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Over the last few years, Egypt has been suffering from a major foreign exchange crisis accelerated by several security-related incidents, such as the 2015 terrorism attack on the Russian airline, Kogalymavia, on route to Saint Petersburg from Sharm el-Sheikh. Several Western countries halted their flights to Egypt and there was a severe drop in tourism, one of Egypt’s major sources of foreign exchange.

This has been accompanied by the dwindling of Suez Canal revenues due to a lull in world trade, which represents the second biggest source of foreign exchange to Egypt. In addition, investment from Arab allies slowed down due to a global drop in oil prices and military involvement. The sluggishness of the Egyptian economy since the January 2011 revolution has also led to a fall in exports and foreign investment in general. All these factors meant that Egypt’s sources of foreign exchange decreased significantly. At the same time though, foreign exchange expenses to cover conventional imports and other financing needs did not experience change. Indeed, such outlays of foreign exchange might have suffered under pressure arising from initiating mega projects including the extension of the Suez Canal, the announcement of a new administrative capital and the reclamation of one million “feddan” (about 1.038 acres) from the desert. The country has been experiencing considerable pressure on its foreign exchange reserves. So far, it is the classic case of a country in need of devaluation – yet there are a number of aspects that need to be considered from the perspective of a political economy.  

The first factor that makes this particular devaluation case different from earlier ones is the high level that the black market premium already reached, which exceeded 40%. This high level implies that the divergence between the official rate announced by the Central Bank of Egypt (CBE) and the actual market is extremely wide. Regardless of the reasons behind such a wide divergence, curing the black market will imply a huge devaluation action accompanied by a sufficient injection of foreign exchange into the market to ensure that the gap is narrowed. The higher the devaluation, the less financial cushioning is needed, which will allow the CBE to enter a comfort zone. Yet this will come at the cost of a higher inflation rate, which might not be tolerated from a political economy perspective. The other option will be to opt for a lesser degree of devaluation, yet this will require a substantial amount of cushioning funds and will probably not close a gap that could grow even wider. From a political economy perspective, this will not lead to ultimately higher inflation rates (at least than those announced by the CBE) but will leave the bank in struggle mode to narrow the gap and ensure the availability of foreign exchange for essential needs. There is no denying that the CBE is left to make a difficult choice. Both options entail economic (depletion of foreign reserves) and political costs (higher inflation rates and possible social and political unrest) that cannot be easily determined or pre-calculated.

The second important aspect is the CBE’s delay in handling devaluation, which ultimately led to this huge unprecedented black market premium. It could imply that the decision is political and hence its announcement does not fully lie in the hands of the CBE. It could also suggest the modest performance of the CBE in handling the crisis or that the waiting period of the CBE is linked to negotiations between the International Monetary Fund (IMF) and the Government of Egypt (GoE) on Egypt’s economic reform package. Regardless of the particular reasons behind the delay, its economic costs cannot be overlooked, not only in monetary terms but also in increasing uncertainty and weakening transparency in the business community, which indirectly causes losses in investment opportunities.

The third important aspect is the type of foreign exchange-rate regime that is likely to be adopted by the CBE in the aftermath of the devaluation. Egypt has declared its regime in the IMF as a country adopting a flexible exchange rate, whereas actual practice has been a fixed exchange rate geared towards anchoring the US dollar price and not inflation. It is worth noting that the announcement of the CBE in Mubarak’s era by the CBE Governor has been that the main goal of monetary policy is targeting inflation, which does not seem to be the case. This foreign exchange regime, as shown by current circumstances, cannot fit the Egyptian economy with its current status. It is very doubtful that full-fledged floatation will take place, but it is likely that a more flexible exchange rate regime will be adopted and probably a fixed exchange rate – with widening bands allowing the market to determine the price (dirty managed floating exchange rate regime) – will be the one adopted.

The fourth important aspect shown by the current foreign exchange crisis is that management of the monetary policy and specifically foreign exchange management cannot be the full responsibility of the CBE. The crisis, which in fact started directly after the 25 January 2011 Revolution, has been deepened partially due to the lack of coordination between the GoE and the CBE, and partially because the CBE is considered the sole saviour of foreign currency reserves. The incidents (the 'shocks' in the economic jargon) that the Egyptian political economic system has witnessed including the tourism crisis, embarking on mega projects and military escalation in the region implied that the CBE is only an actor, among others, in the process of handling foreign exchange rate reserves. It might be the sole manager of the reserves but surely in a narrow sense, as it cannot handle the supply and demand of foreign exchange; especially in an era of turbulence like the one that Egypt has been passing through since the 25 January Revolution. This might require a regulatory reform of the laws related to foreign exchange and the actors concerned with handling its management.

Finally, it is worth noting that devaluation is an indispensable action with no other alternatives. To lessen its negative effects from a socio-economic perspective a prudent management from the CBE is needed, yet better management is a necessary and insufficient condition for the success of the devaluation. A well-managed coordination mechanism with the GoE, more timely decisions, and an understanding of the financial and goods market mechanisms by the CBE Governor are important elements for the success of devaluation.