Another piece on the Egyptian economy and another apparent paradox that seems unsolvable. This time the article came under the title: “The Economic Threat to Egypt's Stability” and the subtitle; “Getting the economy back on its feet is as important for security as transferring power to civilian leadership.” Written by Dalibor Rohac, the article was published in the Wall Street Journal on December 6, 2011.
The two pieces of information that get you thinking are the following. First, there is this: “The country's debt-to-GDP ratio is close to 80%”. And then there is this: “The elephant in the room is ... the military, which controls … 40% of Egypt's economy...” Well, what is known at this time is that the economy of Egypt is humming at the yearly rate of 1.5 trillion Egyptian Pounds (EP). The debt being 80% of this value, it amounts to 1.2 trillion EP. But if the military -- which is supposed to be the invisible elephant in the room -- represents 40% of the economy, it means that the 1.5 trillion value represents only 60% of the “real” economy. In turn, this means that the economy comes up to 2.5 trillion EP. If this is the case, then the 1.2 trillion debt comes to only 48% of the GDP; a far cry from the 80% mentioned earlier. But what is going on that would create a discrepancy like this?
This is a simple question that merits a simple answer. It is this: “When it comes to evaluating the wealth of nations, everything is done wrong.” If it were not, we would not be in the situation we are today, a situation where we are hit by a surprise each and every day. Who but a lunatic would have dared to predict a decade ago that a good part of Europe will be teetering on bankruptcy or that the Chinese will be buying more cars than the Americans? Yes, there is wisdom in the saying: “Figures do not lie but liars can figure.” And when on top of this, the liars you listen to and rely upon don't even know what they are lying about, you find yourself swimming in a pool that has become a big mess. And what can be bigger than America's indebtedness to China, its new arch-rival, and like the situation in Europe?
Money may or may not be at the root of all evil like goes a famous saying. But when it comes to evaluating the wealth of nations and you base the evaluation on the output of a country as measured by money, you definitely go to the root of the erroneous findings that you will be making, and the root of the bad conclusions that you will be reaching. And there are reasons for this; it is that when (a) you have several markets, each of which changes its “fair value” by the very transactions that take place within it; when (b) the transactions that take place do so based on the law of “supply and demand”; and when (c) you “mark to market” what you believe is the output of the nation you are evaluating -- you are bound to make the mistakes that will hurt you more than anyone else because you will be the one to use the false information, and make decisions based on that.
Let us take an example to see what all of this means. Like everywhere else in the world, the value of Egypt's currency as compared to the other currencies is determined in the local markets by the people who have a stake exchanging currencies. But who in Egypt has a stake exchanging the Pound with other currencies back and forth? Well, the people who buy goods or services from abroad do exchange the Pound for say, the American dollar given that the latter is the most liquid currency in the world. On the other hand, the people in Egypt who sell goods or services abroad and get paid in dollars, do exchange the latter for Egyptian pounds. And of course, there is the Central Bank of Egypt whose mandate is to maintain price stability for the goods and services produced locally as well as those which are imported because they too have an impact on the local prices. Hence the need to maintain the exchange rate between the currencies as stable as possible which is what the Central Bank does by buying and selling the Dollar; i.e. by artificially manipulating the supply-demand equation.
This is simple enough but who are the Egyptians that buy goods or services from abroad? They are mostly the importers of raw material that Egypt does not produce enough of. They are the base metals and some food staples such as wheat and sugar. The country also imports high end production machinery for its factories as well as sophisticated equipment for its hospitals and laboratories. And although Egypt has the potential to build enough cars to satisfy the local market and export some, it imports twice as many cars as it produces and exports almost none. The reason is competition from abroad and policies that were put in place long ago. All in all, the price tab for these imports comes up to 60 billion dollars a year.
