1 year later: How has flotation impacted individuals and investors?

On November 3, 2016, the Egyptian government announced that it had liberalized the foreign currency exchange rate. The flotation led to a significant overnight devaluation of the Egyptian pound against the US dollar, a marked increase in the prices of goods and services over the past year and the highest inflation rate in 30 years, all despite the Central Bank of Egypt’s assurances that it would not have any adverse effects on prices.

“Inflation has already happened. It is history,” CBE Governor Tarek Amer said on the day the decision to float the pound was announced. He was referring to the fact that the dollar’s value against the pound had already risen on the black market and dramatically affected prices.

In the months following, however, prices continued to rise, affecting the livelihoods and purchasing power of people, while the growth and investment boom that the government had anticipated never happened, according to economists Mada Masr interviewed.

The flotation was one of several measures that the Egyptian government agreed to as part of an economic program reached with the International Monetary Fund to finalize a US$12 billion loan. Both parties asserted that liberalizing the exchange rate was a necessary condition for structural reform and would allow Egyptian exports to become more competitive, encourage investment and help resolve the foreign currency shortage that had escalated in 2016.

But the IMF announced in January that the depreciation of the Egyptian pound had exceeded its expectations. From an exchange rate of LE13 to US$1 on the black market before the flotation, there were multiple consecutive hikes that devalued the pound to LE20 to US$1, before it stabilized at around LE18.

The steep devaluation of the pound was a driving factor behind the striking increases in the Consumer Price Index in Egypt over the last year, according to the IMF’s staff report published in January, as well as its first review of Egypt’s economic program published in September.

Diminished standards of living

Inflation in Egypt reached some of its highest rates over the last year, peaking in July. The impact of the flotation coincided with the decision to raise fuel prices early in the current fiscal year, sending the overall annual inflation rate for June 2017 rocketing to 34.2 percent.

The latest inflation figures for September have shown that food prices continued to lead the price hikes, posting a 42.2 percent annual inflation rate.

According to Heba al-Leithy, a professor of statistics at Cairo University and a researcher on poverty at the Egyptian Center for Economic Studies, inflation rates as abstract figures do not reflect the impact they have on the vast majority of Egyptians. “Inflation is the depletion of people’s purchasing power, and it leads to lowering their standards of living,” says Leithy.

“When inflation rates are this high, many people resort to buying food of lower quality than they used to consume and eat smaller overall amounts of food,” she says, adding that child malnutrition figures in Egypt are high and that one third of Egyptian children suffer from stunted growth, according to the UN’s Food and Agricultural Organization’s figures.

The high cost of living does not only affect food and nutrition, but it extends to other aspects of life. Some deny themselves treatment due to the high prices of medication and some are forced to transfer their children to less costly schools, sometimes accepting lower quality of education, according to Leithy. This, she says, contributes to lower standards of living and less valuable human capital in the long term, as people’s health and education deteriorate.

The average Egyptian in the top 10-percent income bracket spent approximately LE64 per day before the flotation, which was valued at US$7.4, according to the Central Agency for Public Mobilization and Statistics (CAPMAS). That figure, which dropped to $3.6 after the flotation, implies that 90 percent of Egyptian individuals spent less in a day.

Salma Hussein, an economic researcher at the economic and social justice unit of the Egyptian Initiative for Personal Rights, describes inflation as “a type of tax that poor and low-income people will bear the brunt of.”

According to Hussein, the aggregate demand in Egypt is unprecedentedly low, which reflects the impact of inflation on consumption. Such a decrease in demand is demonstrated by the latest figures published by the Central Bank of Egypt that show that individual and government consumption grew by a factor of 4.2 percent between July 2016 and March 2017, compared to 5.3 percent during the same period the previous year. The fall comes after consumption figures had been increased each year over the past three years.

In multiple pieces over the past year, Mada Masr reported on changes in the consumption patterns of individuals from different income categories, as a result of high inflation rates, to which flotation was a key contributing factor.

Impact on investors

In a statement that the IMF released at the same time it was conducting its first review of Egypt’s economic program, the fund said that investor confidence in the Egyptian market has increased and capital has started to flow into the country since November 3, 2016, the day the program was implemented. The fund’s statement also said that, in the wake of the flotation, Egypt’s shortage in foreign currency reserves had been resolved and the parallel currency market has faded into the background, removing the hurdles that had faced investors in the past.

