A first read on Egypt’s introduction foreign-currency auctions at the end of last week is that the government is trying to manage an orderly devaluation of the Egyptian pound through a two-tier exchange rate. The currency’s fall to a record low of 6.30 to the U.S. dollar on Sunday suggests a measure of success, though it is success only in the sense of achieving the least bad of several undesirable outcomes.
The country’s foreign-exchange reserves, now barely $15 billion, have dwindled to critical levels. The government is facing a deepening economic crisis. The economy grew by 2.2% in its most recent fiscal year (to June), compared to growth rates of 5%-7% before the Arab Spring. Standard & Poor’s cut its credit rating on Egypt’s sovereign debt to the same level of junk as Greece’s, and even that rating is at further risk. Finalization of an emergency $4.8 billion loan from the International Monetary Fund, intended to forestall such blows while the government introduced austerity measures to cut its deficit, has been delayed at least until January.
The Egyptian in the street is proving as resistant to austerity as their counterparts on the euro-using northern shores of the Mediterranean. Popular opposition to proposed sales tax rises and energy subsidy cuts forced the measures to be shelved almost as soon as President Morsi had announced them, though they were presented as necessary precursors to the IMF loan. Meanwhile, Egyptians have rushed to convert their pounds into harder currencies and assets. That has prompted the imposition of cash capital controls on individuals and companies.
The Central Bank of Egypt spent an estimated $20 billion during the past two years defending the currency, holding the pound’s fall to just 6% in the face of an almost complete evaporation of the country’s two main sources of foreign currency, foreign tourists and investors, since the ousting of President Hosni Mubarak two years ago. The central bank just can’t afford to continue to fight that fight and have enough foreign-currency left to meet the country’s international debt service payments and to cover imports. It said on Saturday that it could now barely cover three months of imports, so low have its reserves fallen.
Two questions now are how much further will the pound fall and how long will it take for the loan from the IMF to be finalized. A rate of at least 6.50 pounds to the U.S. dollar is taken as a given by commercial economists though the drying up of the supply of cash dollars may make a nonsense of forecasts of the pound plunging to 7.50 to the U.S. dollar. Talks with the IMF are due to resume in January. There is little evidence that the government will be better able to convince its citizens by then that they must take a strong dose of austerity.
Local currency interest rates, meanwhile, have risen sharply. Three-month government bills denominated in Egyptian pounds are yielding 10.4%. That is not a level that suggests the political stability needed for economic stability will come anytime soon.