Egypt's Currency Crisis!

Egypt's Currency Crisis!

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Egypt has had a problem with debt for quite  some time. Since the Second World War,   the country has typically run a trade deficit –  importing more than they export. This has been   partially offset by transfers from abroad, such  as aid from foreign governments and remittances   from Egyptians working in other countries.  Tourism has additionally been an important  

source of foreign exchange for the country,  with millions visiting Egypt each year, mostly   from Europe, Asia, and other Arab countries. In 2016, The Egyptian president Sisi sealed   a deal with the IMF for a $12 billion loan. This  bailout was granted on the condition that Egypt’s   currency would float freely. The Egyptian  Pound halved in value in a matter of weeks,   causing inflation to rocket. Harsh austerity  measures were implemented including cuts to energy   subsidies– to try and restore government finances. Everything was going reasonably well until the   pandemic hit in 2020. This destroyed the tourism  industry, an important source of foreign exchange.  

The central bank began propping up the Egyptian  pound from June 2020 up until March 2022,   repeating the same mistakes that had led to the  prior devaluation. Once the Central Bank stopped   supporting the currency it began its decline. Egypt is the Arab world’s most populous nation   with 109 million people and is the world’s biggest  importer of wheat. When Russia invaded Ukraine,   the shortage of wheat, combined with  other soaring commodity prices caused   real problems in Egypt. The country reached a  3-billion-dollar loan deal with the IMF last   October after again agreeing to let the forces  of supply and demand determine the value of the   Egyptian pound in the foreign exchange market. Egypt allowed its pound to fall to a new low this  

Wednesday. It’s lost nearly 35 per cent of its  value since the deal was agreed in October as the   central bank slowly withdrew support. Analysts  are warning that the pound has even further to   fall before stability is reached. This currency  weakness is adding to the pain of millions of   Egyptians as urban inflation hit 21.3 per cent  in December 2022, its highest level in years.  Around 60 per cent of Egypt’s population of  100mn people lives at or below the poverty   line. Inflation for these people means  going without food and other necessities. 

Egypt has one of the longest recorded histories of  any country, but modern Egypt dates back to 1922,   when it gained independence from Great  Britain, initially as a monarchy,   and after the 1952 revolution, a republic. After the Arab Spring and the overthrow of   Mubarak, the country endured an extended period  of political unrest. Egypt's current government,   which has been in power since 2014  has been described by a number of   watchdogs as authoritarian and responsible  for the country's poor human rights record. 

Today debt is a huge problem in Egypt, more  than 40% of the countries revenues are used   to fund interest payments on debt. Egypt  is the second-biggest debtor to the IMF   after Argentina and October’s deal was its  fourth loan agreement since the deal in 2016,   so the best starting point so that we can  understand the current problems is probably   with the devaluation that occurred in 2016 Before we get to that, let me tell you about   today's video sponsor, Blinkist. Blinkist  is an app that helps you understand the   most important ideas in over 5500 non-fiction  books in around fifteen minutes each. You can   either read or play the books on your phone. The  creators at Blinkist are great at extracting the   most important concepts and ideas from a book  and making them digestible. I sometimes find   myself buying more books than I have time  to read. With Blinkist I can listen to lots  

of new titles on my commute and if I find one  really interesting then read the full book. I   also enjoy using Blinkist to refresh my memory  of a book that I have read a while back. Here   are some of the books I’m currently listening to. They have a new feature called Blinkist Connect,   which allows every Blinkist Premium plan to  be shared by two different accounts. It’s  

no additional cost to you, and it’s free to  the person you invite for as long as you’re   sharing it with them. If you are like me and  planning on reading more in the New Year,   Blinkist might really work for you. Get 25% off Blinkist premium and enjoy   2 memberships for the price of 1. Start your  7-day free trial by clicking the link in the   description box or scanning the QR code. OK, so, Prior to 2016 Egypt mostly relied   on external benefactors, namely Saudi Arabia,  the UAE, and Kuwait, to finance its budgetary   shortfalls. Saudi Arabia alone contributed nearly  $25 billion to the Egyptian economy between 2013   and 2016. Egypt is quite an important  country from a geopolitical perspective,  

