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Study of Currency Devaluation As A Part of Egyptian's Economy Reform
Study of Currency Devaluation As A Part of Egyptian's Economy Reform
Study of Currency Devaluation As A Part of Egyptian's Economy Reform
Individual Assignment
Why do countries choose to devalue their currency and what is relation of devalue with IMF?
Countries choose a policy of devalue their currency, in the event of unstable financial and economic conditions,
which makes the acquisition of foreign currencies an important factor in market turmoil, where speculation
abounds, and the exchange rate is taken out from the hands of the central bank and the banking system, and is in
the hands of the parallel or black market.
Currency market turmoil is caused by poor country balance-of-payments performance, where commodity
imports exceed exports, foreign exchange resources are negatively affected, in terms of export and service
imports, foreign investment flows are reduced, and the Country finds itself forced to borrow at significant rates.
Hence, the Country finds itself facing overstretched obligations, while the country's foreign exchange resources
are beyond its control, and in the hands of the central bank, the banking system and financial institutions, so it
chooses to devalue the currency under an economic program, to try to reach a country of political stability..
Through follow-up and practice, it was known that the devalue of the local currency in troubled economies
came through the wills of the International Monetary Fund, or within the framework of the so-called IMF
agenda, which usually includes a package of measures, including floating the currency rate, liberalizing interest
rates, reducing the number of public sector workers, adopting a program to privatize the public sector, liberalize
foreign trade and open the way for foreign investment.
How does the exchange rate determine?
Since 1971, the world has abandoned the gold base in determining the exchange rate of currencies, and there is
a basket of factors affecting the exchange rate, the first of which is foreign exchange balance, gold balance, and
GDP performance, countries that have a high value added value that greatly increases the value of their
currency, where their products are demanded abroad, increasing their foreign currencies, so central banks seek
to form a balance of foreign exchange and gold, helping to reach a balanced exchange rate that maintains Its
economic interests with the outside, stimulate the local economy, and preserve society's savings and wealth
potential.
There are several types of exchange rate, the first of which is the administrative exchange rate, which is not
dependent on supply and demand mechanisms, but depends on a decision of the monetary authority at a
specified rate. The second is the free exchange rate, which is set on the basis of supply and demand mechanisms
and without interference from the monetary authority.
The third type is the managed exchange rate, where the monetary authority intervenes in determining the
exchange rate through the open market mechanism, which means that the monetary authority manages the
market through its intervention by selling and buying to reach a balanced price that it considers to be in the
interest of the national economy. When it sees the exchange rate of the foreign currency on the rise, it
intervenes by subtracting its foreign currency to increase supply and the price decreases, and if it sees that the
exchange rate of foreign currency falls more than the balance rate, it intervenes by buying to maintain Market
balance at target price.
2. Higher level of exports should lead to an improvement in the current account deficit. This is important
if the country has a large current account deficit due to a lack of competitiveness.
3. Higher exports and aggregate demand (AD) can lead to higher rates of economic growth.
Disadvantages of devaluation :-
1. It is main cause of inflation due to the following:-
A- Imports more expensive (any imported good or raw material will increase in price)
B- AD increases causing demand pull inflation.
C- Firms / exporters have less incentive to cut costs because they can rely on the devaluation to improve
competitiveness. The concern is in the long-term devaluation may lead to lower productivity because of
the decline in incentives.
2. Reduces the purchasing power of citizens abroad. e.g. more expensive to go on holiday abroad.
3. A large and rapid devaluation may scare off international investors. It makes investors less willing to
hold government debt because it is effectively reducing the value of their holdings.
4. If consumers have debts, e.g. mortgages in foreign currency – after devaluation they will see a sharp
rise in the cost of their debt repayments.
How did the Egyptian Government Devalue its Currency?
Egyptian government had attempted to float the pound several times prior to the 2016 devaluation.
In 2003, the government partially floated the pound to decrease in value against USD from EGP 3.85 to EGP 6.86 while
being traded at EGP 7 to USD in the black market. The floatation decision in 2003 resulted in an increase in exports from
$7.1bn in the 2001-2 Fiscal Year, to $10.4bn as well in 2003-2004 Inflation increased from 2.9% in January 2003 to
17.3% in December 2004. Based on a 2007 World Bank study on the impact of the devaluation of the pound between
2000 and 2005, there was a decline in the consumption of Egyptian families to an average rate of 7.4 percent, leading to a
5.1 percent increase in the number of poor families, from 16.7 percent to 21.8 percent.
