Crux of the matter

By Aziza Sami
Prime Minister Atef Ebeid's announcement on Monday that the Central Bank has been authorised to set "safe and defined limits" within which the Egyptian pound will be allowed to fluctuate constitutes the first official acknowledgment of what many have suspected for months -- that the government is engineering a managed flotation of the Egyptian currency.
However astute the management skills involved, though, the flotation means only one thing -- a steady devaluation of the pound against the dollar to which, for a decade hitherto, its value has been pegged. And while there is as yet no indication as to the baseline to which the government will allow the pound to sink in the long run, its de facto devaluation has been welcomed by the market.
According to what the Prime Minister announced in the cabinet's annual policy statement infront of the People's Assembly, the Central Bank will determine the exchange rate based on the average market rate over the past three weeks. It will "ensure that banks and exchange bureaus respect the limits within which the dollar rate will be allowed to rise" in a step that is clearly intended to inhibit levels of speculation and in doing so bring at least some semblance of stability to the foreign exchange market.
Whether or not the government's belated admission of a policy it has evidently been following for several months now will be enough to counteract further pressure on the pound, though, is by no means clear. Running a trade deficit of over $11 billion, with desperately poor productivity figures, a weak savings ratio and deteriorating export performance, the government really has very little room for manoeuvre.
Traditional sources of hard currency -- tourist and oil revenues, expatriate remittances and Suez Canal dues -- have declined over the past two years and are at best precarious.
The downward pressure on the pound is unlikely to abate: the most optimistic commentators predict that by the end of the year it will have sunk to LE5 per dollar, though realistically it may well be closer to LE6.
The government, then, finds itself in a double bind. Having instructed the Central Bank not to make further injections into the market from its foreign currency reserves -- depleted, now, to $14.6 billion -- it has now charged the same institution to "determine the rate of exchange for the Egyptian pound." The pound, even if it is not going to be allowed to go into free fall, is likely to be steadily devalued, which is hardly conducive to promoting the increase in savings necessary to finance investment. Nor is it at all clear what the inflationary pressures involved in devaluation will be: certainly there will be a degree of fall out, and higher inflation figures, again, are going to inhibit savings.
The one certainty is that pressure will continue to be exerted on the exchange rate and it is a situation that will continue until the structural imbalances inherent in the Egyptian economy have worked themselves out.
Hand in hand with managing the devaluation of the Egyptian pound, then, must come a platform of policies capable of tackling the yawning trade deficit. The only long term solution to the dilemma is to turn around productivity levels, though achieving this is likely to prove a long and difficult haul. Tweaking with the exchange rate mechanism, while it is a necessary step, is not going to help solve the underlying weaknesses that beset Egypt's economic performance.
Low savings, an overvalued currency, disastrous levels of productivity, an inflation rate that could easily overheat: it is an unenviable position from which to be working. To avoid the pitfalls will require enormous clarity of vision and a greater degree of political will than has been shown until now.
The removal of some of the ambiguity surrounding the exchange rate, as spelt out in the cabinet's statement, is a welcome first step if it leads to the cabinet's economic group working more closely with the Central Bank on an integrated fiscal and monetary policy. There is, unfortunately, no more time for fudging.
Related stories:
Setting the limits
Ebeid sees a silver lining
Addressing the issue
Dealing with the pound 18 - 24 January 2001
Interest rates -- here and there 18 - 24 January 2001
To float or not to float 23 - 29 November 2000
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