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FEATURE

the search for true values

at last, the central bank has devalued the pound substantially. will this be enough to kill off the black currency market and boost egypt’s flagging exports?

for the past year, the market has watched a local currency drama unfold, as the government, with hesitant steps, has gradually devalued the egyptian pound in relation to the us dollar.

taking the plunge on august 5, the central bank of egypt (cbe) announced its new official exchange rate: £e 4.15 to the dollar. along with the new rate came a widening of the “band” of legally permitted fluctuation, within which currency prices now have room to maneuver 6 percent – 3 percent up or 3 percent down. the band allows for greater flexibility than its 1.5-percent predecessor and permits the legal sale of dollars, at the new rate, within a range spreading from £e 4.03 to an upper limit of £e 4.27.

the new central rate represents a 6.4-percent devaluation from the previous central rate of £e 3.9, and makes the pound an approximate 22 percent less valuable than it was a year ago. given that most legal currency trading is still happening at the top end of the band, the devaluation is arguably even greater.

according to the august 6 edition of business daily al alam al youm, minister of economy youssef boutros ghali assured that “the new system for the exchange market will be able to satisfy all requests for dollars with flexibility and the immediate availability of real dollar resources.” he added that the move would help whittle down the gap in egypt’s balance of trade by making egyptian exports cheaper, as well as diverting the flow of dollars – hoarded until now by private forex bureaus and the black market – into legal channels.

the decision followed a series of earlier devaluations. the first came in january of this year, with the slaying of the sacred £e 3.4 cow to which the dollar exchange rate, as part of the economic reform and structural adjustment program, had been firmly lashed since 1991. the january devaluation, representing a switch to what economics boffins dubbed a “managed peg” regime, lopped about 13 percent off the value of the pound, bringing the official dollar rate to £e 3.85, from which it could deviate, legally, a mere one percent either up or down.

at the time, prime minister atef ebeid was quoted as saying that the central bank wouldn’t let the currency fall into a free float. nor, he added, would it “resort to [artificially] stabilizing the pound, because adopting an unrealistic fixed exchange rate for the pound has proved to be detrimental to national development purposes.”

but despite the prime minister’s seemingly enlightened take on the evils of intervention, the pound, at its new rate of £e 3.85, was still being artificially held in check by the government, with stiff penalties meted out to anyone selling dollars at more than the official price.

in may, the central bank announced a further exchange-rate adjustment – a none-too-radical jump of one piastre – to £e 3.86. this was followed by another mini-devaluation in early july, to £e 3.90, with an accompanying enlargement of the “fluctuation band” to 1.5 percent up or down on us dollars and arab currencies and 2 percent on other foreign currencies.

what’s new?

at a conference held by the egyptian center for economic studies last november, some economists argued that egypt should adopt a variant of the “band, basket and crawl system” which had proved effective in other developing markets in recent years. not long after, the cbe adopted the band – albeit an absurdly tight one. but egypt continues to lack a “basket,” as foreign reserves continue to be held entirely in us dollars. more problematically, the central rate has been “crawling” not in direct response to market pressure, but rather in accordance with cbe decisions.

in spite of the slow crawl seen since the start of this year, the values assigned to the egyptian pound continued to smack of unreality, and the black market has continued to thrive, selling dollars at prices closer to £e 4.3. “all the recent devaluations over the course of the last nine months were considered unrealistic,” said nourhan galal, head of research at the commercial international brokerage company (cibc). “but it had to be done in gradual steps. they couldn’t cut the value from 3.4 to 4.15 overnight.”

what makes this latest devaluation different is that it has actually approximated the pound’s market value against the dollar. the 4.0 level, described in the past by bankers and analysts as a “red line” or a “psychological barrier” was finally transcended – an indication perhaps of a more forward-thinking monetary policy. “no doubt, this was a step in the right direction,” said alaa el seesi, executive director of investment banking at hc securities. “the question is now whether this is the right price or not. but if it’s not the right rate, then it is very close.”

the new system also allows for future devaluations, if the new rate proves inadequate. in order to “restore order to the foreign-exchange market,” the cbe intends to review the central rate once a week, and adjust it up or down based on the average of the market rates within the previous week. could this latest monetary development represent a first, tentative step to creating a real, transparent crawl mechanism?

another major difference between the latest adjustment and those of the past – and a major indication that the new rate is at least close to the “real” one – is that this latest devaluation has actually resulted in the availability of dollars via legal means. forex dealers are finally selling at the official rate – something they weren’t willing to do at the previous rate of £e 3.9. in the weeks ahead, said mohamed fahmy, senior research analyst at prime securities, “we shall see whether dollars are available in the forex market or not, and whether there is real demand-supply equilibrium. if this happens, then there will be no need for another devaluation.”

