Egypt currency depreciation further blow for economy

The Egyptian pound could soon climb above LE6 to the dollar, according to one report   Soaring prices for most foodstuffs and consumer goods -- that's the situation Egypt faces if its' currency plunges further against the US dollar. And, despite popular wisdom, a devaluation for the Egyptian pound means the country's exports will only become marginally more competive, if at all, say experts.
Britannica Online defines devaluation as "reduction in the exchange value of a country’s monetary unit in terms of gold, silver, or foreign monetary units...[Devaluation] is employed to eliminate persistent balance-of-payments deficits."
But while this suggests the move might be a good one for Egypt, a country with a growing balance of payments deficit, the likely effectiveness of devaluation is highly debatable, according to economists interviewed by Ahram Online.
Since the country's popular uprising disrupted economic activity early in 2011, the Central Bank of Egypt (CBE) has overseen a gradual depreciation of the Egyptian pound by tapping into its once abundant reserves.
The local currency lost some 4.75 per cent of its value last year to edge above LE6 to the dollar.
Investment advisory group Business Monitor International has predicted the rate could climb to LE6.5 per dollar within months, according to a report in Al-Mal daily newspaper.
This may soon be out of the CBE's hands, as the central bank's ability to support the currency gets steadily weaker.
Egypt’s foreign reserves, the CBEs main tool for shoring up the pound, dropped to $16.35 billion by the end of January 2012. It has been shedding an average of $2 billion per month since last October.
"The room left for policies to contain the currency drop has become very limited," says Magda Kandil, executive director of the Egyptian Center for Economic Studies.
Last week, Standard and Poor's ratings agency cited the sharp losses in reserves as one of the reasons for cutting Egypt’s long-term rating by a further notch to 'B'. This downgrade means that Egypt’s capacity to source foreign funds through tapping international debt markets is shrinking.
Contacted by Ahram Online, Mahmoud Abdel Fadil, a CBE board member, ruled out the possibility of a sharp devaluation, but refused to comment further.
And should the currency plunge, economists warn the implications would be severe.
"It is very important for the exchange rate not drop below its current levels," Hazem El-Beblawi, Egypt’s former finance minister told Ahram Online.
"Both the standard of living of Egyptians and economic activity will be severely hit if this happens."
Egypt imports almost double what it exports; in the quarter ending September 2011, it sported a trade balance deficit of $7.8 billion.
The country depends on imports to satisfy the basic needs of its population, most notably the mass shipments of wheat it orders for making bread. This import-dependency  would likely lead to a surge in prices if Egypt's currency is devalued.
The other side of the coin is that a depreciated currency makes a county’s exports cheaper, and therefore more desirable in the international marketplace.
But this too could prove troublesome, as Egypt's manufacturers are themselves large-scale importers of raw material and semi-manufactured goods, El-Beblawi says.
These so-called "intermediate goods" make up around one third of Egypt’s total imports, according to CBE figures.
A quick review of academic literature on the subject shows many scholars are also critical of using devaluation as a tool to improve a trade balance.
In a 1995 study, Iqbal Haidari explains that devaluation in developing countries is very likely to raise input cost and breed inflation.
He argues that for countries that import basic goods, such as petroleum, raising the costs of imports will have a knock-on effect on all aspects of the economy, eventually putting pressure on consumer prices.
Similarly, a 1988 study by Khan and Knight indicates that, even if devaluing the local currency increases the competitiveness of a developing country’s exports, the trade balance might not necessarily improve.
They say an increase in exports will be accompanied by a hike in the cost of intermediate goods used for the extra production.
In the case of Egypt, economists interviewed by Ahram Online took a similar view, saying that negatives would likely outstrip the positives.
"Most sectors will be unable to reap the benefits of devaluating the currency," says Ahmed Ghoneim, a professor of economics at Cairo University.
"The heavy manufacturing and chemicals sectors are likely to be significantly hurt by such a move, while clothing and food industries might benefit."
It is Egyptian consumers, Ghoneim says, who will lose the most.
The impact would likely be hard to reverse too, according to a 2008 study by local economist Hala El-Ramly, who concluded that the expansionary effects of currency devaluation in Egypt would be long-lasting.
As as a result, currency depreciation should not be used as a quick remedy to recession, she said.
Similarly, an Egyptian World Bank economist, speaking on the condition of anonymity, added that exports are unlikely to bear the fruits of devaluation due to a general slowdown of economic activity.
"Politics, security and unrest are the main reasons for Egypt’s economic crisis," she said. "A cheaper pound isn't going to solve these problems."