Currency Economics - Egypt Devalues their Exchange Rate

In this short video we look at some of the possible benefits and costs of the decision by the Egyptian government to devalue their currency against the US dollar.

In November 2022, Egypt devalued their currency against the US dollar by 15%.

The country faces an economic crisis and is dependent on IMF financial support. It faces a foreign currency shortage, with the IMF agreeing to a new $3bn loan package. Egypt is now the second biggest debtor to the IMF after Argentina. In total, it owes multilateral institutions $52bn.

Question:

Assess the extent to which a devaluation of their currency will improve macroeconomic outcomes for the Egyptian economy.

Background on the Egyptian Economy

• GDP Annual Growth Rate: 5.4%
• Unemployment rate: 7.4%
• Inflation rate: 16.2%
• Interest rate: 13.25%
• Current account: (-) 4.6% of GDP
• Government debt: 87.2% of GDP
• Budget deficit: 6.1% of GDP
• GDP per capita (US$,PPP): $12,121
• Remittance inflows: $8 billion pa
• Tourism revenues: $13 billion

Benefits from a currency devaluation

A devaluation improves the price competitiveness of Egyptian exports such as textiles, renewable energy and also tourism. If the value of exports rises, this might lower the trade & current account deficit and help to stem the loss of foreign exchange mentioned in the extract

Devaluation in theory can stimulate economic growth and employment. For example, a rise in overseas tourists coming to Egyptian resorts is an injection of AD into their circular flow which in turn might lead to an expansion of SRAS, increased employment and a fall in unemployment from the current level of 7.4%. There might also be positive multiplier and accelerator effects adding to growth.

A weaker currency means that remittance inflows measured in US dollars will be worth more within the Egyptian economy, adding to household disposable income.

Risks from a currency devaluation

• The main risk from a currency devaluation is that it will cause a surge in demand-pull and cost-push inflation in Egypt when inflation is already 16%. Imported food, energy and raw materials will become more expensive, and there is a risk of a wage-price spiral. High inflation will reduce real incomes and threaten living standards.
• Devaluation also increases the real value of external debt measured in US dollars. Egypt already owes $51 billion and this will be harder to repay. Overseas investors may also demand higher interest rates on new issues of debt which is inevitable given that Egypt is running a fiscal deficit of more than 6% of GDP.
• The risk of further currency devaluation might lead to capital flight as investors become nervous of buying assets or lending money.