What are the implications of floating the Egyptian pound?

The Central Bank in Egypt had no other option but to move the Egyptian pound to a free market exchange rate with other currencies. The alternative was to lower its price voluntarily while maintaining the black market and being unable to secure required hard foreign currency reserves. Thus, a decision was made to float the pound in the free market while also increasing interest rates to a record high in an attempt to persuade people not to dispose of the pounds they have.

The exchange rate has fallen from 8.8 Egyptian pounds to the US dollar, to 16 or 17 pounds. It was expected that the rate would reach 20 or 22 pounds per dollar, but the Central Bank pumped 100 million dollars into the market on Thursday, the first day of the change, selling to banks at a rate of 13 pounds per dollar. It also demanded that banks make a profit of no more than 10 per cent. By doing so, the Central Bank guaranteed that the pound would not collapse on the first day of its flotation, thus postponing the predicted collapse in the exchange rate.

As the exchange rate of the pound went down, the Central Bank also raised interest rates by 3 per cent, to 15 per cent, a rate more than 20 times the dollar interest rate. This helped the exchange rate not to plummet as soon as the decision to float the pound was announced. However, the high interest rate doesn’t really mean anything because the Egyptian pound lost more than 50 per cent of its value in one year, while the interest rate is still much less than that. In effect, the Central Bank took 50 per cent of people’s savings and compensated them with 3 per cent (the additional interest), which is payable in one year. It is not important to explain the meaning of the decision to float the pound and the increase in the interest rate, because it has become a reality and people are now able to understand it as they’re living the situation. What’s more important is to answer the question of what comes after the flotation. What are the implications for poor Egyptians?

Moving the pound to a free market rate will necessarily lead to a continuous decline in the exchange rate. This is because the cash reserves of foreign currency are at their lowest level for several decades. At the same time, demand for hard currency is increasing because of the trade imbalance. All of this means that the pound is heading inevitably towards more falls. As to why it hasn’t collapsed immediately, we can look at the Central Bank injecting extraordinary amounts of US dollars onto the market, but this is an exceptional move and will not go on forever. Also, a loan from the International Monetary Fund, if received quickly, could slow down the collapse of the Egyptian pound; slowing down, though, does not mean that it will not happen. Lowering the rate of the pound and removing fuel subsidies mean that Egyptians face an increase in prices of three or even four times for some commodities. Furthermore, local currency will lose its purchasing power, inflation rates will rise along with unemployment and the Egyptian economy — the second largest Arab economy — will enter a new phase of crises.

The bottom line is that the Central Bank and the other financial and monetary authorities in Egypt are running forward without taking steps necessary for decisive action, because such steps are linked to politics, the military and the barons of corruption. Thus, they are taking care of the immediately visible symptoms but are not providing long-lasting treatment of the cause. Over the past three years, the Egyptian economy has survived on financial aid from the Gulf, including US dollar deposits payable with interest. Now it will survive further by living off a loan from the IMF for the next three years, on which interest is also paid.

Translated from Al-Quds Al-Arabi, 8 November, 2016

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