and it has many powerful and wealthy  friends including Saudi Arabia, The UAE,   The United States and China. Egypt was in  fact the first Arab and African country to   establish diplomatic relations with the People's  Republic of China back in 1956. The Saudis,   the Emiratis and the Americans are much happier  with the current regime in place in Egypt rather   than the Muslim Brotherhood that they replaced. In mid-2016, a severe foreign exchange shortage   began to cripple Egypt’s economy, in particular  it’s manufacturing sector, which led to the   country formally seeking an IMF agreement. The  IMF program, which was struck in November of that   year, had a series of objectives: It aimed to  facilitate inclusive private sector-led growth,   increase labor force participation (especially  among women), attract foreign direct investment,   and strengthen Egypt’s macroeconomic stability.  As a precondition to securing IMF approval,   Egypt needed to raise $6 billion in external  funds, which it did thanks to financial support   from the UAE, China, and the G7. The three-year $12 billion IMF loan to Egypt  

was packaged with a reform agenda that focused  on monetary, fiscal, and structural reforms.   Monetarily, Egypt was to transition to a floating  exchange-rate and work to contain inflation.   Fiscally, the country was to reduce public debt  by cutting fuel subsidies while expanding spending   on vulnerable groups like women and children.  Structurally, Egypt was to streamline industrial   licensing, provide financing to small and  medium-sized enterprises, decriminalize   insolvency, and simplify bankruptcy laws. The devaluation of the Egyptian Pound that   occurred when they switched to a floating exchange  rate ended decades of the country wasting billions   of dollars to maintain the country’s currency  peg and stabilized the exchange rate at a new   lower level. The value of the currency  halved, but in truth that was just the   official exchange rate. The black-market exchange  rate started a lot lower so didn’t fall as much. 

While ordinary Egyptians suffered from a sudden  and steep loss of wealth as the currency fell in   value, international investors were now willing  to invest in the country and its exports were   much more competitively priced. Holidays in Egypt  suddenly became a lot cheaper attracting tourists   from all over the world. Additionally, Egyptians  living abroad began sending more of their money   home in both remittances and investments in  the country. Inflation, which had fluctuated   within a range of 8-15 percent between 2011 and  2016, rose to 22 percent in December 2016 and   remained above 30 percent for much of 2017,  “causing deep public concern and hardship.  The 2016 devaluation along with the IMF’s  reform program brought about discipline   in government spending and introduced  policies conducive to economic growth.  The purpose of the IMF is to provide financial  support to countries hit by crisis, creating   breathing room as they implement policies  that restore economic stability and growth. 

There are two types of IMF program, funded and  unfunded, funded is when IMF makes a loan and   supervises spending and unfunded is when they just  adopt that supervisory role while other lenders   make the loan. The fact that the IMF is monitoring  economic policy within a country gives confidence   to big lenders and investors, making them more  willing to step in. Especially in situations   where the economic data being reported might be  unreliable, investors are able to rely on the IMF   as they almost act like auditors of the country.  They will verify numbers like inflation figures,   current account data, reserve data and so on. The first investors to step up to the plate after   the 2016 devaluation were mostly emerging market  hedge funds who had the experience and knowledge   to understand the risks. Other investors who had  just been burned by the devaluation were keeping  

their distance. The Hedge Funds were attracted  by the high interest rates being paid on local   currency bonds and were able to negotiate  agreements guaranteeing their exchange rate   when the bonds matured. This type of agreement  is known as a repack. It’s a structured finance   technique where banks create tailored investments  for customers like hedge funds. The cash flows   from the underlying security are channeled through  a swap counterparty to create a new cash flow,   with characteristics which meet the  requirements of the hedge fund investor. 

