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“Fasten Your Seatbelt Egypt”: 8 Implications of the Pound Devaluation, According to AUC Scholar

As the devaluation of the Egyptian pound becomes imminent, AUC's Venture Labs director Ayman Ismail shares eight implications that will probably affect everyone.

“Fasten your seatbelt, Egypt, and brace yourself for some turbulence,” writes Ayman Ismail, Chair of Entrepreneurship at the American University of Cairo (AUC), and founder of Venture Labs in a Facebook post. The scholar, whose on-point explanation of the Egyptian crisis went viral earlier this year, now tackles the imminent devaluation of the Egyptian pound in another Facebook post, as Beltone Financial alleged yesterday that the Central Bank of Egypt could float the pound “within hours.” What are the implications? Ismail asks, as he rolls out the Egyptian government’s plan in 11 points:

From all the reports, news, and conversations that I'm having, it seems like the final decision has been made to devalue the Egyptian pound and get back to a (managed) free float exchange regime.

First, here is the government plan: (putting the different pieces of the puzzle together from the different sources).

  1. Price discovery for the real equilibrium exchange rate. Over the past months, the government did not attempt to defend the EGP by pumping any extra USD in the market, which they previously tried and failed. Mostly because they didn't have much USD to pump. The result is that the current exchange rate is pretty much the free float rate (now around 13-13.25 EGP/USD).

  2. Get more USD. The government has been negotiating like crazy to get as much USD as they can. Seems like they finally managed to get $6-8 USD billion from a number of countries, development banks, as well as the IMF. This will help cool the markets down, although it would be wise not to use the scarce Dollars to defend the Pound again.

  3. Raise the interest rates. A temporary but steep increase in the interest rates will take place along with the devaluation. It give an incentive to both Egyptians and foreigners to keep their EGP, rather than Dollarize, and also to curb inflation.

  4. A sudden and steep devaluation (the steeper the better, although it is not clear yet what will the exact rate be. Expectations are between 11.50 - 13.00.)

  5. Gradually reopen and decriminalize the private exchange market. And gradually remove the restrictions on credit cards etc.

  6. Borrow $3-5 billion from international markets by issuing more sovereign bonds. Four international banks have already been selected to work in this bond issue.

The ultimate target is to grow the reserves back to $25 billion as soon as possible.

  1. Make sure the social safety net is prepared, at least to provide basic food and necessities to the most vulnerable to avoid major social unrest.

  2. Sign the IMF agreement, which would provide $12 billion over the next 3 years. (Target is the third week of October).

  3. Continue with the privatization plan for several SOE's, including at least one bank. Fix the mess in the telecom sector 4G and try to get as much licensing fees out of it.

  4. Expand the collection of taxes, especially real estate tax and the new VAT.

  5. Also continue with the reduction of subsidies, especially gasoline, which is responsible for a substantial part of the budget deficit.

So what are the implications?

  1. Prices will shoot up immediately. Inflation is likely to increase substantially, at least for the next quarter.

  2. Exchange rates will spike over the short term, but they are likely to move back close to the current rates, and possibly even lower.

  3. Expect a wave of stagnation in the economy, with everyone scared of buying or selling, at least till the turbulence declines.

  4. A price correction in real estate markets, especially for anyone who is eager to sell an asset immediately. (However, this one is debatable and could go either way).

Aside from these negative effects, the hope is that this devaluation and floating should also bring a number of positive effects that will make it worth all the pain:

  1. Increasing the competitiveness of our exports, including industrial and agriculture exports, tourism, and labor (yes, these are our primary exports!). And allowing
    local manufacturers to get the needed supplies of raw material and equipment.

  2. Restoring the previous levels of remittances (which are currently channeled to the black market).

  3. Signaling to all the FDI that was waiting to start flowing again, which is the most critical factor for restoring growth.

  4. And eventually, restoring balance in the forex markets.

So is this a good plan?

The reality is that the next quarter will be painful, especially for the middle class (or whatever is left of it) as well as small businesses. Individuals will experience a substantial decline in their standard of living, with unpleasant choices to prioritize their spending. SMEs will experience delays in revenues and cash flow problems.

Having said that, we don't really have much of a choice, the current policies are disastrous and not sustainable, and we simply can not continue like this.

The bottom line is that we really did not need to be here!

The Pound should've been devalued slowly and continuously over the past 3 years. The current and previous CBE governors are directly responsible for this miserable situation. Today, we are paying the price of bad policy (which I call the stupidity premium). However, Egypt's economy remains resilient and will adjust quickly. And we can recover quickly if we implement a consistent and proper policy framework.

As for the next month or so, brace yourself for major turbulence.

Photo credit: Mohamed Sherif El Dib