Egypt’s recent decision to free-float its currency has certainly come back to haunt its importers resulting in even more suffering and hunger for an already impoverished average citizen. When the country’s President, Fatah Abdel al-Sisi, elected in 2014 after ousting Egypt’s first freely elected government amid mass protests, came under pressure to revive the economy, keep prices under control and create jobs to avoid a backlash from the public, he looked to the International Monetary Fund for a $12 billion three-year loan. As part of the pre-requisites for obtaining the loan, the country had to remove the peg it had put in force on its exchange rate and free float the currency.
A recent article on Reuters about Egypt underscores just how devastating the impact of a free float can be on economy that imports much more than it exports. Here is what I deduced from the article;
- Bankruptcy
Businesses who take out foreign loans to fund imports face an imminent bankruptcy as they are not able to obtain forex to fund new inventory despite seeing their nominal loan balance double due to the currency depreciation.
- Loss of millions of jobs
With bankruptcy comes more job losses for the economy. In the story, affected importers threatened to shut down businesses which effectively means more workers will be disengaged.
- Shortage of essential goods
Another effect of the free float is an imminent shortage of essential materials such as beans, wheat and other grains which are staples for citizens. Interestingly, the Egyptians combined the free float with a newly introduced Value Added Tax, reduction of electricity subsidies and sharply increased import duties, all in the space of a few months.
- Bank losses
Even banks are likely to be affected by the free float as many importers are ready to forfeit it all as even the collateral used to secure the loans are insufficient to clear the shortfall arising from the free float. Egyptian Bankers had estimated the accumulated overdrafts at near $10 billion, which is likely to lead to an increase in bad debt.
The lesson here is clear; a free float is never a silver bullet and not the solution to a country’s currency woes. Floating a currency only takes away government control of the foreign exchange market leaving it to the market to determine its true value. The hope is that a free floating currency will eventually attract the right foreign investors whilst stimulating local demand for goods and services. Even that is a long shot if the government does not take a long term view at diversifying the economy, funding infrastructural developments and cutting down the cost of doing business.
