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Egypt economic crisis: Four ways currency flotation will cause more problems than it solves

The government effectively confiscated 65 percent of people’s savings in one day and then compensated them with 5 percent over a year

The Central Bank in Egypt had no choice earlier this month but to float the Egyptian pound and leave its value to be determined by the market. 

This drastic choice became necessary because the Central Bank reserves no longer contained enough foreign currency and gold to support the local currency, nor enough to meet the increasing demand for the US dollar. 

In just a matter of hours, Egyptians lost over 65 percent of the value of their money

The supply of hard currency had also decreased as a result of the deficit in Egypt’s trading budgets and the collapse of the tourism sector.

Floating the currency, a key demand made by the IMF to loan Egypt $12bn, is supposed to help build up reserves of foreign currency to attract foreign investment and give Egypt enough cash to import key staple items, like food and fuel.

The reasons behind the pound’s collapse are, of course, well known. The much more important question is what crises will follow the pound’s collapse and how much Egyptians will be affected by the flotation?

On 3 November, the first day the pound was floated, its official exchange rate against foreign currencies decreased by 65 percent. At time of publication two weeks later the Egyptian pound had fallen to 17.54 to the dollar, down from 8.78 to the dollar just before the float.

In just a matter of hours, Egyptians lost over 65 percent of the value of their money. In other words, someone with 1,000 Egyptian pounds, which was worth around $112 (based on the official market prices) before the flotation now has only $55 worth.

So today, Egyptians see their money evaporating in their pockets, but how bad will it get? Here are four unfolding scenarios that are a direct result of the collapse of the exchange rate and the subsequent flotation:

Bigger gap between rich and poor 

The pound’s collapse will lead to a large increase in inflation in Egypt, which means an increase in the unequal distribution of wealth among its people. 

Wealthy people and businessmen who keep their money in foreign currency will see their financial assets increase while the poor will become poorer and the middle class will fall below the poverty line. Egypt will witness the purchasing power of its very poorest being eaten away.

Insane price rise 

The decrease in the value of the pound by 65 percent does not mean that prices will increase proportionally. In fact, the price of a number of basic products and imported goods will increase by 200 to 300 percent. 

As a result, millions of local workers will slip into severe financial and economic hardship as there are no companies, institutions or public or private bodies that can raise its employees’ wages to match the rise in prices. 

Wealthy people and businessmen who keep their money in foreign currency will see their financial assets increase while the poor will become poorer and the middle class will fall below the poverty line

Raid on savings: Most importantly, the decision to float the pound will have a huge impact on Egyptians’ money and savings in local currency. The Central Bank raised the interest rates on the pound by only 5 percent.

The 5 percent rise in interest rates on deposits will be paid a year from now while the bank account holders have lost 65 percent of their money’s value in one day. The government effectively confiscated 65 percent of people’s money in one day and then compensated them with 5 percent distributed over a whole year!

A view of a new waterway at the Suez Canal during its opening ceremony on August 6, 2015, in the port city of Ismailiya. (AFP)

The Suez Canal investment was a swindle

After the floating of the Egyptian pound, it has become clear that the 1.1 million Egyptian citizens who rushed to buy investment bonds in the Suez Canal have been swindled. 

They paid the government 64bn Egyptian pounds, on the basis that the annual interest rate on the investment bond in the Suez Canal was only 12 percent, and the original capital should be refunded after five years (2019). The 64bn Egyptian pounds were worth $9bn in 2014. Today, they are worth less than $4bn.

In addition to the fall in the exchange rate, the annual interest on the investment bonds in the Suez Canal is 12 percent while the interest rates on a traditional bank bond in Egyptian pounds exceeds 15 percent.

The 1.1 million Egyptian citizens who rushed to buy investment bonds in the Suez Canal have been swindled

Thus, these investment bonds are seeing their value decrease and evaporate, bringing their holders a definite loss. Consequently, 1.1 million Egyptians have seen their money vanish in this bad investment. 

It is necessary to clarify here that the problem with the Suez Canal investment bonds is that they differ from traditional bonds issued by governments in different countries across the world.

The Suez Canal bond cannot be circulated, sold or transferred, which means the bondholder must wait five years to regain his original investment. During those five years, the bond makes 12 percent annually in interest. 

Thus, investing 100 Egyptian pounds will give a return of 160 pounds after five years whereas in reality the bondholder paid $14 in 2014 and will get back only $10 five years later!

Float is no solution to crisis

To conclude, the floating of the Egyptian pound is merely a desperate attempt to be seen to be taking action. It is not a solution for Egypt’s economic crisis. 

The coming crises will be even more intense as the prices of food, fuel and services will rise at dizzying rates and the population’s economic condition will deteriorate. 

Egyptians will witness the pound’s purchasing power deteriorate and millions of Egyptians will fall below the poverty line while money, savings and local investments will gradually evaporate. 

Those who clamoured to invest in the Suez Canal in 2014 today face the loss of their capital and profits at the same time. For those 1.1 million Egyptians, the interest rates on savings accounts and bank bonds – though in no way commensurate to the massive exchange rate losses they have now suffered - are better than the profits from the investment bonds they hold. 

Image: An employee counts banknotes at currency exchange shop in the Egyptian capital Cairo on November 3, 2016. Egypt floated the country's pound as part of a raft of reforms, after a dollar crunch and exorbitant black market trade threatened to grind some imports to a halt. (AFP)