Tuesday, 8 December 2015

Do we need devaluation, or just want it?

I spend more time than most on the road talking about Egypt, and my day job provides me with more information than your average bear on the views of both foreign analysts and Egypt’s business community. And when I say “business community,” I mean in equal measure the 50 or so household names you see everywhere, the two dozen multinationals that invariably come up in conversation, and home-grown mid-sized enterprises.

For more than two years now, the conventional wisdom of economists, analysts, and businessmen is that devaluation of the national currency is the only route to economic salvation. There has been no gathering of the community over coffee or drinks, in airport lounges or board rooms, since the summer of 2013 that hasn’t arrived at this conclusion.

Devaluation is not a question of “if,” but rather the reality of “when.”

And you know what? They’re wrong.

I agree completely: The EGP is, by and large, overvalued compared to other EM currencies. Maybe devaluation should happen. But it won’t. Not in the near term, at least. And when it does come, it won’t be a significant devaluation in which we see anything more than 8.75 to the USD. My personal view? No more than 8.20.

Ask any three businessmen or economists where the USD should be and you’ll get three different answers. The simple fact of the matter is that there’s no “right number” as we continue to have a shortage of FX. And yes, folks, it’s a shortage — not a crisis.

The reality today is that those who are most vocally declaring “Egypt is facing an FX crisis” and “the USD needs to reach EGP 11” and “we need to remove deposit limits” are the ones whose bottom lines are recording double-digit growth. So, yes, it is a shortage, not a crisis.

So what’s the problem? More than anything else, it’s a lack of transparency on the part of both policymakers and those with their hands on the levers of monetary policy.

The Mahlab government squandered the good will they earned in Sharm El Sheikh this March by failing to communicate clearly what was accomplished and where we needed to go from there. We’re in a similar position today: From fiscal to monetary policy, there’s a clear lack of guidance on what we should expect. Think about it: What was the question most commonly asked after the Central Bank of Egypt cleared the FX backlog? “Where did the money come from?”

If the government were to say we have liquidity on hand to defend the currency for the next 16-18 months, would we still want a devaluation as badly as we do now? Not if we want to maintain social peace.

Yes, ladies and gentlemen, social peace: Because the textbook requirements of a devaluation — the very thing that has worked in economies ranging from Mexico to Russia — will upset the apple cart here at home. Why? Our economic dynamics are not those of a traditional export-led economy.

Think about it: The bottom line is that an economy devalues its currency to make it cheaper for foreigners to invest, winning FDI. In parallel, this makes its exports more globally competitive (all 50 t-shirts we ship to the United States), thus increasing our FX revenues. In parallel, policy makers increase local currency interest rates to encourage people to de-dollarize, ultimately swelling the central bank’s FX position to continue to defend the currency at the new, devalued rate. (Let’s not kid ourselves: We will defend the currency because Egypt never had a free currency to begin with.)

Break down each of these ‘amazing gains’ from devaluation from the perspective of an ordinary Egyptian, and what do you get? The import of inflation — the very “enemy number one” of Egypt’s central bank and policymakers alike for more than a decade lest we risk a “revolution of the hungry.” Or, perhaps more to the point, the rage of the shrinking middle class: The poor will make do, as they have, with subsidized commodities. We fat cats will tighten our belts. The middle class? They’re in deep trouble with spiraling inflation.

We can all agree that Egypt has always suffered chronic inflation (closer to 10-12% annually and not the official 5-7% figure we all silently laugh about). Similarly, we all know our banking penetration is dismal and that the economy is in many ways kept afloat by a massive grey economy that continues to deal in cash. (For Enterprise’s international readers: It is not alien to any Egyptian to see someone walk into a car dealership with a duffle bag full of cash to buy an EGP 500k vehicle, then sit there having coffee and smoking a cigarette while four people are called over to sit and count the cash for the better part of the afternoon.)

Put that together and the conclusion is inescapable: Interest rates are not the most effective mechanism of transmission in Egypt. In fact, they’ve never been as useful a tool as they would be in any other economy because in terms of banking penetration, we continue to be 100 years behind the rest of the world.

Inflation doesn’t stop there: We should all be able to agree that Egypt is a net importer. More than 90% of corporates in Egypt have imports in their production process, whether it’s ingredients (that “special” sauce you get with your food), packaging, component parts or other raw materials. Devalue and the spike in prices will ultimately by passed onto the consumer and translate into sticker shock.

Now, on the other side of the equation, there’s our exports, the primary one being tourism. And here I ask: Do you really think tourists are not coming to Egypt because it’s too expensive? Or might it have something to do with perceptions of security, both ours and that of our region? If the answer is security, it’s arguable that beefing-up the security environment will ultimately lead to more tourists coming in than would devaluation.

Finally, there’s the mountain of FDI long-rumored to be sitting on the sidelines, eagerly waiting for devaluation as the trigger to pile into our market. They’re not going to be rushing in because, bottom line, devaluation = inflation = recession. Think about it: A 20% devaluation will lead to 25% inflation, because even your barber / hairdresser will jack up prices (“Asl el dolar ghely, ya beh”). Those prices rises will filter down to every household, leading to social discontent, demands for raises, and a business community that will hold back from investing. Sounds like a textbook receipt for devaluation, if you ask me.

If you’re a foreign investor, are you going to buy-in during a recession?

At the end of the day, I am not saying that our currency is fairly priced, nor am I saying that I have an answer to our current challenge beyond “Communicate, communicate, communicate.” What I am saying, though, is that given these moving parts, it’s unlikely policymakers will see devaluation as a viable option today.

The author, who asked to remain anonymous, is a senior member of the Egyptian business community at one of the ’household name’ corporates of which he speaks.


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