A Currency Conundrum: Inflation, Devaluation and Flotation in Egypt

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Egypt is facing an unprecedented economic crisis as we head into 2023, with inflation soaring to 21.3 percent as of December 2022 and the value of the Egyptian pound falling to record lows. This crisis point has been reached by a series of unfortunate events, including the war in Ukraine, which has led to a decrease in tourism and a rise in commodity import bills, as well as foreign investors pulling more than $20 billion out of the country. The black market for US dollars in Egypt has emerged as a result of these crises, with traders taking advantage of the situation to make a quick profit.

In order to abolish this black market, the Egyptian government is using various tools, such as enforcing strict regulations and penalties for participating in the black market and providing incentives to save and invest through the newly introduced certificates of deposits. The IMF is also making it quite clear that there will be no going back to a fixed exchange rate and that it wants to see more fiscal restraint, more investment in the social safety net, structural reforms, and less competition between the state and the private sector.

In an attempt to ease the import crunch, the Central Bank of Egypt (CBE) had announced a free exchange rate regime with a flexible monetary policy in October 2022. This resulted in a 25 percent devaluation of the pound, which was followed by a 6.34 percent devaluation on January 5, 2023, and during the past week the official rate of the Egyptian pound against the US dollar dropped as far as 32.20, a decrease of more than 16 percent, before recovering and closing at 29.61 on Thursday, January 12, 2023, according to the official CBE rate. As a result of this dramatic fall, the pound is currently trading at its weakest rate ever against the US dollar and is expected to fall further in the coming months if Egypt remains without any new inflows of foreign investments, hot money, or exports.

According to Ahmed Farouk Ghoneim, deputy minister of planning and professor of economics at Cairo University, to solve the currency crisis “Egypt must find a way to increase its net foreign currency inflows in order to ease the import crunch and restore macroeconomic stability.” Ghoneim stated that in the short term “the Central Bank of Egypt must focus on finding an optimal interest rate at which Egypt can see a direct and significant increase in hot money.”

In order to attract foreign investment, Egypt’s central bank has increased overnight deposit rate to 16.25 and introduced a one-year savings certificates with a 25 percent return. These measures are designed to control inflation and help protect some Egyptians from the expected surge in prices, but the overall cost of living is still high for the average citizen. The CBE is also introducing the managed float of the currency. This will involve the central bank of Egypt intervening in the foreign exchange market to ensure that the pound does not fall too far, which is expected to help stabilize the currency, but it is unlikely to lead to a significant appreciation of the pound. The managed float will also involve the CBE setting a new exchange rate every day, which will be used to determine the exchange rate for transactions. In addition to the managed float, the central bank of Egypt is also taking steps to increase liquidity in the economy by cutting reserve requirements for banks and introducing a new liquidity injection facility. This will help to ensure that banks have enough cash on hand to meet customer demands, which is essential for the stability of the economy.

To alleviate the effects of inflation and provide relief to those who are most affected by the crisis, the government is also taking measures such as increasing the minimum wage and introducing price controls on certain commodities. However, it is unlikely that these measures will be sufficient to help the economy recover. On the other hand, tax incentives and introducing some tax amendments – possibly impacting the new capital gains tax- are being considered to attract foreign investors’ money into the country and creating some economic stimulus.

Ghoneim also stated that other short-term solutions include “increasing foreign exchange through, agricultural exports, tourism, the Suez Canal and worker remittances. However, on the long-term having a strong export-oriented economy is what’s truly needed. Fostering a better business environment, export promotion and utilizing our comparative advantage in trade in services will play a critical role in putting the Egyptian economy back on track.”

Indeed, the key to restoring economic stability to Egypt lies in implementing long-term structural reforms. The government needs to reduce its debt burden and work on drastic reforms to improve the ecosystem for private sector performance, in order to ensure that the economy is able to recover in the long-term. These measures are essential for ensuring that the economy can bounce back and for restoring the confidence of the people in the government.

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