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Egypt’s increasingly controversial attempts to hold the pound steady against the US dollar require strict policies to maintain. While these measures seemingly have the desired affect when it comes to exchange rates, they have also heavily impinged on local business activity.

With foreign reserves low, the Central Bank can ill afford to defend the pound by selling off its dollars at the desired exchange rate. Instead, it has resorted to strict controls on the purchase of dollars and transfer of hard currency, a policy that is hitting local businesses hard.

The overwhelming majority of businesses in Egypt depend at least in part on imports. In addition to billions of dollars of food, fuel and consumer goods each year, Egypt also imports machinery and spare parts essential to keeping factories running, as well as raw materials ranging from plastics to pharmaceutical chemicals. Overall, Egypt’s trade deficit — the difference in the dollar value of imports vs. exports — stood at US$38.8 billion in the 2014/15 fiscal year.

These imports have to be paid for with dollars or other hard currency, and this is where shortages and capital controls are hindering business operations.

An August report by UK-based research firm Capital Economics attributed Egypt's apparent economic slowdown and a 30 percent year-on-year contraction in manufacturing to a combination of currency restrictions and gas shortages. A survey of businesspeople attending the Euromoney conference earlier this month revealed that Egypt’s currency policy was the most frequently cited macroeconomic concern, outranking other issues like the deficit.

“This is the number one concern of my importing customers,” said one local banker, who asked not to be named due to the sensitivity of the policy. “The foreign currency supply is very, very limited and that is creating a lot of difficulty for small and medium businesses to run their enterprises, even if only 10 percent of their components are imported.”

“It has definitely affected us. The supply chain is [very] much affected,” says Ahmed Ragab, CEO of Baraka Group, which operates a chain of high-end eyeware stores around Egypt. Virtually all of the products the chain sells are imported from countries including Italy, the Netherlands and China.

For Ragab, the most pressing issue is a CBE-imposed cap on hard currency transfers out of the country. “You have a limit for transfers outside of the country limiting your business. As a fashion group, we need to transfer about $25 million per year. We are only allowed to transfer US$600,000," he tells Mada Masr.

Although Central Bank policies have highlighted the US dollar as the most common currency of global trade, Ragab says he faces similar issues with other currencies like the euro.

Companies whose import needs are below the transfer cap have been relatively unaffected by such restrictions. Importers of food and other commodities deemed essential are given priority when the Central Bank parcels out dollars, and many manufacturers are exempted from transfer limits. Meanwhile, multinational companies can skirt these regulations by relying on overseas branches to transfer hard currency to pay for imports, keeping Egypt out of the financial loop entirely.

The hardest hit are companies like Ragab’s, who need more currency than they are legally allowed to use, and whose operations are based entirely in Egypt. These companies are forced to choose between reducing imports — thus trimming the size and profitability of their operations — or resorting to legally questionable practices such as setting up shell companies simply to handle financial transactions.

“I have to manage at the end of the day,” says Ragab.

Even businesses who are exempted from transfer limitations feel some effects, says Alaa Syro, CEO of office supply manufacturer Sasco group. The company relies on imported plastic for manufacturing — Egyptian plastic is available, but simply isn’t high enough quality, Sryo explains.

Overall, the company needs to import around US$600,000 worth of goods every month, which it manages through credit lines at two different banks that provide Sasco with letters of credit to secure import deals. “Manufacturers don't have restrictions on LCs, and can transfer depending on their credit limit with the bank," Sryo says. “We are happy.”

Still, the process of obtaining letters of credit adds about two weeks to the import process and has extra banking costs due to the necessity of maintaining two credit lines.

Companies like Sasco, which are well established and have an incoming supply of hard currency from export markets, are able to get foreign currency credit lines from banks, but this is not always so easy for smaller players.

Until earlier this year, smaller players who had trouble sourcing currency from banks had the option of buying dollars on the black market and then depositing those dollars in banks to obtain letters of credit and arrange imports. That loophole closed in February when the Central Bank barred companies from depositing more than US$50,000 per month into bank accounts.

The move was aimed at killing off the black market and was largely successful, business people say.

“The black market disappeared for four or five months, then started to show up two to three weeks ago,” says Sryo.

The timing of the black market’s resurgence seems to be linked to comments from Minister of Investment Ashraf Salman, who recently said that allowing the Egyptian pound to depreciate against the dollar was “no longer a choice,” suggesting such a move was inevitable.

Even people like Ragab of Baraka Optics recognize that the Central Bank had to take steps to get the currency market under control, even though his business is negatively affected.

“Something had to be done about the black market,” Ragab says. A country with two exchange rates scares off investors, who are reluctant to bring in hard currency at the official rate.

However, maintaining capital controls also comes at a cost. Such restrictions make it hard for local businesses and also discourage new investment. “People won’t invest if they can’t get their money out," says Sryo. “We won’t get foreign direct investment, which we need for the dollar.”

When the limit on cash deposits was introduced, analysts predicted it was a precursor to a managed devaluation of the pound; once the black market was under control, the CBE would gradually float the pound.

So far, except for a minor devaluation in July, that hasn’t happened, to the increasing frustration of experts — most notably, the investment minister.

“In a world where you see devaluations everywhere, it makes Egypt’s policy of a strong currency look a bit out of step,” says Angus Blair, founder of research firm Signet Institute. “Egypt is a great investment story. It could be a fantastic story if the capital controls were eliminated.”

Still, the Central Bank has continued to hold the pound steady, even as it rises against global currencies like the euro. “There is a fear, a correct fear, of inflation,” says Blair. If the pound drops against the dollar and the euro, then each Egyptian pound will buy fewer imported goods, inevitably driving up prices in the local market. Those concerns can be managed by introducing measures to mitigate the effects of inflation on vulnerable citizens, Blair says.

Persisting in maintaining the dollar against the pound has, largely, led to a situation in which the CBE has to impose currency controls to clamp down on the black market.

“You would be hard pressed to find any economist that would say anything other than Egypt needs a managed devaluation,” Blair says.

For now, government is trapped in a holding pattern of high exchange rates and tight controls, for which businesses have to pay the price.

By Isabel Esterman | Published in Mada Masr | September 27, 2015