In 2011-2016, the Egyptian economy, still recovering from the 2008 world financial crisis, was also hit by political
instability that also contributed to the decrease of foreign currencies inflows which were as per the following :-
Exports
Exports, which is one of the main sources of foreign currency, decreased from $26.3bn and $31.5bn in 2010 and
2011 to $21.9bn and $22.5bn in 2015 and 2016
Remittances
Lower oil prices and the fall in economic growth in the Gulf also indirectly had a negative impact on the
Egyptian economy since many companies were laying off employees, of which many were Egyptians. This
resulted in a drop in total remittances into Egypt of about 15% year-over-year in May 2016
Tourism
The tourism sector, a major source of foreign currencies before the 2011 revolution, was severely hit after a
sequence of terrorist attacks in Egypt. The biggest hit was on October 31, 2015, when the Russian Airbus A321
was hit over Sinai peninsula shortly after takeoff from Sharm El-Sheikh killing the 224 passengers on board
resulting in several countries suspending their tourism inflows to Egypt
Suez Canal Fees
Suez Canal, the fastest shipping route between Europe and Asia and one of Egypt’s main sources of foreign
currency was not an exception to the slowdown that faced the other sources of foreign currencies. Despite the
completion of the ambitious $8.2bn parallel canal in August 2015 with a goal to increase revenues to $13.4bn in
2023 from $5.5bn in 2014, revenues have been decreasing since the opening of the new canal affected by a
slowdown in the global economy. Annual revenue of the canal totaled to $5.2bn in 2015 and declined by 3.2%
to $5bn in 2016. In July 2017, canal revenue reached $2.9bn. Based on these figures, the $13.4bn revenue goal
by 2023 is highly unlikely
Thus, On November 3rd, 2016, the Central Bank of Egypt floated the Egyptian pound in an attempt to stabilize
the economy which had been set back by a shortage of foreign currency inflows and political instability. Among
the key goals behind the floatation was to meet one of the key demands of the IMF to secure a $12bn loan,
boost external competitiveness through a weaker currency, encourage foreign investors back to the country
through a more transparent economy and to end the currency black market which was trading at double the
price set by the CBE at the time of floatation.
The Egyptian government took several measures to ensure the success of its wider economic reform program;
CBE hiked interest rates by 300 basis points to limit the inflation that’s likely to follow the weaker currency.
Agreed reforms with the IMF include increasing the government’s income from tax sources via the
implementation of the Value Added Tax (VAT) and introducing a law to speed up the resolution of tax disputes
and settlements, and in view of a different structure of progressive salary tax rates.
The government also began to restructure its subsidy program. A five-year energy subsidy reform program
began in 2014 aiming at stopping energy subsidies by 2019. Electricity prices increased by 25-40% depending
on usage in August 2016, In July 2017, Electricity prices increased again by 15-42% for domestic use and by
29-46% for the commercial Sector, Fuel prices increased 2 times since floatation, The government is moving
into a cash-based subsidy system, where the less fortunate get their subsidies in cash, rather than subsidizing
food commodities and fuel for all.
In addition, an infrastructure intensive works policy were launched such as the construction of a new $45bn
administrative capital, the construction of the third metro line in Cairo, the expansion of the port of Sokhna and
the renovation of the rail and road network, which offers numerous investment opportunities to foreign
companies.
A new investment law was also passed to attract more foreign investors. According to the new law, investors have the
right to finance the project from abroad in foreign currency and are entitled to derive profits, transfer profits abroad, or
liquidate the project and transfer the output of liquidation abroad, Foreign employees of investment companies have the
right to transfer their compensation abroad. Investors can also recoup half of what they pay to acquire land for industrial
projects if production begins within two years and have a 50% tax discount on investments made in underdeveloped areas.
