Exchange Rate Lessons from Egypt
If all the economists were laid end to end, they'd never reach a conclusion – George Bernard Shaw
My favourite economic quote also turns out to be one of the truest. A strange thing happened in 2016 though – most Nigerian economists agreed that the Central Bank of Nigeria (CBN) made the wrong decision by fixing the exchange rate. In fact, this publication agreed too. But the CBN stuck to its guns, and though fundamental issues remain, the foreign exchange (FX) market looks healthier than it did six months ago.
The improvement in economic conditions and Nigeria’s FX market brings the Egyptian comparison to mind. Until November 2016, the Arab State charted a similar path, fixing its currency (the Egyptian pound) despite a slump in tourism revenue after the fallout of the Arab Spring. Unlike Nigeria, they even kept fuel subsidies. But with an economy on the brink, the government struck a $12 billion deal with the International Monetary Fund (IMF) to bail out the economy. In return, the IMF compelled them to remove fuel subsidies and yes – float the pound. All this time, Nigerian policymakers watched, even as many, especially in the international community, called for us to follow suit.
Fat with foreign investment
They were right. Once the deal took off, Egypt became a top investment destination for investors in emerging markets – a stark contrast to Nigeria’s capital flight. Supported by the IMF, the removal of an artificial currency peg and other previously delayed reforms boosted international confidence in the Egyptian economy as foreign investment rushed in. Even remittances went up following the devaluation. Such foreign inflows are crucial for ensuring an adequate supply of dollars in the country, and foreign direct investment can also help spur long-term growth.
As evidence, Egypt’s $4 billion January Eurobond offer was three times oversubscribed ($13.5 billion), dwarfing Nigeria’s initial $1 billion sale ($7.8bn subscription). Now, the demand for Egyptian debt is so high abroad that the country could be set for a ratings upgrade which would help reduce borrowing costs. In contrast, Nigeria’s rating outlook is “negative” for the major agencies, indicating the likely direction is down.
How much is an Egyptian pound worth?
Still, the reforms have come at a high price. Literally. The numbers are startling – the pound has lost more than half its official value since the float and inflation is at a 30-year high. On-the-ground reports are just as worrying. Food prices have skyrocketed; so much so that subsidised bread, the cause of a famous 1977 riot, is now consumed in place of nearly everything. Even the government believes people are feeding subsidised bread to animals as it is cheaper than animal feed. Unsurprisingly, this strains public finances; but altering the program is a politically toxic agenda. Moreover, without it, many of Egypt’s poor may not survive.
Unfortunately for this group, inflation is here to stay. Though the pound has stabilised a bit in recent months and greater access to dollars is easing costs, the damage is done. Monetary policy is ineffective here too as it is a case of imported inflation, not excess demand or currency in circulation. The IMF itself predicts inflation will remain high – 17% next year, up from 13% in its pre-float forecast in October 2016.
Overall, the short-term economic picture may be direr than the financial market activity suggests. Whereas the IMF upgraded Nigeria’s 2017 GDP growth forecast (from 0.6% to 0.8%) between October 2016 and April 2017, it cut Egypt’s from 3.9% to 3.5%. Clearly, the positive impact of the deal is not expected now.
To be fair, not all the woes are linked to the decision to float the currency. Islamic State (ISIS) continues to terrorise certain parts of the country and has increasingly infringed on areas known for tourism, dealing a blow to government efforts to revive those revenues. While Nigeria has been able to recover its oil production by negotiating with Niger Delta militants, Egypt has no such luxury, and it is unlikely that tourism – possibly as important to them as oil is to Nigeria – will pick up anytime soon.
Damned if you do, damned if you don't
Those familiar with economic theory will glibly accept that the picture is inconclusive. Nigeria looks like it may just ride out the FX crisis, though not without serious casualties. Would the Egyptian path have been a steadier one? Maybe, maybe not.
More accurately, it depends on who you pose the question to. The poorest Egyptians have been hardest hit by record-high inflation. For them, this is a significant part of their welfare and is likely to outweigh all other positives. Meanwhile, some businesses have been buoyed by the additional dollar liquidity so would look more favourably on the reforms. The former will be hoping that these firms, along with foreign investors, can help drive the growth needed to atone for the economic damage caused by the reforms.
Despite taking separate paths, both countries have one thing in common: execution is key. CBN’s aggressive dollar sales demonstrate its understanding of the need for improved dollar liquidity, despite its grandstanding throughout 2016. Meanwhile, some Egyptians worry that their government lacks the will to follow through with the IMF reforms. Suggestions that the Egyptian pound is no longer being allowed to float freely would be particularly damaging if found to be true. Then, Egypt would be emulating Nigeria, not the other way round.
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