Desperate for dollars? A brief explanation of what the devaluation of the Egyptian pound means

Desperate for dollars? A brief explanation of what the devaluation of the Egyptian pound means

REUTERS/Mohamed Abd El Ghany/File Photo

Egyptians woke up Thursday to more trepidation to the news, with the local currency sliding to a new all-time low, falling more than 14% against the US dollar.

The news comes after the acting governor of the Central Bank of Egypt, Hassan Abdalla, said at the Egyptian economic conference on Sunday that Egypt would develop a new monetary indicator based on a basket of several currencies as well as, possibly, on gold.

The acting director added that Egypt aims to change the culture that the Egyptian pound should only be pegged to the US dollar to reduce the effects of major currency fluctuations on investment performance.

Although he did not provide any further details, analysts pointed out that the move reflects a shift in the direction of the economy, as Egypt’s current major trading partners are China and Saudi Arabia, not United States.

Along the same lines, Prime Minister Mostafa Madbouly spoke at the same conference to refute claims that the value of the currency against the US dollar indicates the strength of the economy. He noted that a weaker currency is sometimes necessary to strengthen the economy by increasing exports and investments.

But to what extent can a devaluation be beneficial? Egyptian Streets provides a brief explanation of what the current devaluation means for the economy and society as a whole.

What has happened so far?

Since the conflict between Ukraine and Russia, Egypt has faced financial constraints that weigh on its currency due to rising commodity prices and a sharp drop in portfolio investment. In early March, portfolio outflows from Egypt were estimated at $3.0 billion (EGP 69 billion), signaling a massive reduction in foreign exchange reserves.

In response, the Monetary Policy Committee (MPC) decided to increase the CBE’s overnight deposit rate, overnight lending rate and main rate by 200 basis points to 11.25%, 12.25% and 11.75%, respectively.

As a result, the Egyptian pound has fallen to near historic lows since the 2016 devaluation, trading at EGP 19.27 to the dollar.

Investors have previously said the Egyptian pound needs further devaluation, with analysts at investment bank JPMorgan noting in March that the Egyptian pound is currently overvalued by more than 15%.

The investment bank Goldman Sachs Group Inc. has also estimated that Egypt may need to obtain an envelope of 15 billion USD (286 billion EGP) from the IMF to meet its financing needs over the next three years.

However, Egyptian Finance Minister Mohamed Maat told the conference on Sunday that “analysis of financial performance indicators over the past 42 years confirms progress” and that “debt and GDP deficit ratios are under control despite successive global crises”.

“We want to diversify sources of financing, reduce the cost of development, integrate the informal economy and increase tax revenue by 5% of GDP per year over the next four years,” the minister added.

Egypt’s partnership with its Gulf allies has helped ease its funding crisis in light of the conflict in Ukraine and the COVID-19 pandemic. In August, the Sovereign Wealth Fund of Egypt signed a draft agreement with the Public Investment Fund of Saudi Arabia to launch a new company – the Saudi Egyptian Investment Company – in Egypt to attract investment from a worth $10 billion (194 billion EGP).

What are the disadvantages of devaluation?

The devaluation caused serious economic turmoil in other countries, with examples such as Argentina, Turkey and Lebanon.

Adoption of this policy may pose a risk of price instability in the local market and lead to unofficial dollarization in parallel markets due to the desperate need for dollars and pessimism around the local currency. The rise in the price of the dollar in exchange for the local currency may also lead to an additional budget deficit as external debt payments become more expensive.

Local and international confidence in Argentina’s economy has deteriorated over the years due to its devaluation since 2018, when the government struggled to finance the economy and failed to control foreign exchange operations. on black markets. The US dollar hit new highs against the pesos, selling dollars for more than 300 pesos instead of 130 pesos at an official currency exchange.

“The only thing customers don’t want to hold are pesos. . . many are asking questions about what will happen next,” an Argentinian told the Financial Times.

One of the main risks of devaluation can be explained by the term “monetary illusion”, which is a bias in the appreciation of the real value of transactions due to frequent and unpredictable changes in the value of a currency or currency. one currency to another. When people lose a sense of the value of a currency, they misjudge the value of their accumulated wealth, which may actually have decreased rather than increased.

This bias may be more detrimental in the long run, as it affects individuals’ decisions regarding long-term financial contracts, such as buying and renting housing. In these situations, the money illusion resulting from currency devaluation can affect an individual’s perception of the true value of a particular asset.

To avoid this scenario, economists have recommended that policymakers reduce reliance on the US dollar and encourage the use of a basket of currencies.

What are the advantages of devaluation?

The benefits of devaluation largely depend on the strength of a country’s economy and the goals it aims to achieve.

For example, an economy primarily based on tourism will attract more visitors because travel will become much cheaper. The same is true for remittances, which are increasing in value, implying that more money will arrive from Egyptians living in other countries with stronger currencies.

Additionally, devaluation may cause people who produce and sell things abroad or earn money in a different currency to earn more money, which may encourage Egyptian brands to export and earn more. .

How will this affect the Egyptians?

One of the obvious setbacks of the devaluation of the Egyptian pound is that Egyptians who earn in the local currency lose their purchasing power, and due to lack of financial education, an individual’s wealth will often be overestimated.

Egyptian Prime Minister Mostafa Madbouly on Wednesday announced an increase in the minimum wage for public employees from EGP 2,700 to EGP 3,000 and the fixing of current electricity prices for households until June 2023.

Tuition fees for children studying at international schools or in other countries may also increase, which could put additional pressure on parental and household spending, and possibly increase the popularity of school loans. Exposure to such fluctuations in exchange rates may force private companies to offer compensation in the form of loans, benefits or salary increases.

Recently, the International Monetary Fund (IMF) and Egypt reached an EGP 68 billion ($3 billion) agreement, which aims to “preserve macroeconomic stability and debt sustainability, improve the resilience of the ‘Egypt to external shocks’.

However, these policies will certainly determine political legitimacy and the level of trust between citizens and government in the long term. During the closing ceremony of the Egyptian Economic Conference, President Abdel Fattah El-Sisi admitted that the country is facing difficult circumstances and that wages are not enough to meet the needs of ordinary Egyptians.

“I speak from the bottom of my heart with all of you, but salaries are not enough, and any salary below EGP 10,000 is not enough to earn a living,” he said.

Egypt receives $3 billion IMF loan, another $6 billion could follow

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