A Dollar Crisis Threatens Egypt's Economy
By: Analysis | Stratfor.comMarch 10, 2016

Forecast

  • Egypt will continue to rely on foreign aid to keep its economy afloat, putting off tough but necessary reforms.
  • In an effort to both reduce its import bill and mitigate the dollar crisis, the government will make inconsistent policy decisions.
  • Cairo's erratic behavior will raise more questions among Egyptians about their leaders' ability to revive the economy, raising the risk of instability across the country.

Analysis

Egypt's economy is once again in crisis. Cairo, unwilling to move more quickly on the painful economic reforms that would ease its heavy deficit burden, has all but drained its foreign exchange reserves. But its people have grown accustomed to the government's wide-reaching subsidy programs, which are being kept afloat largely by foreign aid. If the Egyptian government cannot find a way to sustain them, the country's fragile stability may not hold.

Western and regional powers have considered Egypt a crucial Middle Eastern ally for most of its modern history. Cairo's backers will make sure that the Egyptian economy continues to limp onward, even as it deteriorates. But even if Egypt accepts their help in an effort to keep funds flowing, the concerns of the Egyptian people will not be alleviated. The economy will still be scraping by, and, as criticism of the government's handling of the crisis grows, so will the risk of unrest.  

Egypt's Dollars Are Drying Up

During the 2000s, when markets were calm and oil prices high, Egypt's foreign reserves climbed steadily. At the same time, its demand for imports grew in response to a weak dollar and a burgeoning population with an appetite for foreign goods. Eventually, Egypt's imports began to outweigh its exports. But the country had a healthy cushion of foreign reserves, bolstered by tourism dollars, remittances and foreign direct investment, that enabled it to artificially prop up the Egyptian pound.

But now those revenue streams are drying up. In the face of declining foreign investment and tourism revenues, Egypt has sought to stem the flow of precious dollars from its reserves by slashing its hefty import bill. In January, central bank Gov. Tarek Amer suggested trimming imports, which cost the country roughly $80 billion in 2015, by as much as 25 percent in 2016. But a cutback of that size is easier said than done, and the process of implementing it has been messy.

Competition among Egyptian companies and consumers for what is left of a dwindling dollar supply has put strain on the Egyptian pound. The black market rate for the currency, which has been rising steadily since early 2015, is now between 9.6 and 9.8 Egyptian pounds to the dollar. (By comparison, the official exchange rate is about 7.8 Egyptian pounds to the dollar.) On the heels of two politically costly devaluations last year, pressure is mounting to devalue the Egyptian currency yet again.

Cairo may be forced to respond to this pressure by allowing the Egyptian pound to be traded at its true exchange rate. But doing so would contradict a recent statement by Amer that Egypt would not devalue its currency and risk hiking up inflation and cost of living, which have been on the rise since Egypt's 2011 revolution. Then again, if Cairo does not devalue the pound, the government will have to continue propping up the currency with its ever-shrinking reserves. This would in turn put stress on Egyptian importers, which cannot access the dollars they need to produce goods for export.

Erratic Policies Generate Uncertainty

As the Egyptian government struggles to find a solution to its financial predicament, the country's importers and citizens bear the consequences of Cairo's indecision. An odd string of refused commodity shipments earlier this year made this clear: Egypt's ports turned away a number of wheat and soybean cargoes, despite high demand for those products among Egyptians. Most of the country's 90 million citizens must buy wheat and soybean oil, and amid recent reports of scarcity of these basic goods, many are concerned that they may become less available and more expensive. Because higher food prices have repeatedly led to riots in Egypt in the past, Cairo often goes to great lengths to avoid creating public anxiety over the country's food supply.

That is why its denial of the wheat and soybean cargoes was so unusual. According to the Agricultural Quarantine Authority, the shipments contained high levels of ergot fungus and ambrosia spores. Though possible, it is far more likely that Egypt could not pay for the goods when they were delivered. Cairo's inability to make good on payments, and the inconsistent decision-making among the ministries of government involved in trade, have made Egypt a less reliable trading partner. As a result, the country has had to pay additional risk premiums for its imports.