As to the exports, Egypt receives a great deal of money from services it exports such as tourism, the Suez Canal, the Suez-Mediterranean (SUMED) pipeline and the remittance from expatriates. It also exports agricultural products, processed foods, medicine, some metals and minerals, manufactured goods such as car parts (but not fully assembled cars), textiles, furniture, appliances, electronic equipment and a great deal of petrochemical products such as plastics, fertilizers and insecticides. All in all, the price tab for these exports comes up to a little more than 60 billion dollars a year. And this gives the country a small surplus which allows it to build up a reserve of foreign currencies.
If we ignore the inflow and the outflow of capital, we see that because there is a rough balance between the imports and the exports, the Central Bank of Egypt does not have much of a problem keeping the value of the EP stable in relation to the dollar. But then, what should be the real value of the EP? It is currently valued at about 6 pounds to the dollar or a little under 17 cents. Is this a fair value or is it unfair? Whatever the answer to this question, it is here that you open a Pandora's box from which you can pull any myth you desire. But there is the reality that to determine a rate of exchange between two currencies, you must have a point of reference against which the two are compared. That is, you need a mark-to-market operation that can be applied equally to both currencies. And it is here where the problem begins.
Look how things work out. If you are an Egyptian living and working in Egypt, you can buy an average condominium apartment for 150,000 EP. If you are an American living and working in America, you can buy a similar apartment for 150,000 dollars. You determine that the fair value for the Egyptian Pound should be parity. That is, one EP should be exchanged for one dollar. You now look at something else: In Egypt, you buy a loaf of pita bread for one piaster which is a hundredth of an EP or 0.17 US pennies. In America, you would pay at least 17 cents for a similar loaf. And this puts the value of the EP at 17 dollars believe it or not. So now, you look at yet another example: In Egypt you buy a car for 150,000 pounds whereas in America you would pay 25,000 dollars for a similar car which puts the exchange rate at 6 EP for a dollar; the value that is currently set by the market. And you ask yourself: which is the real EP? Is it the one that exchanges for 17 cents? Or the one that exchanges for a dollar, or the one that exchanges for 17 dollars?
How does all this help us understand what is happening in Egypt, and help us determine what might unfold in the current circumstances as compared to what Dalibor Rohac says might happen? In fact, he takes up three points. The first is the balance of payment which he says has come close to a crisis. The second is the debt-to-GDP ratio which he says is getting worse as shown by a deficit that will reach 9% of GDP. And this is happening, he says, because of a system of subsidies that is neither sustainable nor fair. And the third point he brings out is the matter of the military's control of a large chunk of the economy.
We can simplify the matter considerably when we view an emerging economy such as that of Egypt as being made of two parts. There is the part that functions as if the rest of the world did not exist; and we call it the internal economy. It can be stagnating or it can be growing organically as if it were experiencing an industrial revolution of its own. It has a currency that is divorced from the rest of the world, one whose value is determined in relation to the amount of the locally produced goods and services that the currency can buy. The other part of the economy is the business which is transacted in foreign currencies; and we call it the external economy. As long as the inflow and the outflow of foreign currencies remain in balance, there will be no spillage between the two parts. But if not, the internal economy will be impacted by the external economy. However, the smaller the population of the country, the more that the external economy will affect the internal one. A small surplus or deficit will swing the economy considerably one way or the other.
Because Egypt has a large population, a drop in the inflow of foreign currencies will have a small impact on the country's ability to grow the internal economy. When this happens, Egypt may have to postpone buying some of the equipment it usually buys or it may have to curtail the importation of foreign cars for a while but this will do little to dampen the economic activity of the nation. Thus, the GDP can still grow at a clip that prompted Rohac to write the following: “Before the revolution … the IMF once called Egypt an 'emerging success story' for its impressive growth rates.” When things stabilize in Egypt, that performance can be repeated.
Also, if we believe that the debt-to-GDP ratio is smaller than the purported 80% which is most probably the case, and if the country will go back to the high growth rate it used to score which will most probably happen, then the problem of subsidies will become manageable as it has been managed for several decades.
A revolution is a tough period for a country to go through. Egypt is going through one now. But this is a country that has been around since the beginning of recorded history. It lived through all sorts of hardships and survived them all, coming out of each of them stronger and more resilient than ever before. Egypt will do so again; I am confident of that.