Egypt’s posturing pound pledge may return to bite
Devaluation is a more certain path for Egypt’s economy as a weaker currency would boost Egypt's competitiveness says Una Galani
August 28, 2012 3:26 by Reuters
Politicians and central bankers are in the business of downplaying fears over a currency. New Islamist President Mohamed Mursi, however, hasn’t left himself much room for manoeuvre after ruling out a widely anticipated devaluation days after a senior advisor acknowledged its necessity. Mursi could end up eating his words.
The pound has been fiercely defended by Egypt’s central bank, falling just five percent against the dollar since the uprising 18 months ago, against a backdrop of high inflation. This has proven a high-cost defence. Foreign reserves have fallen by more than half. The current account deficit will widen to $8.5 billion in the fiscal year ending in June or 3.3 percent of GDP, according to HSBC. That has raised the cost of borrowing, with the government currently paying near 16 percent interest on treasury bills.
A lot would need to happen for Mursi to fulfil his pledge on the currency. Investor confidence is slowly building after a move to retire two top military chiefs and force legislative powers to civilian rule. But security must improve before the recovery in tourist numbers translates into higher revenue. And a deal with the International Monetary Fund is needed to win back foreign investors en masse, and kick start economic growth to the level required to create jobs.
Devaluation is a more certain path. A weaker currency would boost Egypt’s competitiveness. Egypt’s export-to-GDP ratio increased by over 10 percentage points on average in the three years following previous devaluations, according to Capital Economics. A weaker pound would also win back foreign investors. The increase in the cost of food and fuel subsidies, which already account for one quarter of government spending, could be limited if coupled with sensible reforms.
The IMF is likely to seek a guarantee that the $4.8 billion loan Egypt has requested won’t be frittered away in a hopeless defence of the pound. A number of economists had speculated that devaluation would be a condition of the agreement. Investors might not take Mursi’s assertions at face value but if the pound does fall, Egypt’s president will lose credibility along the way.