Egypt’s Currency Catch 22

The board of the International Monetary Fund (IMF) is due to meet sometime in the next two to three weeks, at which point it will formally sign off on the deal for Egypt. It’s a deal wrought with challenges, but is likely to go forward anyway. Cairo insists that the IMF deal ties in well with its own economic reform agenda, which then allows it to internally dissuade nationalistic opposition to the IMF plan. Nevertheless, it is expected that prior to the board actually meeting, Cairo will present evidence that is serious about the reform program – and one of the most delicate parts of that program is the devaluation of the Egyptian pound.

Prior to the revolutionary uprising of 2011, it cost about 5.8 Egyptian pounds to purchase one US dollar, according to the official bank rates. Today, that same dollar is worth about 8.8 Egyptian pounds on the fixed, official rate of the central bank – which is in itself more than a 50 percent increase. On the parallel market – which is now where, it seems, most dollars are actually accessible to the average consumer –the price of the US dollar there is around 12.5, with some traders reportedly selling as high as 13.10. That black market rate is 40 percent more than the official bank rate – and it is a 115 percent difference than 2011.

The government has responded with three measures. The first has been managing the price of the US dollar with a controlled floating exchange rate – the currency is not pegged, which means the state intervenes by selling dollars when the price is higher than it wants it to be. That has resulted in the currency reserves being depleted. The second has been to crack down greatly on the parallel market, which has resulted in the black market going further underground. The third has been to institute massive restrictions on the buying of US dollars from banks, and the spending of Egyptian pounds abroad via Egyptian credit or debit cards.

The difficulties this imposes on Egyptian companies trying to deal with the outside world, and on international companies that want to invest in Egypt are tremendous. KLM, for example, announced in early September that it will halt flights in and out of Egypt in 2017 because foreign currency restrictions have prevented it from repatriating its earnings.

For the last few years, Cairo has been trying to ameliorate the difficulty by periodically devaluing the Egyptian pound. As the IMF board is expected to meet in early to mid October, another devaluation is expected in the next couple of weeks, particularly as the difference between the black market rate and the official rate is so large. But therein lie yet more minefields.

There are three options for the Egyptian state in this regard. It can devalue the pound a little bit; or it can devalue it quite a lot; or it can float the pound altogether, and let the market decide. Each comes with its own risks.

Devaluing the pound to, say, EGP10.5 to the dollar, the market might stabilize a bit, allowing for confidence, and investment, to increase. Certainly, investments in Egypt at the moment, internally and externally, have taken a dive, and any change in that regard is welcome. Alternatively, however, there could be panic—and investors would still know that the currency is overvalued. Even more so, the black market, while temporarily 20 percent different less than the official rate, might eventually increase, and the same gap of 40 percent would be restored. Which means the cycle would repeat again. In the end, it might be similar to ripping a band aid off a wound – is it better to remove it in one go, or slowly take it off, lacking in transparency about when it is finally going to be removed?

Devaluing the pound to around the black market rate would mean that cycle might be broken altogether, as the black market would lose a lot of its imperative to exist. Floating the pound would also make that possible, as there would be little point for people to sell on the black market if the rate is the same as banks. In the final analysis, a healthy Egyptian economy would float the currency, rather than impose state protections—something that Cairo seems to have implicitly accepted, but only in the long term; the current head of the central bank has implied he won’t consider it until FX reserves exceed $25 billion. It’s something the IMF wanted—but probably knew it could not get.

But here is the rub—the Egyptian economy is not healthy, and floating the pound altogether, or devaluing it too much, could have unmanageable consequences. What Cairo seems most concerned about is a run on the pound, inflation, a rise in prices, and consequently, civil unrest in the form of riots. These are not unreasonable concerns.

The problem is—those concerns are also important to keep in mind if Cairo does not devalue the pound enough. Prices are already rising, and while the economy hasn’t crashed, there is a legitimate concern that civil unrest could take place in the near future, if the standard of living decreases, the cost of living increases, or both. The devaluation is probably taking place at the best time of the year, in that Egypt is approaching winter, rather than summer, when pressures on the economy due to economy consumption and Ramadan are at their highest. But that still doesn’t mean the economy will absorb the changes without some kind of a backlash.

In reality, the floating of the currency should probably have taken place years ago—perhaps right after the uprising in 2011—when the sense of social and civic responsibility was at its highest, and support of the international community could have been leveraged to buttress Egypt as it transitioned. But the float did not happen—nor did any of the direly needed economic reforms, or, indeed, other important reforms in the security sector, the judiciary and the political arena.

Cairo now finds itself in something of a catch-22—the currency is in an unsustainable situation, so devaluation must take place—but if the devaluation is not done carefully, and at the right time, then a backlash could hurt the economy even further. But if the devaluation is left till too late, then a backlash could happen anyway—and steps to address the economy would have to be taken anyway, which would lead back to the same cycle again. Status quo is certainly not an option – it’s thoroughly untenable, because investors and consumers alike are on a ‘wait and see’ kind of option. And the later the reforms are done, the harder they are likely to be – unfortunately.

Dr. H.A. Hellyer is a Nonresident Senior Fellow at the Rafik Hariri Center for the Middle East at the Atlantic Council. He is also Associate Fellow in International Security Studies at the Royal United Services Institute (RUSI) in London.

Related Experts: H.A. Hellyer

Image: A man talks on his mobile phone as he walks in front of the construction of a new bank building covered with an image of the U.S dollar in Cairo, Egypt July 26, 2016. (Amr Abdallah Dalsh/Reuters)