The long-expected devaluation of the Egyptian pound is finally taking place. The pound has undergone its greatest devaluation against the US dollar since the 25 January revolution, falling from LE5.90 to about LE6.60 in a little over a month. In this context, the pound has hit a historical low against the dollar and the euro since 2003, when the decision of floating the pound was first made. The question raised is why now, and not before, given the constant and continuous decline in the country's foreign reserves since January 2011? The pound is subject to an exchange system of managed floating. According to such a setting, the pound is left to float, so its value is primarily decided by the forces of supply and demand. However, the Central Bank of Egypt manages the price through constant regulatory intervention so as to stabilize the pound value and fend off speculative attacks. In the past, the Central Bank would deploy some of the foreign reserves at critical times to increase the supply of dollars in a manner that would reduce the run on US dollars and thus save the pound value. Before the revolution, the Egyptian currency was further supported by the successful efforts of building up relatively big foreign reserves that reached a peak of US$36 billion in early 2011. Following the 25 January revolution, political turmoil, capital outflows and low growth rates have all led to the depletion of Egypt's foreign reserves, which have fallen from about $36 billion to almost $15 billion in two years. Yet, despite the remarkable decrease in reserves, the pound retained its value throughout most of this period. It only started to depreciate against the dollar three months ago. However, the devaluation back then was rather gradual and mild, while the pace has quickened considerably in the last month. This went hand-in-hand with the downgrading of the country's credit ranking by US-based ratings agency Standard & Poor's to B-, which is only a step away from insolvency. The downgrading is not the first since the revolution. However, what is alarming about it is its timing, which, unlike earlier instances, did not happen during the transitional period. Rather, the recent downgrading took place days after the ratification of the first post-revolutionary constitution and six months after Mohamed Morsy was sworn in as the country's first democratically elected president. The timing of the decision suggests that the country's political transition has not, and is not, expected to produce any long-term stability, with negative implications for economic recovery. It is in this context that the Central Bank issued a statement in which it expressed its concern about the status of foreign reserves for the first time since the revolution. The bank clearly stated that the current reserves barely suffice for the importation of basic food and fuels. The intensification of the country's foreign reserve problems synchronize with the indefinite suspension of the International Monetary Fund loan agreement, following Morsy's failure to enforce the tax increases he issued on 8 December. Why the devaluation now? A simple answer would be that the old way of managed floating of the pound is not sustainable with such little reserves. Hence, the Central Bank seems not to possess enough dollars to fend against speculative attacks and thus protect the value of the pound. Indeed, the Central Bank, together with other giant commercial banks such as Al-Ahli Bank, withdrew hundreds of millions of dollars from their accounts abroad to increase the supply of dollars in the Egyptian market. However, what has been alarming is that while more and more dollars were injected into the local market, the demand kept increasing, and the devaluation trend was not offset. The Central Bank's first auction pumped about $73 million, an amount that was consumed instantly, with little effect on the exchange rate. It appears that many Egyptians have fallen victim to self-fulfilling expectations, in which fear of higher dollar value only leads to higher demand and thus higher dollar prices. The Mexican example of 1994 is worth mentioning in this context. The Mexican peso was pegged to the US dollar in the early 1990s. When the peso collapsed against the dollar, the Mexican central bank attempted to defend it against abrupt devaluation by pumping billions of dollars into the currency market. However, the result was the total consumption of the Mexican foreign reserves within a couple of days. Was the Central Bank's strategy sound from the beginning? The bank's board knew too well that pound depreciation can be explosive socially, politically and economically, especially in a context like that which followed the 25 January revolution. Egypt is a net food importer and the largest importer of wheat, which is the primary staple. Moreover, any sudden increase in the value of the US dollar is likely to generate inflationary pressure on the broadest variety of goods and services, given the fact that the greatest percentage of imports is made up of production inputs and medium and capital goods. Hence, the bank's original strategy of safeguarding the value of the pound during political turmoil was not a bad idea, by any means. However, the bet was put on those in charge of the country to bring about an end to the transitional period and usher Egypt into political stability. Unfortunately, this was not the case — neither under the administration of the Supreme Council of the Armed Forces, nor under the presidency of the Brotherhood. Amr Adly is director of the Social and Economic Justice Unit at the Egyptian Initiative for Personal Rights. He has a PhD in political economy.