In the wake of the food cargo confusion, Egypt has tried to assuage the concerns of companies operating in the country by addressing one of their biggest problems: accessing dollars to pay for their imports. But a satisfactory solution has been slow to emerge, in part because Egypt is trying to solve two opposing issues. On one hand, Cairo could reduce its own deficit, curtail excess import demand and help Egyptian businesses by devaluing the pound, which could lessen the strain on the country's foreign currency reserves and put more dollars into Egypt's banks for companies to borrow. On the other hand, a currency devaluation would drive up inflation and food prices, worsening standards of living for average Egyptians and risking instability across the country.

Over the past month or so, the government has oscillated between the two, much to the frustration of Egyptian citizens and companies alike. For example, the central bank set a ceiling on foreign currency deposits by Egyptian importers in early 2015, only to raise it later in the year and again in mid-February, before lifting it entirely on March 8. The government similarly placed a cap on travelers' foreign currency deposits in mid-February before adjusting it some two weeks later.

Cairo's reactionary policies have created uncertainty within Egypt's population, raising the question of how much longer such decision-making can stave off economic collapse. The government's historical pattern of enacting a measure, testing the public's response and amending its policies accordingly has often resulted in simply putting off tough but necessary reforms. But that strategy cannot last forever.

Few Good Options for Cairo

The Egyptian government could respond to the situation in one of three ways. First, it could devalue the Egyptian pound, deterring black market currency activity and reducing demand for nonessential imports. But before doing this, Egypt wants a bigger cushion of reserves. Alternatively, Cairo could dismantle some of its subsidy programs, as it promised to do in the proposed reforms it submitted to the Egyptian parliament. Scaling back subsidies would also meet the World Bank's requirement for releasing further loans to Cairo, and in fact Egypt has already made some progress since 2014 in lifting energy and food subsidies. However, its ability to further reduce its subsidy burden will remain limited. Cairo's final option would be to ask for more foreign aid and investment, acquiescing to the demands of individual creditors in exchange for cash.

Because the first two options would place a heavy burden on the Egyptian people, increasing the potential for social unrest, Cairo will likely take the third path — foreign funding — for the remainder of 2016. The Gulf Cooperation Council has already promised Egypt tens of billions of dollars in aid over the next five years, and the World Bank has agreed to give $3 billion in loans. The United States also provides $1.3 billion to Egypt in security assistance each year, and the African Development Bank granted Cairo a $500 million loan in December 2015. Finally, China and South Korea committed to invest $15 billion and $3 billion in Egypt in February alone.

Still, some of these funds are far from certain, and Egypt will seek as many sources of funding as it can as its financial troubles pile up. Investments from oil-producing states are not nearly as reliable as they once were, and the World Bank loan hinges on the enactment of Cairo's economic reforms, which are currently stalled in parliament. At the same time, countries that send aid to Egypt often expect something in return. East Asian donors want tenders reserved for their own companies, while the United States assumes its military assistance will ensure Egypt's support for U.S. activities in the region. The Gulf Cooperation Council, for its part, would like to see greater participation by the Egyptian military in the Saudi-led coalition in Yemen.

Taking its latest cuts into account, Egypt's monthly import and subsidy bill totals about $6 billion — a figure it cannot hope to pay on its own. Regardless of the expectations of its lenders, Cairo will have to rely on external help to keep the gears of Egypt's economy turning. The International Monetary Fund recently announced that it would finance Africa's oil producers with no strings attached, which could be Cairo's best chance of securing funding without having to make difficult promises in return. Indeed, despite Amer's denials, as of March 9, Egypt may have decided to open talks to secure a loan with the IMF, which said it stands ready to engage with Egypt. Either way, for now Egypt will continue to do what it has done since the country's revolution ended: depend on its allies to get by. 

This article originally appeared on Stratfor.com

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