit increased during the third quarter of 2000-2001 to LE1.128 billion compared to LE630 million during the previous quarter -- a matter highlighted by all reports on the Egyptian economy. And the government's measures to reduce the deficit have added to the woes of Egyptian businesses, which have questioned the wisdom of implementing the new phases of the sales tax amid a recession.
Exports came to a mere LE1.8 billion compared to the growing import bill of LE4.1 billion in the third quarter of 2001. Imports, which reached LE17 billion for the calendar year 2000, are draining the county's already shrinking foreign reserves. The latest CBE figures show that Egypt's reserves, which amounted to $20 billion in 1997, had dropped to $14.7 billion in April -- the latest available figures.
Experts believe reserves might be buoyed slightly with the increase in oil exports due to increasing foreign interest in the sector. The steady improvement in the number of tourists visiting the country is also cited as a factor that will boost Egypt's reserves. However, more circumspect observers note that the increase in the number of tourists has not been accompanied by an increase in revenue as travel agents have slashed their prices by an average of 20 per cent since the beginning of the Al-Aqsa Intifada last September in an effort to attract visitors to the region. Moreover, the second largest source of foreign currency, the Suez Canal, is facing stiff competition from alternative routes which, among other effects, has resulted in a decline in the number of oil tankers passing through it.
As for monetary policy, Egypt has defended its exchange rate peg with artificially high interest rates, which have exacerbated a slowdown in GDP growth in the last 18 months. These rates have also weighed on stocks and individuals' purchasing power.
According to orthodox monetary theory, Egypt should adjust its interest rates in accordance with changes made to these by the United States to bolster its currency peg with the dollar. But this was not the practice in 2001 as the CBE failed to follow the Federal Reserve's bold measures. It is true that it lowered its discount rates to 11 per cent on two half-point cuts in April, but this move only really kept it in the same place. In contrast, the Federal Reserves eased its interest rates six times by a total of 2.75 percentage points since the beginning of the year.
Moreover the reduction to the discount rate did not trigger a similar decline in the commercial bank credit rates due to the dearth of liquidity, meaning that the measure failed to encourage portfolio or direct investments and thus had virtually no tangible effect on the economy.
In fact, interest rates are only one of a handful of factors that have pushed the local capital market over the edge. A lethal cocktail of domestic economic woes, bearish international markets and an escalation in the violence in Palestine combined to create inauspicious conditions for investment.
During the past two weeks, the capital market has recorded new lows. Its blue chip index, the EFG- Hermes financial index, has registered its lowest levels in its seven-year history, falling beneath 5,250 points. Experts are predicting that things will get worse as the devaluation increases the value of the foreign currency debt burden on the traded stocks.
Moreover, issuing sovereign bonds in the international market has made the Egyptian market and economy vulnerable to the ratings of international agencies which have been tough graders recently.
Standard & Poor's (S&P) has reaffirmed its negative outlook on its investment rating for Egypt, meaning the risk continues a downgrading it in the next 12 months to junk grade.
The agency said in a statement this month that Egypt's ratings were hindered by the slow pace of structural reform, weak spending controls and an inflexible exchange rate regime.
"Egypt lags behind most of its peers in liberalising key sectors of the economy and attracting significant foreign direct investment," it said. "If within the next year the government misses its fiscal deficit target, the current exchange rate regime loses credibility and the pace of structural reforms remains slow, then the ratings would be lowered," S&P said. Moody's rating agency already puts Egypt at just below investment grade.
The government seems to be worried that things might be reaching a head. Egypt's much vaunted social stability, always a government priority, gives the appearance of being somewhat precarious, with people stuck between unemployment, low state salaries and a stagnant economy.
Exasperated university graduates thronged the streets recently to protest against a government announcement that it would only provide new graduates with state employment. Its plans to hire 170,000 labour- market entrants, effectively at the expense of thousands of unemployed graduates, some of whom had been waiting for state employment since finishing their education as far back as the mid-eighties, was too much for those who had waited so long for secure employment. The government hastily extended age limits for accepting state employees in a move aimed at containing the unusual -- by Egyptian standards -- explosion of opposition.
The early retirements and layoffs accompanying Egypt's 10- year-old privatisation programme, together with a two year economic slump have added to the number of jobless. Economists believe that real unemployment rate in Egypt is double the official level of 9 per cent. As the Egyptian job market has recently been receiving 800,000 entrants every year, this rate appears set to increase.
Even those employed in low- or mid-level positions in the state apparatus are suffering from very low wages. With the general slump in the economy many of these people have been deprived of the income they obtained from moonlighting.
A survey conducted by the local Central Agency for Public Mobilization and Statistics (CAPMAS) showed that about three per cent of Egyptian families are living in poverty, which according to an international convention means that each family member survives on less than a dollar a day.
The 12-month survey covering until September 2000 indicates that 2.94 per cent of Egyptian families earned less than LE3,000 ($759) a year, which translates into purchasing poser of $1 a day for each family member.
The number of poor would sadly be much higher if the agency used the real official exchange rate -- not the artificial LE1.7 to the dollar rate based on World Bank purchasing power estimates. Using the then-official exchange rate of LE3.4, one in five Egyptian families would be considered to be living below the poverty line.
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