Following the conditions of a loan-agreement with the International Monetary Fund (IMF), the Central Bank of Egypt floated1 its national currency, which resulted in skyrocketing consumer price inflation. However, this creates further tensions for an already combustible mixture of social and political tension.
Since 2003, the Egyptian pound has been pegged to the US dollar, meaning that its value depends on the current course of the US currency. To control the exchange rate, the Egyptian Central Bank manages dollar reserves, which it offers to financial intermediaries in auctions at a predefined price. This has the advantage of providing stability for international trade operations, as the value of the money is anchored to a relatively stable currency with low volatilities. Given that the Egyptian Central Bank has sufficient reserves to effectively control the value of the pound and that it contains black market trading, this system is relatively sound.
Yet, Egyptian currency reserves are dwindling and the discrepancy between the official and the black market value of the pound has reached alarming levels. This is due to a declining income and increased outflow of foreign currency: ever since the political turmoil of 2011, the post-revolutionary Egyptian state is dealing with an ever-expanding trade deficit and struggles to become more independent from imports (mostly undertaken in US dollar). On the one hand, the Egyptian government under President al-Sisi runs a glaring household deficit and therefore relies on international loans with interest payments in US dollar to finance its policies. On the other hand, terrorist attacks and extreme state violence considerably reduced foreign currency inflows from the tourism sector, while crucial revenues from the Suez Canal, which was only recently enlarged, failed to materialise.
Hence, the Egyptian pound continued its nosedive: while, in January 2011, 1 US dollar was worth 5.818 Egyptian pounds, in November 2016, rates for the dollar in the black market went up to 13 pounds. As a result of the flourishing black market currency trading, the dollar became somewhat of a rare commodity. Facebook groups like “daily rate of the Dollar in Egypt” quickly gained several hundred thousand members and people on the streets of Cairo randomly asked foreigners to exchange their pounds.
Unable to sustain its household and to stabilise its currency, the Egyptian government entered into an agreement with the IMF for a US $12 billion loan on a three-year basis. One of the sine qua non conditions of the IMF was the abolishment of exchange rates in order to drain the black market and to unify dollar rates. As a result, On November 3 2016, the Central Bank of Egypt floated the pound, letting individual banking institutions freely fix the value of the pound against the dollar. In subsequent central bank auctions, the pound stabilised at a historic record low of 15.75 against the dollar – a two-fold depreciation in the currency’s value compared to its former level.
While it is evident that the unsustainability of the Egyptian economy and exchange rate regime need to be addressed, it is highly questionable whether the sudden abolishment of exchange rates is the best way to proceed. In fact, this drastic approach is likely to affect the long-term stability of the Egyptian economy and society in two important ways:
The loss in value of the Egyptian pound translates into a direct loss of purchasing power for the Egyptian population. In the aftermath of the decision, consumer price inflation reached a record high of 19.4 percent and is unlikely to decrease in the long run. Rising prices, of course, affect all parts of society. Yet, for upper classes it is a matter of delaying bigger purchases and investments, for lower classes of society higher prices for food commodities are a matter of pure survival. With 27.8 percent of Egyptians living below the US $2 per-day poverty line, a large part of the population is extremely dependent on the complex system of government food subsidies and sensitive to minor price volatilities. As prices for foodstuff are expected to increase by 25 percent over the following months, the government would need to increase its budget devoted to subsidies to compensate for the hike. A lifting or reduction of government support could induce severe consequences for an important number of Egyptians. Yet, this is precisely one of the conditions of the IMF loan agreement. Shortly after the abolishment of the exchange rate, the Egyptian government thus started cutting subsidies on fuel, which resulted in a reported 47 percent increase of pump prices.
Back in 1976, when the Egyptian government implemented conditions for economic reforms put forward by the IMF, including subsidy cuts, Egyptians all over the country rioted as a result of rising prices for foodstuff. The upheaval resulted in such a chaos that the government was ultimately required to reintroduce food subsidies. This illustrates the crucial role of state support for upholding the difficult equilibrium of social peace in the Egypt. Today, in spite of extreme state repression, an important part of society grows, once again, increasingly frustrated about the status quo and has less hesitation to take its anger to the street. The controversy surrounding the possible transfer of several Egyptian islands to Saudi Arabia for instance, has sparked the most important demonstrations against the government since 2011. Few things have changed to delegitimize the slogan of the Egyptian revolution of ‘aish, hurriyya wa karama – bread, liberty and dignity.
In Egyptian Arabic, ’aish means both bread as well as life – and this homonym is symbolic for the paramount importance of bread and other wheat products in the modern Egyptian diet: people in Egypt spend around 40 percent of their income on food. Due to the rapid growth of its population in the 1950s and the problematic management of domestic agriculture, the country has become one of the largest wheat importers on the planet. The continuous depreciation of the Egyptian pound therefore means that the state has to spend an ever-increasing part of its budget on imports. In order for the government to mitigate the impact of rising consumer prices, it would need to considerably increase the total allocations for subsidies. While it is still uncertain whether or to what extent the state will compensate for increasing prices, the depreciation of the pound certainly questions the ability of the Egyptian government to uphold its liabilities in the long run.
While state media and members of Parliament continue to use the Egyptian Muslim Brotherhood as a scapegoat for the increasing price of the dollar, it is evident that high inflation rates primarily benefit producers, who have a considerable influence on decision makers. The floating of the pound is part of a desperate attempt of the Egyptian government to stabilise the status quo. While unlikely to tackle the root causes of the problems, this course of action comes at enormous economic and social costs that question the very stability of the Egyptian state and society. Beating around the bush, however, is a dangerous business in the current social climate in Egypt.
1 In contrast to a “fixed” or “pegged” exchange rate determined by the government, “floatation” describes an exchange rate regime where individual banking institutions determine the value of a currency freely on a domestic currency market.
Franz Paul Helms is a Middle East and North Africa Analyst with the Initiative for the Future of Global Risk (IFGR). Coming from the very North of Germany, Franz spent his bachelors degree studying sociology and social science in France. While doing so, he developed a keen interest in the Middle East and thus spent an exchange year in Cairo, before becoming a student in International Security at Sciences Po Paris. The Initiative for the Future of Global Risk (IFGR) provides a platform for unconventional approaches to existing and emerging areas of risk.