Egyptian Initiative for Personal Rights commentary
By Mohamed Ramadan, Economic and Social Justice Unit researcher

What happened?

-               In an anticipated move, the Central Bank of Egypt announced on 6th of March  its decision to allow the pound to float. In the early trading hours at banks, the national currency’s value plummeted, with the dollar exchange rate  to the pound reaching over LE50 in some instances throughout the day. The dollar's value against the pound appreciated 60 percent in a single day. The central bank also raised interest rates by 6 percent (600 bps), the largest interest rate hike in a single meeting in the history of the country's monetary policy. The pound’s devaluation was a precondition for the International Monetary Fund’s 2022 loan program with Egypt and the current year. Later in the day, the IMF representative in Egypt Ivanna Vladkova Holla announced a staff-level agreement had been reached to increase Egypt’s 2022 US$3 billion loan to $8 billion, and the Prime Minister Mostafa Madbuly indicated that Egypt intends to apply for about $1.2 billion in new financing through the fund’s Resilience and Sustainability Facility. 

-               According to the central bank statement, the significant interest rate hike intends "to accelerate the monetary tightening process in order to fast-track the disinflation path and ensure a decline in underlying inflation" However, the central bank foresees the rate of increase for consumer prices, i.e. inflation, to remain “substantially above” its target range of 7 to 9 percent in the fourth quarter of 2024.

-               This move is in response to the IMF’s demands for exchange rate flexibility, the absence of which the IMF considers a direct cause of the economic crisis, despite the Egyptian government implementing more than three significant devaluations since March 2022.

-               Since that point two years ago, the Egyptian pound’s value against the dollar has depreciated from LE16 to LE50 (gradually on several moves during 2022 to reach 30.9 LE and then in one move in 2024). If we look further back to the period preceding the previous 2016 IMF agreement, the currency’s value against the dollar has depreciated over eight years from LE8.85 in March 2016 to over LE50 pounds by March 2024.

-               On the flip side of this economic equation, the dollar has appreciated against the pound by approximately 462% since 2016, with an average annual increase of 57% during that period.

-               The two largest government banks in Egypt — the National Bank of Egypt and Banque Misr — announced new three-year certificates of deposit with decreasing returns starting at a rate of 30 percent in the first year. This was also an expected step to come in line with a devaluation of the currency to  tighten the liquidity resulting from dollar inflows of the household sector. Said otherwise, the CD issuance is an attempt to encourage households to keep their savings in pounds and to prevent the flight of bank deposits toward other assets, such as gold or dollars.

What can be expected after this move?

-               Inflationary pressures, especially on consumer goods, are likely to increase as Ramadan approaches. As the month witnesses high demand on food and consumer goods, Inflation may later come down as market pricing adjusts to a more stable dollar rate.

-               Closing the significant gap between the official foreign currency exchange market and the parallel market could theoretically help in eliminating pricing volatility. However, this would require that there is a sufficient supply of dollars in banks with streamlined procedures for importers, and travelers at least, [5] as well as easing other restrictions on accessing dollars, such as raising the limit for credit card payments domestically and abroad.

-               Egypt’s past experience is proof that interest rate hikes are not an efficient tool for curbing inflation. Such hikes increase operating capital costs across many production sectors and raise opportunity costs in the manufacturing sector  due to bank interest rates being higher than prevailing market profit rates for producers. The devaluation of the pound will generate a fresh wave of inflation, exacerbating the already challenging situation, especially with expected energy price hikes and other cost increases.

-               Expected inflation will have further repercussions on living standards and poverty rates in Egypt. Following the 2016 devaluation, the number of individuals living below the poverty line increased by about 5 million, according to the 2019-2020 Income and Expenditure Survey issued by the Central Agency for Public Mobilization and Statistics. In a research paper published in June 2023, researchers Heba al-Laithy and Dina Armanious projected an increase in the poverty rate from 29.7 percent in 2020 to 38 percent in 2023 under a scenario estimating inflation at around 23 percent. However, the average annual inflation rate for 2023 far surpassed that estimate and sits at 35%, suggesting that Laithy and Armanious’s projected rate of poverty would have exceeded 38%. A quarter of Egyptians are already on the brink of poverty, so further inflation will push more people into poverty.

