EGYPT: Reforms for Promoting Economic Growth

The Dollar to Pound Parody 2004-2010

By: Dr. Khaled F. Sherif

Background: Economic Strengths

► Large GDP = 38th in world (2001) ► Sound macro fundamentals:

► Large pool of educated and skilled workers

Inflation under control

Fiscal deficits manageable

Debt profile sound

Growing exports,

including non-oil and services

High levels of reserves

Background: Economic Weaknesses

► Low gross national income, even by regional peer group. Examples:

● Among 13 MENA countries reviewed, higher only than Morocco, Syria and Yemen

● Lower than Algeria, Iran, Israel, Jordan, Lebanon, Oman, Saudi Arabia, Tunisia, UAE

● Only 14% relative to Portugal (lowest among EU)

► High levels of underemployment► Weak human development indicators

● Low levels of literacy, particularly among women (40%)

● Problems with health care access and affordability

The Egyptian Pound vs US Dollar(Dollar Supply and Demand)

► Imports

► Subsidies

► Spare parts

► Repatriation

► Travel

► Hedging

► Capital Investment

► Imports

► Subsidies

► Spare parts

► Repatriation

► Travel

► Hedging

► Capital Investment

► Remittances

► Oil/Natural Gas

► Tourism

► Foreign Investment

► Exports

► Interest rate spread

► Remittances

► Oil/Natural Gas

► Tourism

► Foreign Investment

► Exports

► Interest rate spread

$4.2 bln

$3.1 bln

$1.1 bln

$800 mln

$1.4 bln---------

$10.6 bln+

Dollar Demand

$3 bln

$1.2 bln

$2.7 bln

$400 mln

$1.2 mln

---------$8.5 bln

Dollar Supply

Dollar Demand Trends

Imports

Hedging

Capital Investment

Spare parts

Travel

Subsidies

Repatriation

?

Dollar Supply Trends

Remittances

Interest Rate Spread

Tourism

Exports

Oil/Natural Gas

Foreign Investment

?

?

?

Current Trend Implications

► As it stands, Egypt maintained a dollar deficit in excess of $2.6 billion in 2003*● This serves to explain the recent surge in

the price of the US dollar; and suggests increasing further declines

► Moreover, there has been an inability on the part of Egypt to fulfill its potential in attracting dollar inflows● Example: At $400 million, FDI represents a

shocking $5.7 per capita

* Figures for hedging and interest rate spread were not available

Projecting Dollar Demand vs Dollar SupplyThe Impact of Current Trends

Price

Quantity

Supply (S)

LE 7.00=US$ 1.00

Demand (D)

Q

Current Outlook

P'

D'

Q'

Demand Increase

Projecting Dollar Demand vs Dollar SupplyThe Impact of Current Trends

Price

Quantity

Supply (S)

LE 7.00=US$ 1.00

Q

Demand (D)

Current Outlook

Q'

S'

P'

Decrease in Supply

Projecting Dollar Demand vs Dollar SupplyThe Impact of Current Trends

Price

Quantity

LE 7.00=US$ 1.00

P'

D'

Q'

S'

LE 7.00=US$ 1.00

(P)

Q

Resultant Outlook: Increase in Price; Decrease in Quantity

Supply (S)

Demand (D)

The Impact of Current Trends:Case Example: Subsidization

► Currently, the Egyptian government subsidizes a number of goods, including:

Cooking Oil Sugar Bread Lentils

► Meanwhile, as the population continues to increases, subsidies are likely to increase in greater proportion:

0

20

40

60

80

100

120

2004 2008 2012 2016 2020

-1

1

2

3

4

5

6

7

8

Population(Millions)

Subsidies(US$Millions)

The Impact of Current Trends:Case Example: Subsidization

► Increasing subsidization decreases the supply of dollars within the system, resulting an increase in its price:

Price

Quantity

Supply (S)

LE 7.00=US$ 1.00

Q

Demand (D)

Q'

S'

P'

