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What happens if the Egyptian pound keeps falling?

The Egyptian pound is likely to continue to decline in value, and indeed needs to accelerate its decline to reach its real market value.

Investment Minister Ashraf Salman’s statements that Egypt isn’t far from a crisis and is studying devaluing the currency sent a clear signal that the Central Bank of Egypt (CBE) will likely have to drop or soften its protection of the pound’s current value.

Most analysts would comfortably argue that the pound is overvalued due to the CBE’s interventions. The pound has actually increased in value against the euro over the course of the past year. As the euro and many currencies have dropped dramatically against the dollar, the CBE seems to focus its policies on the pound’s value against the dollar. This all makes Egyptian products and services, such as tourism, less competitive.

Failure to lower the value of the pound deters foreign investment for a very simple reason. If you know that the currency you’re buying to invest with is overvalued, the very act of purchasing that currency is taking a loss. Hypothetically, if you believe that the pound should be sold at about LE10 to the dollar, and you’re buying at LE8 to the dollar, you’re effectively incurring a 25 percent loss before you start your investment. This is a major deterrent to investing.

Another problem is Egypt’s capital controls. If your venture is profitable but you can’t take the money out of the country, then that profit isn’t of much use to you as a foreign investor.

What does the investment minister’s announcements mean for you? Mohamed El Dahshan, a non-resident fellow at the Tahrir Institute for Middle East Policy, says that “merely announcing the intention of devaluing the currency is like de facto doing so, because the market will account  for that future devaluation and internalize it, and it will be reflected in today’s currency value.”

In the short term, this will encourage more pressure on the black market. Combining the strict capital controls that make the supply of dollars smaller than the demand for dollars, along with the government announcing it’s looking to further devalue the pound, will push up the price of dollars in the black market — assuming regulators can’t control the situation.

In the medium term, as the currency’s value continues to decline, the cost of imports will continue to increase. The bad news for Egypt is that a substantial portion of our consumer goods are imported. The World Bank estimates that over 24 percent of Egypt’s gross domestic product (GDP) is spent on imported goods and services.

The devaluation will also encourage the government to raise the price of energy. Otherwise, maintaining the current pound price will actually cause government subsidies to rise again, thus further straining an already overstretched state budget. The government is unlikely to accept this, as it has stated clearly that it intends to cut and eventually eliminate electricity subsidies over a 5-year period.

Going forward a bit further, a lower currency value will make Egyptian products more attractive for export because they will be cheaper. But Egypt will only be able to fully capitalize on this if currency controls are loosened or done away with altogether.

That’s because those controls don’t only deter foreigners from investing in Egypt. They also make it difficult for businesses to get the raw materials they need to produce goods — and this is aside from the fact that our relatively power-cut-free summer was reportedly provided by cutting power to factories. Here again, the government seems to have put its political popularity ahead of the country’s economic interests.

Longer term still — and again, the extent to which this will happen depends heavily on capital controls being softened or lifted — the country can expect greater foreign investments when the currency moves down to its real value, making Egypt a more attractive emerging market investment.

In the short to medium term, though, Egyptians should expect a fair bit of hardship, with higher prices for basic commodities and more costly access to hard currencies. The eventual economic benefits of this correction are probably still a while away, and will only come if smart banking and monetary policies are put in place to take advantage of the devaluation’s potential benefits.

Timothy E. Kaldas