Production and consumption had faced staunch obstacles given Egypt’s depleted foreign currency reserves before the IMF program was implemented.

Radwa al-Soueify, the head of the research division at Pharos Holding for Financial Investments, says that the decision to liberalize the exchange rate has achieved some of its most important goals, including a remarkable increase in foreign investments in treasury bills, as they jumped from less than $500 million before the program was implemented to approximately $18 billion at the close of September 2017.

Soueify adds that the devaluation of the pound “made the Egyptian market quite attractive to foreign investors,” as they can buy Egyptian securities at the nadir of the pound’s devaluation in hopes that the yield will be paid out with interest and according to a more favorable exchange rate.

The flow of US dollars into the banking system also solved the industrial sector’s problem. With no access to hard currency required to purchase production supplies, the sector was not operating at full capacity before the flotation. There has been an increase of 43.3 percent in industrial activity in the fourth quarter of FY 2016/17 compared to the same quarter of the previous fiscal year.

Soueify agrees with a report published by London-based economic research consultancy Capital Economics in noting that the increase reflects the uses of resources that had not been used due to a halt in production under the dollar crisis.

However, the industrial sector remains in need of further investment to achieve growth in the future, she says.

Noaman Khaled, a macroeconomics analyst at the Cairo-based CI Capital, says that the structure of the Egyptian economy has not changed since the flotation, pointing out that various economic sectors’ contributions to gross domestic product have not exhibited any substantial changes.

“Agriculture, forestry and fishing continued to contribute approximately 10 percent to the GDP, while the mining sector’s contribution held at around 9 percent, the downstream sector’s at 7 percent and the construction sector’s at 18 percent,” says Khaled, comparing figures of the period between July 2016 and March 2017 to those of the same period of the previous year.

“The same crises will occur again unless the government devises a plan to channel investments toward development sectors as opposed to portfolio investments or mega-projects that benefit the real economy in the long term, such as industry, agriculture, education and public transportation,” he adds. For Khaled, although mega-projects, such as the new administrative capital and the Suez Canal expansion, and foreign investments in gas fields, such as Zohr, have made major contributions to national growth over the past two years, they do not make room for sustainable development.

Despite expectations that might be inspired by this year’s increase in growth compared to the previous year, several research institutions have reported weaker company performances and less corporate confidence in the market. The ECES’s quarterly Performance and Expectations of the Egyptian Business Sector report that was released in September stated that firms were starting the fiscal year with cautious forecasts regarding Egypt’s market and that the corporate outlook for growth over the current quarter was lower than that for the previous one.

While the report noted that small, medium and large businesses expected the volume of exports to increase, thanks to the devaluation of the pound, it also found inflation to be the primary constraint limiting economic activity through a survey of 120 firms.

The non-petroleum private sector experienced a significant downturn in September, according to Emirates NDB Egypt Purchasing Managers’ Index. The index remained below 50 percent throughout the year, indicating a continued reduction in business activity, with the report emphasizing inflation as a key contributor to weak local demand and economic activity by citing a survey of businesses.

According to Khaled, surveys conducted by CI Capital have shown that companies that produce steel and cement goods have reported a decrease in production over the past months, due to low consumption caused by inflation. “This is simply the definition of a recession,” he says.

The increase in the volume of Egyptian exports to approximately $21.6 billion during the year since the currency exchange rate was liberalized, while 16 percent higher than the previous year, is quite modest, judging from the volume of previous years, which posted figures of $26 and $27 billion in FY 2013/14 and FY 2012/13 respectively.

Khaled argues that flotation does not encourage all types of investment, contrary to the speculation that the mere depreciation of a currency’s value would allow it to be more competitive in international markets. This might be true for certain industries — such as the textile industry — but the reality of other industrial sectors is more complex, he says.

Making more investments in order to compete externally is not easy for many companies, according to Khaled, because the prices of intermediate and capital goods have also risen in the aftermath of the flotation.

Translation by Salma Khalifa

Osman El Sharnoubi 

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