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Decision time for monetary policy
Come October, after the elec-tions, President Hosny
Mubarak will have to answer the difficult question of what to do
with the Egyptian pound. His is not an enviable position. The tight
link between the pound and the dollar has kept capital in the country
and prices in check for nearly a decade, and there’s no agreement
at home or abroad on how to achieve more flexibility.
But for about a year now, the link – or at least the government’s
attempts to maintain the link at minimal cost – has eroded
Egypt’s credibility and growth prospects. The policy of stalling
until the problem solves itself may yet work. But eventually Egypt’s
growing economy will require a loosening of the peg.
The issue is not, as many fear, a matter of devaluation. Despite
the pressure of the past year, Egypt still has deep reserves of
foreign currency, minimal foreign debt, and a sustainable current
account deficit. There are no alarm bells. Overvalued or not, the
pound is defendable at its current rate.
Instead, the challenge is to return the pound to full convertibililty.
When a country’s currency comes under pressure, monetary authorities
have three immediate choices: let the currency depreciate, raise
interest rates to make it more attractive or spend down the country’s
reserves of foreign currency to defend it. Egypt has tried to avoid
choosing. It has kept the pound at about £E 3.4 to the dollar,
but has refused to meet the full demand for dollars in a timely
fashion at that rate.
By all accounts, this foot dragging has made the problem worse.
People worried about convertibility buy up more foreign currency
than they need and become reluctant to turn over any more than they
must. Foreign investors, meanwhile, lose their appetite for Egyptian
securities. Pressure on the pound will ease when inflows of foreign
currency pick up. But if foreign currency can’t easily leave
the country, it won’t come in. It’s entirely plausible
that the bulk of the pressure on the pound is produced by the perception
that it’s in trouble, a perception created by the government’s
restrictive policies.
The government, in choosing semiconvertibility over depreciation
or a reduction in reserves, has sided with the greater evil. Investors
have plenty of ways of dealing with currency risk. What is unacceptable
is for investors to be unable to move easily in and out of their
investments.
Unprincipled policy shifts are also unacceptable. Making the pound
fully convertible was a key achievement of Egypt’s reform program,
one Egypt has too casually set aside, even on the premise that the
retreat will be temporary.
Whether the pressure on the pound fades or not, Egypt will have
to return the pound to convertibility. Doing so will mean opening
up the country’s foreign-exchange reserves, something the authorities
are understandably reluctant to face. Observers typically expect
heavy consumption of reserves at first, followed by relaxation or
even reversal once availability is no longer in question. But the
reserves could be run down to uncomfortably low levels. Then devaluation
really would be an issue.
The prospect that Egypt could one day face a decision to devalue
the pound without its comfortable cushion of reserves is what leads
economists to argue that Egypt should abandon its strict peg now.
A more flexible arrangement would likely lead to some devaluation.
But it would introduce also an element of self-correction: rising
demand for foreign currency would make it more expensive, thus reducing
demand.
That’s the theory, anyway. The reality is that Egypt’s
current monetary policy has come to the end of its useful lifespan,
and uncertain territory lies ahead. Still, it’s decision time.
ANDREW DOWELL
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