These hedge fund investors were earning returns  of around 16% a year on these bonds, with limited   foreign exchange risk. There is of course some  tail risk – as these were not dollar denominated   bonds, where the investors could sue in New York  if they went unpaid. They fell under Egyptian law,   but this was still a very high return in the near  zero interest rate environment of the time. This  

was a big trade for emerging market hedge funds  in 2017 and 2018 and they will have made a lot   of money from it. They were often investing in  short term (so 3-month and 6-month bills), and   as they expired, the Egyptian Central Bank honored  the agreements and paid out dollars as requested.  So why was Egypt willing to pay this high return  and guarantee an exchange rate upon exit? In   particular when they were supposed to be letting  their currency float. Obviously guaranteeing   an exchange rate for certain investors is  outside the spirit of that agreement. Well,   it was expensive debt, and the country will  have paid out 300-500 million dollars in   interest per year on it, but in return, they  demonstrated their financial stability to much   bigger investors and brought in a huge amount  of Foreign Direct Investment from investors like   big oil and natural gas companies. Once those  companies invested in offshore exploration,  

Egypt could export fossil fuels bringing in  more foreign exchange which they badly needed.  Multinational corporations want to see that a  currency is stable and that the central bank   has sufficient reserves. Egypt used this fast  money – from Hedge Funds to build a track record   of stability to attract the long-term investors  like Oil and Gas companies who would only invest   after seeing a track record of repayment. A very large number of Egyptians work abroad   in neighboring countries. Egyptian workers’  remittances began to grow over this period too,   reaching $8 billion in the second quarter of  2017, up by 13 percent from a year earlier.   Bankers reported at the time that  the currency black market had all   but disappeared after the devaluation, and  banks were enjoying improved dollar liquidity.

Egypt reduced public sector expenditures under the  IMF agreement and curtailed overall spending on   subsidies. To increase revenue, the government  introduced new fees and a value-added tax.   They brought in more money by selling telecom  licenses and land. The introduction of value   added tax was particularly hard on the poor,  who were already suffering due to inflation.  There was one major aspect of Egypt’s economy that  the IMF program didn’t address – the well-armed   elephant in the room: the Egyptian military. For decades, the Egyptian military had been   allowed to engage in economic activities as a  way of reducing the official defense budget.   This was also a way of compensating senior  officers for their low pay by giving them   a way of earning additional money. It started  with the military working on land reclamation,  

the army then got involved in reconstructing  infrastructure along the Suez Canal that   was damaged during the war with Israel. This military involvement in the economy,   while small to begin with expanded greatly  when Sisi, a former army chief, took power   in a 2013 coup. As a former military man, he  increasingly relied on the military to take   major management roles in the civilian economy. The military today has a large and privileged   role in the Egyptian economy. In 2015, the  president issued a decree “permitting the  

military to form companies or partnerships  with local or foreign investors and gave   the Armed Forces a share of the revenue when  these companies were sold. He additionally   enabled them to retain ownership of the land.  Another law that was passed exempted military   businesses from certain taxes. Military-run  businesses get subsidized loans through   state-owned banks, distorting market forces. As the military was put in charge of hundreds   of projects across multiple sectors, it has  been blamed for crowding out the private   sector and discouraging foreign direct  investment which is needed to bring in   sustainable sources of foreign currency. Military-owned companies in Egypt benefit   from free labor provided by the mandatory military  draft and preferential tax treatment. Analysts say  

that they are run with the same efficiency  as the Egyptian Military, which I’m told   locals describe as “organized buffoonery.”  Without these benefits these military owned   companies wouldn’t even be profitable. It was a  mistake for the IMF to allow this to continue.  After the 2016 devaluation, Egypt’s economic  growth accelerated from 2017 through 2019   but slowed when the Covid Pandemic hit in 2020.  The entire economy was impacted but the tourism  

industry was hit particularly hard. In response,  the Central Bank began propping up the Egyptian   pound, repeating the same mistakes that led to  the 2016 devaluation and borrowing billions of   dollars to maintain the illusion of stability. To make matters worse, analysts started to   notice that the Egyptian pound was not moving  at all as many other currencies were at the   time. Investors became skeptical about the  nation’s financial position and started to   pull their money out. $5 billion of capital fled  Egypt between September and December of 2021.  In 2022 Russia's invasion of Ukraine unsettled  global investors and led them to pull even more   out of the country. Wealthy Egyptians took  advantage of the unnaturally strong currency  

and moved their money abroad too. Russia and  Ukraine were Egypt’s two main source of wheat,   as well its top two sources of tourism  dollars. The war in Ukraine would have   a huge impact on the Egyptian economy. Bread is an important food staple in Egypt   and is heavily subsidized by the government. The  price of a basic loaf has been kept at a fraction   of a cent in Egypt through subsidies since the  1980s. This cost the government around $5.5bil   per year before the prices skyrocketed  with the Russian Invasion of Ukraine. 

