1. E GYPT : Reforms for Promoting Economic Growth The Dollar to Pound Parody 2004-2010 By: Dr. Khaled F. Sherif

2. Background: Economic Strengths Large GDP = 38th in world (2001) Sound macro fundamentals: Large pool of educated and skilled workers Inflation under control Fiscal deficits manageable Debt profile sound Growing exports, including non-oil and services High levels of reserves

3. Background: Economic Weaknesses Low gross national income, even by regional peer group. Examples: Among 13 MENA countries reviewed, higher only than Morocco, Syria and Yemen Lower than Algeria, Iran, Israel, Jordan, Lebanon, Oman, Saudi Arabia, Tunisia, UAE Only 14% relative to Portugal (lowest among EU) High levels of underemployment Weak human development indicators Low levels of literacy, particularly among women (40%) Problems with health care access and affordability

4. The Egyptian Pound vs US Dollar (Dollar Supply and Demand) Imports Subsidies Spare parts Repatriation Travel Hedging Capital Investment Remittances Oil/Natural Gas Tourism Foreign Investment Exports Interest rate spread $4.2 bln $3.1 bln $1.1 bln $800 mln $1.4 bln --------- $10.6 bln+ Dollar Demand $3 bln $1.2 bln $2.7 bln $400 mln $1.2 mln --------- $8.5 bln Dollar Supply

5. Dollar Demand Trends Imports Hedging Capital Investment Spare parts Travel Subsidies Repatriation ?

6. Dollar Supply Trends Remittances Interest Rate Spread Tourism Exports Oil/Natural Gas Foreign Investment ? ? ?

7. Current Trend Implications As it stands, Egypt maintained a dollar deficit in excess of $2.6 billion in 2003* This serves to explain the recent surge in the price of the US dollar; and suggests increasing further declines Moreover, there has been an inability on the part of Egypt to fulfill its potential in attracting dollar inflows Example: At $400 million, FDI represents a shocking $5.7 per capita * Figures for hedging and interest rate spread were not available

8. Projecting Dollar Demand vs Dollar Supply The Impact of Current Trends Price Quantity Supply (S) LE 7.00= US$ 1.00 Demand (D) Q Current Outlook P' D' Q' Demand Increase

9. Projecting Dollar Demand vs Dollar Supply The Impact of Current Trends Price Quantity Supply (S) LE 7.00= US$ 1.00 Q Demand (D) Current Outlook Q' S' P' Decrease in Supply

10. Projecting Dollar Demand vs Dollar Supply The Impact of Current Trends Price Quantity LE 7.00= US$ 1.00 P' D' Q' S' LE 7.00= US$ 1.00 (P) Q Resultant Outlook: Increase in Price; Decrease in Quantity Supply (S) Demand (D)

11. The Impact of Current Trends: Case Example: Subsidization Currently, the Egyptian government subsidizes a number of goods, including: Cooking OilSugarBread Lentils Meanwhile, as the population continues to increases, subsidies are likely to increase in greater proportion:

12. The Impact of Current Trends: Case Example: Subsidization Increasing subsidization decreases the supply of dollars within the system, resulting an increase in its price: Price Quantity Supply (S) LE 7.00= US$ 1.00 Q Demand (D) Q' S' P'

13. Increasing value of the US Dollar * Estimate 1980: $1= LE 0.73 1985: $1= LE 1.10 1990: $1= LE 2.30 2005*: $1= LE 7.20 1995: $1= LE 3.30 2000: $1= LE 5.20

14. Diminishing value of the Egyptian Pound 1980: 1LE= US$1.36 1985: 1LE= US$0.91 1990: 1LE= US$0.43 1995: 1LE= US$0.30 2000: 1LE= US$0.19 2005*: 1LE= US$0.13 * Estimate

15. Diminishing value of the Egyptian Pound Net Worth Comparisons The following table and graph illustrate the decline in value of LE 100,000 between 1980 and 2005: YearUS$ Equivalent 1980 136,986 1985 90,909 1990 43,478 1995 30,303 2000 19,231 2005* 13,889 * Estimate US$ Equivalent

16. The substantial damage experienced by the Egyptian pound is reflected in the following example: An individual/organization who held $100,000 in 1980 and converted that to Egyptian pounds would have approximately the equivalent $10,000 today Meanwhile, an individual/organization who purchased $100,000 in 1980 and maintained it in US currency would have increased their investment by almost ten-fold (from LE 73,000 to approximately LE 700,000) Meanwhile, The IMF estimates that the value of deposits held by Egyptians overseas is approximately US$ 77 billion By placing this currency in the Egyptian financial system, it would have a multiplier effect of 5! The fear is that if this continues, this will spur increased dollarization, as has been the case with dramatic capital flight from Mexico and Argentina Diminishing value of the Egyptian Pound Capital Flight Implications

17. Reform Strategy: 2004-2010 I. Financial Sector Reform Program II. Investment/ Tourism Promotion

18. Financial Sector Reforms: Privatization Finalize privatization of state banks by 2006 4 large commercial banks 2 specialized financial institutions 11 joint venture banks Use subsequent years for post-privatization resolution as needed Non-performing and restructured loan collection

19. Financial Sector: Strengthening Intermediation and Achieving Stability With a floating exchange rate regime, this means ensuring hedges are properly used More efficient banks will be able to pay higher real rates to depositors if they need the funds Risk-seeking banks have greater need for funds, making creditor rights essential for increased intermediation Strengthen the banking environment to reinforce public confidence in deposit safety Minimum capital increasing Prudential norms tightening Stricter loan classification and tougher asset valuation standards means banks will have more pressure to sustain adequate capital adequacy ratios Increased investment will be needed for increased efficiency to bolster earnings and exceed minimum capital and CAR requirements Combine privatization and deposit safety efforts as part of investment approach

20. Financial Sector: Prudential Framework and Enforcement Raise minimum CAR to 12% in 2007 Articulate clear thresholds that trigger specific corrective actions as CARs fall below prudential requirements Ensure tax rules for provisioning are consistent with international standards Strengthen CBE mandate and stress testing capacity Monitor banks risk management systems, internal controls, and internal audit

21. Investment/Tourism Promotion Policy and Institutional Checklist Macroeconomic stability Credit, investment and financial sector policies that promote intermediation Labor market flexibility Effective judiciary and legal enforcement Low barriers to entry AND exit Good governance Open trade and investment regime

22. The Way Forward… Devaluation is not a choice - it is a reality (an outcome) Even with the best economic reform scenarios, the pound will fall sharply against the dollar To stem the tide of devaluation, we have to act now: A serious financial sector reform program is needed Renewed investment will be required in trying to push exports Tourism must take the lead in the development effort Foreign direct investment must be tapped to its potential and cannot persist at $5.7 per capita