Increasing value of the US Dollar

* Estimate

1980: $1= LE 0.73

1985: $1= LE 1.10

1990: $1= LE 2.30 2005*: $1= LE 7.20

1995: $1= LE 3.30

2000: $1= LE 5.20

Diminishing value of the Egyptian Pound

1980: 1LE= US$1.36

1985: 1LE= US$0.91

1990: 1LE= US$0.43

1995: 1LE= US$0.30

2000: 1LE= US$0.19

2005*: 1LE= US$0.13

* Estimate

Value of LE 100,000 in US$

0

20000

40000

60000

80000

100000

120000

140000

160000

1980 1985 1990 1995 2000 2005

Diminishing value of the Egyptian PoundNet Worth Comparisons

► The following table and graph illustrate the decline in value of LE 100,000 between 1980 and 2005:

Year US$ Equivalent

1980 136,986

1985 90,909

1990 43,478

1995 30,303

2000 19,231

2005* 13,889

* Estimate US$ Equivalent

► The substantial damage experienced by the Egyptian pound is reflected in the following example:

● An individual/organization who held $100,000 in 1980 and converted that to Egyptian pounds would have approximately the equivalent $10,000 today

● Meanwhile, an individual/organization who purchased $100,000 in 1980 and maintained it in US currency would have increased their investment by almost ten-fold (from LE 73,000 to approximately LE 700,000)

► Meanwhile, The IMF estimates that the value of deposits held by Egyptians overseas is approximately US$ 77 billion

● By placing this currency in the Egyptian financial system, it would have a multiplier effect of 5!

► The fear is that if this continues, this will spur increased dollarization, as has been the case with dramatic capital flight from Mexico and Argentina

Diminishing value of the Egyptian Pound Capital Flight Implications

Reform Strategy: 2004-2010

I. Financial Sector Reform

Program

II. Investment/ Tourism

Promotion

Financial Sector Reforms:Privatization

► Finalize privatization of state banks by 2006● 4 large commercial banks● 2 specialized financial institutions● 11 joint venture banks

► Use subsequent years for post-privatization resolution as needed● Non-performing and restructured loan

collection

Financial Sector: Strengthening Intermediation and Achieving Stability

► With a floating exchange rate regime, this means ensuring hedges are properly used

► More efficient banks will be able to pay higher real rates to depositors if they need the funds

► Risk-seeking banks have greater need for funds, making creditor rights essential for increased intermediation

► With a floating exchange rate regime, this means ensuring hedges are properly used

► More efficient banks will be able to pay higher real rates to depositors if they need the funds

► Risk-seeking banks have greater need for funds, making creditor rights essential for increased intermediation

Strengthen the banking environment to reinforce

public confidence in deposit safety

► Minimum capital increasing

► Prudential norms tightening

► Stricter loan classification and tougher asset valuation standards means banks will have more pressure to sustain adequate capital adequacy ratios

► Increased investment will be needed for increased efficiency to bolster earnings and exceed minimum capital and CAR requirements

► Minimum capital increasing

► Prudential norms tightening

► Stricter loan classification and tougher asset valuation standards means banks will have more pressure to sustain adequate capital adequacy ratios

► Increased investment will be needed for increased efficiency to bolster earnings and exceed minimum capital and CAR requirements

Combine privatization and deposit safety efforts as

part of investment approach

Financial Sector: Prudential Framework and Enforcement

Raise minimum CAR to 12% in

2007

Articulate clear thresholds that trigger specific

corrective actions as CARs fall below

prudential requirements

Ensure tax rules for provisioning are consistent

with international standards

Strengthen CBE mandate and stress testing

capacity

Monitor banks’ risk management systems, internal

controls, and internal audit

Investment/Tourism Promotion Policy and Institutional Checklist

Macroeconomic stability

Credit, investment and financial sector policiesthat promote intermediation

Labor market flexibility

Effective judiciary and legal enforcement

Low barriers to entry AND exit

Good governance

Open trade and investment regime

The Way Forward…

► Devaluation is not a choice- it is a reality (an outcome)

► Even with the best economic reform scenarios, the pound will fall sharply against the dollar

► To stem the tide of devaluation, we have to act now:

● A serious financial sector reform program is needed● Renewed investment will be required in trying to push

exports● Tourism must take the lead in the development effort● Foreign direct investment must be tapped to its

potential and cannot persist at $5.7 per capita