fighting the forex phantoms

whether the adjustment will prove sufficient to abolish the black, or “parallel,” market is still uncertain, and some analysts did not exclude the possibility that black-market rates would resurface immediately if the government refused to take account of the pound’s real market value. “the new exchange rate should eliminate the black-market rates,” said el seesi. “but after the devaluation, we should still be flexible, in line with real market rates. if such rates were to go up, then we should follow them.”

even though the devaluation was substantially larger than expected, dollar trades immediately rushed up to the higher end of the widened trading band (£e 4.25) at most banks and foreign-exchange bureaus, suggesting that the adjustment may not have been large enough to deal a final deathblow to speculative pressure on the pound.

mohamed hassan al abyad, president of an association of exchange companies, also quoted by al alam al youm the day after the devaluation, said that “the new price will exceed the one found on the black market, which moved in previous days from 4.18 to 4.19 to the dollar.” he insisted that there was no longer a niche for a parallel currency market.

however, despite official assurances that dollars were now flowing freely in and out of egyptian banks, the market reality looked different. some banks initially refused to part with their us currency, and others were selling it only in very limited amounts and under specific conditions – if, for example, a client can prove that he or she needs foreign currency in order to travel abroad.

as one exchange-bureau trader complained, “it is unfair that we have to continue buying and selling dollars while banks only buy dollars from people and refuse to sell any back.” the banks, he added, “don’t contribute to the circulation of dollars in the market; they only continue to accumulate them.”

the government, meanwhile, has threatened to withdraw the license of any exchange bureau that is found hoarding dollars. several times in recent years, the minister of economy has ordered certain exchange bureaus shut down for violating the official rate. “there is no confidence between the exchange bureaus and the government,” the trader said. “the same harsh restrictions and regulations that they impose on us are not carried out against banks that still refuse to sell dollars.”

unleashing export potential

while the government exacts retribution on shadowy forex dealers, the currency’s devaluation should boost the country’s competitiveness in the global marketplace and hopefully lead to an improvement in export-based economic growth. egypt has witnessed a gradual erosion of its balance of payments for several years, going from a $7.3 billion deficit in 1994 to one of $11.4 billion in 2000, with an import bill – £e 17 billion for the calendar year 2000 – rising in tandem with a decline in exports.

in the face of such circumstances, the devaluation “was a very good decision,” according to ahmed el wakil, president of the wakalex import/export company and vice president of the alexandria chamber of commerce. “it will promote our exports and give more power to egyptian products to compete in the global market.” even the inevitable increase in the cost of imported goods has its silver lining, he added, as “people will buy fewer imports, thus giving egyptian products a chance to compete in the local market as well.”

automotive assemblers are more circumspect. “although we have high local-content percentages, we also have high imports,” said dan mccarthy, chairman and managing director of general motors egypt. “even our local suppliers, who make components here in egypt, are importers. so it does put pressure on us from the standpoint of our returns.”

other local auto manufacturers would be affected in the same way, he added.

general motors egypt operates in egyptian pounds, but pays for its imported parts in dollars. even so, mccarthy called devaluation “the right thing to do” in terms of improving the egyptian economy as a whole. “in the context of other structural changes, we need to get a proper valuation for the pound,” he said.

and the currency devaluation can only help a tourism industry hard hit by regional tension and violence in neighboring palestine. true, the operating costs for hotels and tour companies might rise, but tourists will find their hard currency going further in egypt. “the devaluation will have an [negative] effect on the tourism industry in the sense that costs for imports like furniture and machinery will go up,” said mohamed sakr, professor of economics at cairo university and economic adviser to the tourism ministry. “but in terms of tourist companies, it will make egypt cheaper and more competitive vis-à-vis other tourist destinations.”

the overvalued pound has contributed to the depletion of foreign reserves, which, according to official statistics, currently stand at $14 billion. at the end of 1998, state coffers boasted an even $20 billion, before two years of a clumsy – not to mention expensive – policy of using cash reserves to prop up the local currency. “the cbe couldn’t satisfy the local demand [for dollars] on its own, when most of the dollars were in the hands of forex bureaus and the black market,” said galal at cibc. “it couldn’t afford to just keep throwing money at the problem. but now that dollars are readily available from banks, people will be more inclined to keep their assets in egyptian currency.”

galal added that she didn’t expect to see much further deterioration of reserves.

the central bank will continue to manipulate interest rates in an effort to tempt those with substantial savings accounts to keep their funds in egyptian pounds. in april, the cbe cut interest rates for the pound twice, in two increments of 50 basis points each, after having left them unchanged for more than two years. the result was a one-percent decrease from 12 to 11 percent. but now there are rumors of a possible hike to 14 percent, in a bid to keep people from dollarizing their assets. the current interest rate for dollars is a mere 3.5 percent.