-               The significant interest rate hike will have significant negative impacts on the state budget, deficit, and the “already high” interest payments. This will lead to budgetary reallocations and a further narrowing of the margin of the already narrow margins that the state had planned  to spend on social protection, health, and education. Wednesday’s economic developments require increased social protection allocations to absorb some of the repercussions of inflation on the most vulnerable segments of society.

-               Moreover, the devaluation of the pound will inflate the value of external debt (when calculated in local currency) automatically increasing the value of public debt. The finance minister stated that each LE1 rise in the exchange rate of the US dollar against the pound translates to an additional burden of LE110 billion on the budget. Thus, yesterday’s LE20 increase to the exchange rate will impose an immense financial strain. This cost represents the total amount that must be paid to service external debt obligations denominated in pounds.  The cost of financing local debt will also surge with the current interest rate hike. Therefore, high interest  rates will entail an additional cost for interest payments in the current and forthcoming budgets. Notably, interest payment projections in the current fiscal year budget approach 37 percent of total expenditure, approximately LE1.12 trillion annually. The first seven months of the current fiscal year have seen interest payments reach LE962.86 billion, equivalent to 55 percent of expenditure, a figure likely to increase significantly in the remaining five months.

-               Raising interest rates is a contractionary measure on two fronts: it reduces consumption, a key driver of economic growth, and it curbs the appetite to borrow for investment. Taken together, these two aspects have a negative impact on economic growth.

-               The success of this move in eradicating the black market hinges on addressing the accrued demand for dollars in banks, both for backlogged imports and other various purposes, through providing liquidity.

Was it possible to implement a smaller depreciation of the currency at, particularly considering the anticipated dollar inflows from the asset sales deals like Ras al-Hikma project and the government's ongoing asset sale targets?

The answer is that it could have been possible to devalue the currency at a slower pace or over a longer period to allow the pound to adjust more gradually. However, it appears that the central bank opted for a quicker resolution to its battle with the black market to preempt anticipated ongoing speculation. Though, this came with certain costs.

To control consumer price inflation associated with the exchange rate decline as quickly as possible, the government must adopt several  non-monetary policies aimed at putting the economy on the right path in the long run, including:

1. Implementing a disciplined public fiscal policy that curtails domestic borrowing, as the government's expansion in local debt and the high interest rates on this debt are among the causes of increasing money supply and inflation in Egypt.

2. Reducing reliance on external borrowing for financing large-scale projects and shifting away from the current path centered on major construction projects funded through hard currency loans as much as possible while taking priorities into account. Foreign currency loans can have catastrophic repercussions, including creating significant pressures on the balance of payments due to the debt service obligations they entail and triggering successive exchange rate drops.

3. Utilizing foreign currency inflows from asset sales, especially from the Ras al-Hikma deal, to address the net foreign asset deficiency in Egyptian banks as it reached a high- record low of 29 billion USD in January 2024

4. The government can relatively mitigate the impact of downward fluctuations in the exchange rate on path-through inflation by introducing clear classifications for essential and intermediary goods, allowing banks to apply varying commission rates for hard currency allocations based on these categories. For example, setting commission rates lower than 5 percent for essential food items, higher rates for intermediary goods, and further elevated rates for final consumer goods can help maintain lower inflation rates in food prices. This selective approach can help cut down on the import bill, thus contributing to tamping down inflation resulting from shortages of goods and pricing volatility in the market in general.

5. If there is no alternative to raising interest rates on the pound to forestall potential dollarization of the economy in light of escalating exchange rates, it becomes essential to provide interest rate subsidies for a certain duration to support key production sectors such as industry and agriculture. Offering subsidized loans to these sectors can help control inflation by lowering the cost of operating capital for those companies. These loans should be managed with greater transparency to prevent their misuse.

6. The government's fiscal austerity priorities should be adjusted to include investment austerity over infrastructure projects that can be deferred, rather than reducing expenditures in education, health, and social protection, which are already facing cutbacks. There is a great importance in unifying the general budget (meaning including all aspects of public expenditure as mandated by law) to accurately determine priorities.

7. Increasing spending on food subsidies and social protection is essential at present to offset the impact of inflation on the most impoverished segments of society, both in response to current price hikes and anticipated future increases, while also neutralizing the long-term impact of nutrition crises.

8. Sustaining the policy of adjusting the minimum wage in line with inflation developments, coupled with immediate action to broaden its implementation for temporary government employees, public business sector workers and private sector employees.