In a surprising move, the Egyptian Prime Minister, Atef Ebeid, told a business roundtable organized by the British weekly The Economist, that effective immediately, namely, January 29, "there will be a free market for foreign exchange." The floating[1]of the Egyptian currency means that the government has abandoned the "managed peg system" of the central rate and is allowing forces of supply and demand to determine exchange rates.[2]

Almost immediately, the Egyptian pound lost 17% of its value[3] and, with unfailing speed, the First Deputy Managing Director of the International Monetary Fund, Ms. Anne Krueger, issued a statement hailing the decision of the Egyptian authorities "to adopt a fully flexible exchange rate regime." "Such flexibility," added the IMF statement, "is important for the continuing efforts of the authorities to introduce structural reforms to promote economic efficiency and to stimulate trade and investment."[4]

The Reasons behind the Floating of Egypt's Currency

While the timing of the announcement by Mr. Ebeid was surprising, the reasons for it were compelling. The decision to float the currency reflects two admissions by the Egyptian government:

First, the Central Bank of Egypt (CBE) was no longer able to meet the demands of the market for dollars. The foreign currency reserves have been in a steady decline in the last three years as the CBE continued to fight a rearguard battle to arrest the assault on the Egyptian pound by market forces. Expanding imports and declining exports as well as diminishing revenues from the Suez Canal and remittances from Egyptians working overseas have drained a considerable amount of the foreign currency reserves. During this period, these reserves have declined from $20 billion to $13 billion while the pound has lost 40% of its value since November 2001.

Second, the black, or parallel, market, rather than the CBE and the managed peg system, was largely responsible for setting the real exchange rate of the pound. For months, the buy and sell price of the dollar against the Egyptian pound has been over LE5.2 [LE stands for Livre Egyptianne, or Egyptian pound, which was historically used to distinguish it from the British pound] on the black market. The official price had remained steady at around LE4.6.[5] The Egyptian banks however charged their customers 12-13% as administrative fees which, in effect, represented the differential between the official and the actual rate of exchange.

The Implications of the Floating

Like most changes in major economic policies, the floating of a national currency, including the one in Egypt, is fraught with both prospects and dangers.

I) On the prospects side, the floating of currency:

• Reduces speculative fervor and brings equilibrium into the exchange rate regime.
• Forces the market to adjust to greater competitive forces.
• Enhances long-term structural reforms in the economy by weakening the heavy hand of bureaucracy and government controls.
• Encourages exports and foreign investments.
• Releases hoarded foreign currency. This already took place on the second day of the new policy. Many Egyptian banks were forced to open additional windows to serve clients who sought to convert their hoarded foreign currency into pounds.
• Benefits the tourism industry which, in Egypt, is a major provider of foreign currency.
• Fulfills an obligation toward the international financial institutions that have insisted that privatization, market liberalization, and currency floating are key conditionalities for renewed economic assistance.

II) The dangers arising from the floating of currency are equally significant:

• Inflation represents the biggest danger. Egypt relies heavily on the import of agricultural commodities to feed itself and on raw material for its factories. It was reported that, the day following the floating, the price of clothing went up 70%, cigarettes 40%, pharmaceuticals 65%, cars 35%, and tuna prices increased 50%.[6] Some of these prices will roll back after the immediate shocks but the upward trend is inevitable.
• The purchasing power of most Egyptians, other than those who fall in the top 20 percentile, will erode. The ability of the government to increase its subsidies of key commodities or to increase the salaries of employees and pensioners is already limited by rising budget deficits.
• Risks of social unrest and political instability. It happened in Egypt in January 1977 when, when under pressures from the international financial institutions, subsidies were reduced and the price of bread spiked. Twenty-one members of the Egyptian parliament from the opposition parties have already questioned the government decision.[7] It is hardly surprising that in the government regulated press of Egypt not a single article has raised the risk of social or political unrest.

The Devil is in the Details--The Role of Gamal Mubarak

The floating of the Egyptian currency would have been of less significance had it not been for the identity of the forces behind it. The attribution made by the Egyptian government daily Al-Ahram, was that this significant economic measure is the brainchild of the governing party's policy secretariat established and headed by Gamal Mubarak, the son of President Hosni Mubarak.

According to the newspaper, "an important transformation has occurred in the eighth conference of the National Party [the ruling party] which has contributed to the political and social life brains that consider (Egypt First)." These brains have planned the future of Egypt's policies; first among them is the new monetary policy. The article concludes with the statement:

"There is a new spirit and a firm stand, and no one can stop the march of reform after today as long as we have new brains whose primary concern is the interest of Egypt and of the Egyptians and will overcome difficulties with a courageous heart and solve the problems with awareness and caution."[8]

It is a significant attribution which must be seen as part of concerted efforts in Egypt in recent months to bring Gamal Mubarak into the forefront of the political arena and prepare him for higher heights. It is in this context that his visit to Washington this week as the head of large Egyptian delegation must be considered.

*Dr. Nimrod Raphaeli is Senior Analyst of MEMRI's Middle East Economic Studies Program.