luring foreign investors

another – and certainly not the least important – perk of the devaluation is the greater confidence that egypt will enjoy among foreign investors, who will hopefully jump at the relatively cheaper valuations of egyptian stocks dollar-wise. “the devaluation will have a positive impact on foreign investors as it will encourage them to enter the market,” said reem mansour, economic analyst at sigma security brokerage. and cheaper, more realistic asking prices for state assets could further serve to jump-start the privatization process, which has lagged conspicuously for the past couple of years.

by bringing the pound more in line with its real value vis-à-vis the rest of the world, egypt can display its readiness to bite the bullet and become a serious contender in the global economy. the devaluation, said galal, “sent a signal to the investment community at large that egypt is coming to terms with its monetary policy.” to take a recent case, “the exchange-rate issue was raised by practically every investor at the roadshow for the recently launched eurobond.”

according to galal, the decision to devalue the pound was prompted by fears of a downgrade of egypt’s foreign-currency ranking by ratings agency standard & poor’s. the country’s local-currency ranking was lowered in june.

“time will tell,” stated an august 10 report prepared by international finance house morgan stanley dean witter, entitled is devaluation the savior?, “but a more flexible exchange-rate regime is wise in the face of a major global slowdown that has increased the risk aversion against emerging markets around the world.”

still, the effects of the devaluation obviously aren’t all positive, or the government would have done it ages ago. one of the inevitable drawbacks is that those institutions with dollar-denominated debt – foremost among which is the government – will suddenly owe that much more in terms of egyptian currency. the state’s public debt, which currently stands at 95 percent of gdp, continues to rise as the currency devalues, making egypt’s dollar debts more difficult to repay.

the morgan stanley dean witter report calls the adjustment a “bold step in the right direction” and states that even if the devaluation initially worsens debt-to-gdp ratios, this is a small price to pay for the correction of an overvalued currency. the unrealistic value assigned to the pound “was undermining the competitiveness of the entire egyptian economy,” the report contends, adding that “fiscal policy is key to overall macroeconomic stability.”

shoring up the local bourse

on the cairo stock market, the news of the devaluation immediately drove up share prices, which had been plunging during the two weeks prior as the hermes blue-chip financial index fell to its weakest levels in seven years. “before, people were afraid to enter the market – would they be able to exit later or not, and at what cost?” said el seesi. but as long as the pound is tradeable at a realistic value, he added, investors don’t have to worry about heavy forex losses in the event that they want to cash out. “now, there is more transparency as investors can enter or exit the market whenever they want.”

market analysts, however, cautioned that the devaluation would hurt some local companies burdened with foreign debts, like those of the telecom sector, which depend mainly on loans denominated in foreign currency to finance their expansion activities. mobinil, for example, which has dollar-denominated loans amounting to $220 million, might be exposed to considerable risk, as every piastre of devaluation translates into forex losses of £e 2.2 million.

orascom telecom (ot), in contrast, “is exposed to minimal forex risk, as it has already paid off the bulk of its dollar loans,” said amr el-alfy, assistant manager of research at cibc. however, for ot to take advantage of its recently acquired algerian gsm license, “equipment and network expansion will need to be financed in dollars.”

the impact of devaluation depends on the nature of the industry. the cement sector is expected to enjoy substantially improved market conditions post-devaluation, since imports are not vital to the industry and because egyptian cement exports will become more competitive in foreign markets. “generally, the cement sector is not expected to be negatively affected from the devaluation, since the inputs to production are locally procured,” said yasmine al ebiary, senior investment analyst at cibc. “but there is risk for some cement companies, such as suez, which is loaded with a $50 million loan.”

the banking sector, meanwhile, will suffer few negative effects, according to analysts. central bank governor ismail hassan has assured banks that the cbe will reimburse them for any forex losses incurred based on the new exchange rate, as well as fulfilling all their requests for dollars. the first week under the new rate saw the central bank pump close to $150 million (apparently supplied by the cbe’s “internal resources,” not its forex reserves) into the banking sector. this money was in turn lent to clients.

in banking, as elsewhere, the effect depends on the financial structure of each company. “with the recent devaluation, some banks, like cib, will be positively affected as they have part of their capital and positions in dollars,” said fahmy. “so, those banks will actually be posting gains.”

as of press time

so far, the center seems to be holding.

as of august 13, hassan was declaring, according to hc securities, that there was “no need this week to change the official exchange rate based on market forces,” even though exchange rates the week before had hovered around the weaker end of the band, between £e 4.20 and £e 4.24.

but three days later, on august 16, shortly before business monthly went to press, the headlines splashed across al alam al youm’s front page read ominously: “forex bureau dollar prices jump to 427.45 piastres” – a figure which represented the furthest extremes of the fluctuation band and therefore intimated a possible need for further devaluation.

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