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Egypt devalued its currency: Now comes the hard part
Boston - Egypt's central bank in early November took the long-awaited step of devaluing its currency as part of an IMF program hoped to help right the ship of Egypt's economy.
Since former President Mubarak stepped down from office amidst mass protests in 2011, Egypt has shown little in the way of structural reform. The collapse of growth, tourism, and a decline of foreign investment in the midst of social upheaval led to the implementation of capital controls and the overvalued Egyptian currency.
Such measures helped prop up dwindling hard currency reserves and create the illusion of stability, but also crippled the economy and was a disincentive to new foreign investment.
Finding an exchange rate more in line with economic reality is an important first step to solving Egypt's problems, but is not sufficient on its own. Egypt has a bloated public sector and a difficult business environment. The government has run fiscal deficits averaging 12% of GDP for the past five years, and outstanding debt has reached almost 100% of GDP. Its "ease of doing business" score is 122 out of 190 countries in the World Bank's rankings. Inflation has increased from about 7% to 15% over the past four years. Unemployment stands at almost 13%, including a youth unemployment rate higher than 40%.
While the devaluation has been enough to win the IMF's approval and $12 billion in funding, Egypt will still need to tap other sources of financing, like a Eurobond offering that has been under discussion, along with continued aid from its Gulf neighbors. The latter may prove increasingly difficult, as Saudi Arabia and Egypt are at odds over Syria - Saudi has backed rebel forces, while Egypt has quietly supported the Assad regime.
Therefore, in order to begin to solve its huge structural issues and convince foreign investors to participate in its recovery, Egypt must present a cogent set of structural reform policies. A credible plan to consolidate the budget deficit, pare the size of the public sector, and improve the business environment is required. Removing all capital control measures and allowing the exchange rate to move flexibly from here will also be important. Given six years' experience of such promises not coming to fruition, investors are right to remain skeptical.
Bottom line: Currency devaluations generate headlines, and in many cases, can be helpful. But Nigeria's devaluation of last June is a good example of how such a move can be a poor predictor of substantive progress. Egypt needs to overcome the skepticism it has earned from the world investment community, and needs more than a currency devaluation to do that.