Analysts: The poor will bear the brunt of price shocks after pound floats

While Egyptians wait for an imminent Central Bank decision to float the pound, leading to a surge in prices, many suggest the shock waves will hit the poor first.

The decision to float the pound will lead to a high increase in the inflation rate in the long run, which “could continue for months before citizens start to adjust their spending and inflation returns to its natural rate,” says Rami Oraby, an economist at Mubasher for financial services.

Annual inflation reached its highest rate last August since 2008, at 16.4 percent, according to the Central Agency for Public Mobilization and Statistics (CAPMAS), which attributed this to price hikes of commodities and services, particularly food and beverages (the latter by over 20 percent). This was before the implementation of Egypt’s value-added tax law, which is expected to cause more inflationary pressure.

President Abdel Fattah al-Sisi attributed the increase in inflation to a rise in citizens’ purchasing power amid pay raises for state employees, in his speech in late September. Sisi promised prices would be regulated within a month or two, “regardless of the price of the dollar.”

A research paper published by Capital Economics forecasts an increase in the inflation rate of up to 18-20 percent by the end of the year, beginning of next, as a result of anticipated economic reforms, particularly the floating of the pound. The increase in the inflation rate might even reach 25 percent, according to professor of statistics at Cairo University and supervisor of CAPMAS’ research on income and expenditure.

According to CAPMAS’ 2015 research on income, expenditure and consumption, the poverty rate in Egypt reached 27.8 percent in 2015, an increase of 1.5 percent, compared to the rate in 2012/2013, the highest level since 2000. CAPMAS claimed 10.8 percent of Egyptians spend less than LE300 a month, and 14.2 percent spend LE600 to LE800 on a monthly basis, indicating a decline in purchasing power.

Leithy believes floating the pound “will not achieve its goals unless the government provides a program for poorer sectors that protects them from its negative effects.”

The natural step after floating the pound, according to Oraby, is for the Central Bank to raises interest rates on loans. A report by investment bank Beltone predicts that Banque Misr and the National Bank will raise their interest rates on saving certificates in Egyptian pounds, and that this decision will be followed by the raising of interest on investment certificates by the Central Bank’s Monetary Policy Committee in order to increase the appeal of the local currency and limit inflation.

Capital Economics estimated the Central Bank would raise interest at a rate of 1-3 percent to increase the revenue of the Egyptian pound and attract foreign investment, rather than curtail inflation. The government predicts that the floating of the pound and the rise in interest will push those with dollars to go to the official exchange market rather than the black market.

Investment banks argue that the reduction of the pound is a necessary condition to eliminate the exchange rate crisis and the parallel market for trading dollars, as well as to increase foreign investment. This should lead to an increase in the competitiveness of Egyptian exports, the banks claim.

Oraby says the decision will not lead to the elimination of the black market unless the Central Bank is able to cover all the market’s needs through the official exchange. He expects the black market will continue to operate for one or two more years, adding, “Egypt is not yet ready to decide to float the pound, because there isn’t enough liquidity to cover the needs of the market.”

The Central Bank announced foreign currency reserves rose to US$19.6 billion last September, an increase of $3 billion from August, and the highest rate since June 2015.

Leithy suggests the increase in exports as a result of the reduction of the pound will not lead to major savings, because most Egyptian industries depend on raw materials and imported machines, which lower the added value from exports. There are basic steps the government should consider, he says, such as limiting imports, increasing the manufacturing base and encouraging Egyptians working abroad to transfer remittances through official channels.

In a report published on October 2, Beltone predicted Egypt’s Central Bank would lower the pound to 11.5-12.5 to the dollar, which is 30 to 40 percent of its current value. This precedes meetings with the International Monetary Fund, where the fate of the loan Egypt applied for will be determined.

Sisi held a meeting with Governor of the Central Bank Tarek Amer on October 1, which was interpreted by many as a green light to begin the process of floating the pound.

Beltone explained that this process would likely begin with a managed floatation through an exceptional auction, in which the price of the pound would be lowered against the dollar to reach an official price of between LE11.5 and LE12.5. This would then be followed by a fully-fledged floatation over the course of two to three weeks.

Any reduction in the exchange rate of the Egyptian pound is likely to lead to price hikes due to Egypt’s dependency on importing basic commodities, including wheat, cooking oil and others.

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