On the other hand the negative results of devalue were but It should be noted that the negative results of
the Egyptian flotation experiment are some due to the float itself, some of which were caused by other
financial measures that accompanied the float
- In short term within 2017 most of sectors affected by the floatation include the construction sector,
where EMAAR Egypt reported FX EGP 83.6m losses and Arabian Cement EGP 81.1m, the
telecommunications sector, where Orange Egypt reported EGP 2.27b losses, and the food industry,
where Edita reported EGP 203.8m losses but most of those companies started to make profits later in the
long term.
- Egypt's external debt in 2017 increased to 60.152 billion by about $14 billion in a year From $46.148
billion at the end of the first quarter of the previous fiscal year 2016, Egypt's public debt has reached
EGP 3.8 trillion, which means that it has exceeded GDP of EGP 3.2 trillion, with the ratio of public debt
to GDP accounting for about 118% of GDP.
- Inflation in Egypt reached some of its highest rates over 34.2 percent in 2017 but it decreased to 9.4 in
2019.
- The sudden and significant price hikes that followed the float which rose almost to 150 %, and even
after the dollar fell against the pound, prices did not fall to a parallel level, This led to the collapse of the
value of citizens' savings in Egyptian pounds
- Egyptians were among the lowest wages in the world if they were paid in dollars, even after the dollar
fell slightly and wages increased relatively, this did not make Egyptian dollar-denominated wages return
to their pre-float level.
- Egypt's high reliance on imports, including industrial and agricultural products and materials, many
businessmen have had a big problem in complying with their commitments under the price difference
before and after the float
- The majority of Egyptians continue to suffer from weak purchasing power as well as an increase in
poverty from 28 to 32.5 percent in 2017 and 2018.
What were the mitigations measures to reduce the negative results on citizens?
1- Takaful & Karama Program & Social Security pension
Providing 325 pounds per month per person in the family monthly assistance to poor families,
Monthly assistance is spent for each student within the family up to a maximum of 3 students, where 60
pounds is spent for the student in primary school, 80 pounds for the student in the preparatory level, and
100 pounds for the student in secondary school.
In addition to monthly assistance for widows, divorcees, the disabled and the elderly, worth 350 pounds
per month per person, and can receive some assistance up to a maximum of 3 members of the same
family.
2- Providing 200 billion pounds aids in shape of long term loans for small projects & entrepreneurs.
3- Providing 1 million small apartments for youth with long term payments as installments
Conclusions & Recommendations about Egyptian Currency Devaluation
- In light of the above we can say fairly that the Egyptian flotation experience saved the country from a possible
economic collapse, but at the same time it was very harsh and tough on the citizens, in other words, in the
famous Islamic jurisprudence rule "Preventing damages is a benefit,", which has been relatively
achieved with the Egyptian float, the float have benefits which stopped a lot of damages for the Egyptian
economy.
- The most important advantage from devaluation is to increase exports, in which Egypt could not
maximize from floating its currency, the decline in wages is a major potential advantage of flotation, as
it leads to lower export prices for the country (which increasing its exports and mechanism key in the
success of Asian experiments), But in the Egyptian case, exports have not increased significantly due to
the high cost of imported production inputs, which devoured a large proportion of the gains from the fall
of the pound against the dollar, in addition to political and security disturbance and dissatisfaction in
many major Arab markets for Egyptian products, as well with the correctness of previous
interpretations, there are in addition problems in the quality of Egyptian products, and the absence of
efficient government support for the industry, the golden chance of float to get its most important fruits
must be followed by a clear plan to strengthen industry and exports, but Egyptian industry has suffered
from shrinking domestic purchasing power as a result of the float without clear governmental
compensating strategies, as a matter of fact and in order to achieve the maximum benefits from floating
Egypt shall improve its competitiveness in industrial sector to be at least 50 % of its GDP which is now
about 18% and of course this is not sufficient to maximize the exports.
- Egyptian Government shall take more mitigation measures in order to reduce the tough increase in
poverty and prevent any future social unbalance and huge unwanted separation in society classifications.
- Egyptian Government shall take more proactive measures to monitor & control market prices especially
with essential goods & food giant distributors.
- Egyptian Government should support, encourage and demonstrate all the flexibility for all investors
especially the industrial investors to build a favorable climate of investment.