Egypt’s got the first act right with the de-pegging

This article appeared originally in Gulf News: link to original article

Egypt floated its currency in November 2016. Even though this was requested by the IMF as a precondition for the $12 billion (Dh44 billion) loan, it was anyway a step that needed to be taken sooner or later.
As a country that does not gain US dollars from oil exports yet maintains a highly valued peg between the Egyptian pound and the dollar, it created a major strain on its foreign currency reserves. Not only that, the unrealistic peg value added to the already big gap between the official exchange rate and the black market one.
And post-2011, Egypt was collecting less revenues from its US dollar-generating sectors, mainly tourism. In short, Egypt wasn’t making enough money, while at the same time supporting an artificially high exchange rate.
Overall, the de-peg tide is not one that is going to ebb anytime soon. In the 1970s, more than 80 per cent of currencies were pegged to another currency. That figure decreased to less than 30 per cent by 2015.
And so, the trend is not necessarily one that is strongly correlated with the dip in oil prices, or one linked to the Fed’s rate hikes, but is rather a general direction towards more monetary policy freedom. As for Egypt, the action taken is timely given its economic situation.
So post the peg, what happened in Egypt?
The Egyptian pound depreciated a lot and then adjusted to a more realistic, market-driven exchange rate. The depreciation led to two things: first, higher prices for imports, and hence inflation, especially as Egypt also introduced higher import duties to encourage local manufacturing and consumption.
In addition, and due to a greatly depreciated Egyptian pound, higher prices paid for imports resulted in hundreds of Egyptian companies becoming insolvent. Because of that, Egypt came up with a new bankruptcy law to address all issues arising out of this.
Egypt also postponed collection of hotel industry debts to provide them with some leeway to re-invest their returns in their assets and operations. Second, the de-peg resulted in increased investor confidence in the Egyptian economy, with a $4 billion government bond issuance being more than three times oversubscribed (according to the “Economist”).
Egypt also attracted $500 million from Germany for its SME programme.
In Egypt, it wasn’t only companies that suffered as a result from the de-peg. Individuals were greatly affected with their purchasing power being reduced, which anyway discouraged their consumption of imported stuff regardless of whether or not import duties were increased (which they were).
The positive side to this though is — and taking into account Egypt’s huge population — a hopefully higher domestic consumption. Presumably, and according to the IMF, it will take anywhere from 12-24 months for the Egyptian economy to adjust to the de-peg and its aftermath.
Between now and then, Egypt will need to be active in the following: one, ensuring that its newly-established fund to bail out insolvent companies is being effectively managed, bailing out only those worth saving. And, two, initiating huge infrastructure projects, the new capital being a China-like recipe for development and job creation.
However, this needs to be properly planned to not have the end result being ghost towns and under-utilised roads, bridges, and the such.
To conclude, Egypt’s latest economic measures were long overdue, though being late is better I guess.
Egypt will now need to carefully plan how it spends its dollars, including those saved from not having to support the peg. This means that it should next continue building on investors’ confidence (moving up the Ease of Doing Business Index by four places is a great start), promoting SMEs versus government recruitment to shrink government payroll, and making use of public-private partnerships versus borrowing in an era of increasing interest rates.
The last thought that I want to leave you with: is Egypt capable of achieving a China-like economic success story?