The war sent wheat prices spiraling, heavily  impacting Egypt, one of the world's largest grain   importers, and piling pressure on its foreign  currency reserves. The problem wasn’t just the   price of wheat, it was sourcing wheat. Egypt had  to buy wheat from Australia and the United States,   suffering higher shipping costs on top  of the higher grain prices. In a country   where 60% of the population (which is 60 million  people) live at or below the poverty line – the   price of food staples rising could cause  riots and the overthrow of the government.  Short of dollars, the Central Bank began adding  restrictions on importers. Under new rules,  

for an importer to get a bank letter of credit,  they would have to deposit the full cost of the   import transaction in advance with their bank,  plus interest, in the required foreign currency.   Only then could they apply to the Central Bank  for approval for the transaction. Applying, by   no means meant that the request would be approved. Importers became suspicious that the central bank   was suffering from a foreign currency shortage.  Their suspicions were confirmed when the central   bank allowed the Egyptian Pound to fall in  March 2022, but this time the devaluation   did not lead to dollar availability like it had  in 2016. People quickly realized that this was  

because the government was still pegging the  exchange rate but at a new lower rate (which   was still too high). This would go on cost Egypt  billions of dollars it couldn’t afford to waste,   while denying the private sector the  dollars they needed for imported goods.  That same week, Egypt submitted an official  request for another $15 billion IMF loan and   announced securing around $22 billion in  funding from the Gulf countries. This time  

none of them were grants or favorable loans. In August, Egypt’s central bank governor stepped   down and was appointed as a presidential advisor. the IMF approved a $3 billion loan to Egypt in   October, a lot less than the $15 billion  that Egypt had originally asked for. The  

IMF said the reform program it agreed with  Egypt was aimed at “pushing forward deep   structural and governance reforms to promote  private sector-led growth and job creation”.  Egypt is the IMF’s second-largest debtor after  Argentina and has become increasingly dependent   on support from Saudi Arabia, the UAE and Qatar.  China’s appetite for lending to Egypt is very   limited as they have many bad debts to deal both  domestically and abroad. Chinese banks financing  

the new administrative capital have shown  concerns over Egypt’s ability to repay its debt.  Economists are saying that Egypt been  living beyond its means and overspending   on big infrastructure projects like an  $8.5 billion dollar Suez Canal widening,   expensive military weapons systems, a  nuclear reactor, and, of course, Egypt’s   $60 billion-dollar “New Administrative Capital”. The IMF announced earlier this week that Cairo   had agreed to structural reforms to reduce the  role of state entities, including military-owned   companies, in the economy. It said that Egypt  needed “a permanent shift to a flexible exchange   rate regime to increase resilience against  external shocks and to rebuild external buffers”.  

The fund also warned that rising living costs  could cause political and social pushback.  “The durability of the shift to a flexible  exchange rate remains to be proven and the   [central bank] may face political and social  pressure to reverse course,” the IMF said.   “The proposed structural reforms will take time  to implement and deliver the intended results,   while reforms aimed at reducing the role  of the state may face resistance from   vested interests in the country.” There is a long list of difficult   improvements needed to get Egypt’s economy  back in shape. The state needs to improve   the environment for business, reduce corruption  and eliminate competition from the military to   allow space for the private sector to thrive. If you enjoyed this video, you should watch   my video on China's Belt & Road Initiave next.  Don’t forget to check out Blinkist, our video  

sponsor using the link in the description below.  Have a great day and talk to you again soon. Bye.

2023-01-17 12:41

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