J curve that failed to shape up in Egypt

In the months after Egypt’s 2011 uprising, economists and bankers began to speak about the J curve.

Even though the economy had dramatically weakened after the collapse of tourism and the flight of foreign and Egyptian investors (the first part of the J on the charts), the theory was that investors would come rushing back with pent-up demand to make up for lost time once a stable government was in place, leading to a sharp rebound in GDP (the second part of the J).

But nearly four and a half years after the uprising, and a year after a relatively stable government has been in place, the rebound has still not happened.

It is not hard to figure out why. The central bank’s currency policy is choking the economy.

Ask investors why they are not bringing money into the country, and most will say it because of the currency. A few, especially in money markets, hesitate to put dollars into Egypt’s overvalued pound when a devaluation seems all but inevitable. Even more say they are afraid that once their dollars are converted into pounds, they will have a heck of a time getting them back into dollars if they need to.

This is because the central bank continues to peg the pound at a seriously unrealistic level against the dollar. Even though the value of the pound dropped dramatically in 2011 with the loss of demand from tourists and investors, the bank has not let the official rate weaken anywhere enough to reflect that.

People with dollars don’t want to buy overvalued pounds, and people with pounds are trying to buy dollars. As a result, the central bank is forever short of foreign currency.

The policy has succeeded in hurting both exports and imports at a time when both should be rising.

Exports have fallen because the pound has remained relatively strong against the dollar, which has been strengthening, while the currencies of Egypt’s competitors have been weakening. Why buy oranges or textiles from Egypt, whose currency has only fallen to 7.63 to the dollar from 5.82 just before the uprising, when you can buy the same products from nearby Turkey, whose currency has had a bigger percentage fall, plummeting to 2.68 to the dollar from 1.56 in the same period?

The same goes for imports. Egypt’s central bank has made it increasingly difficult for importers, who used to collect dollars on the black market and deposit them in banks for their overseas purchases. But in February, the central bank limited the amount businesses could deposit to $50,000 a month, stifling their ability to pay for imports. This had led to a serious decline in foreign trade.

According to preliminary central bank statistics, non-petroleum exports in the first three months of this year fell 10 per cent from the same period a year earlier to $3.18 billion, while non-petroleum imports fell 5.3 per cent to $11.58bn.

The decline seems to be accelerating. According to my own calculation using statistics on the finance ministry website, non-petroleum exports plunged to 9.7bn pounds in April from 19.2bn in April last year.

The deterioration in exports look set to continue. Al Borsa newspaper two weeks ago quoted officials at the government General Organisation for Export and Import Control as saying that May exports were also down (although they didn't seem to subtract out petroleum exports, which have a separate dynamic because of the sharp fall in oil prices over the last year).

One of the few growth industries resulting from the artificially high pound is the introduction of new rules and regulations to stop people from buying dollars. Ever ingenious, Egyptians have worked out ways to find dollars, such as by using brokers to buy foreign currency from Egyptians working in the Arabian Gulf countries in exchange for pounds back home, or by opening multiple bank accounts for the dollars they buy on the black market.

Among the newest rules is that banks are being told to phase out $100 bills and give clients $50 and $20 bills instead, presumably because the bulkier bundles will be harder for black market dealers to handle.

Yet another restriction was put in place on Monday. The stock exchange ordered that Egyptian investors who buy global depository receipts in Egyptian pounds must receive their returns in pounds.

The ever-expanding restrictions are taking an unacceptable toll on growth.

One of the most widely watched measures of business activity is the Purchasing Managers Index (PMI), which is calculated from a monthly survey of several hundred private sector firms in Egypt. The PMI had been in positive territory in most months since November 2013, after curfews imposed in the wake of Mohammed Morsi’s removal from power were lifted and a semblance of normality returned.

But in every month since January, when the central bank imposed its new currency restrictions, business activity has contracted, according to the index.

Patrick Werr has worked as a financial writer in Egypt for 25 years.

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