Egypt and Nigeria have a lot in common. They are Africa’s No. 2 and No. 3 largest economies with a strong natural resources bases. Both have seen tough economic times recently. Both are led by strong military men and both are attempting to meet the requests of international bodies such as the International Monetary Fund (IMF) with subsidy reductions and currency floating.
But if the market’s recent response to Egypt’s currency devaluation is any indication, that’s where the similarities end.
Egypt floated its currency earlier this month in a move to meet a demand set by the IMF in exchange for a $13 billion loan over three years.
The Egyptian pound accordingly dropped nearly 50 percent. A shortage of dollars in the Egyptian economy was applying severe downward pressure on the Egyptian pound. A rare opportunity for the pound devaluation surprisingly arose when the dollar dropped on the unofficial market from an all-time high of 18.25 pounds to approximately 13 pounds.
Why did Egypt take this measure?
The Egyptian economy has struggled since the revolution in January 2011. The macroeconomic instability, political uncertainty and ongoing terror concerns have weighed on the Egyptian economy. The subsequent effects – rising unemployment and foreign currency shortages – perpetuate the problem.
Propping up the Egyptian pound against the dollar appeared a short-term measure to address some of the issues. But the Egyptian central bank governor had already characterized the policy as a “grave mistake” as it prevented investors from truly assessing the market opportunities and risks as well as punted the football on the economy digesting true costs of goods and services.
It is fair to assume that a free float may now create an avenue for the government to lighten the capital controls, including currency transfers abroad and travel withdrawals for the average Egyptian. That said, it also appropriately fair to assume Egypt’s poor will bear the burden of the devaluation as it will hit a significant amount of imported goods or imported inputs used in local goods.
Boost to Egyptian markets
The first sign of confidence to the Egyptian devaluation was a near-9 percent gain in the main Egyptian stock market the following Thursday. Early indications point to increased investment in the country with investors able to put stakes in the ground around economic trajectories and true underlying valuations.
The Egyptian Central Bank also increased interest rates by 3- to-14.75 percent. All these actions generally point towards Egypt’s increasing comfort with the IMF’s perspective on the Egyptian economy.
Yet true acceptance of terms will require a cut to subsidies on household electricity, fuel and sugar among other things. Economists differ on the full effects on such cuts. The IMF expects a strengthening of the economic foundation in Egypt with long term upside. Some economic critics argue that the market is not prepared to digest these cuts in a single gulp, adding that slowly phasing them in may be more appropriate. Still, despite diverging perspectives on the methodology, most economists buy the long-term upside.
Why is this not the same in Nigeria?
Nigeria freely floated the naira back in May 2016, with the official peg of 197 naira per $1 now settling around approximately 300 naira on the official market. The currency, six months later, is less of a debate. Yet many locals still prefer to hold money in dollars with remaining fears on the currency, most locals often pointing to greater concerns about the Nigerian economy and its ability to rebound.
The Nigerian economy is in recession. The National Bureau of Statistics (NBS) recently announced that the Nigerian economy had contracted 2.2 percent year-over-year in the third quarter of 2016. Foreign reserves have declined dramatically from $37.3 billion in June 2014 (when oil prices were still high) to $25 billion in September 2016.
President Muhammadu Buhari continues to argue that Nigerian economic recovery is around the corner. As examples of the uphill climb to recovery, many skeptics point to the debt and government spending tied to expectations of incessant high oil prices and, as a result, the lack of economic diversity on the country’s financial books.
The second major distracting factor in the Nigerian equation may simply be credibility. Most investors prefer a fully floated naira and see the May 2016 float as a start. But those same approving investors are doubtful the government can achieve the “fully floated” part of the equation. New currency limitations on holding dollars in the country fall in line with other currency controls the country has offered up in the past.
The Nigerian Central Bank says it is mainly focused on unleashing the growth opportunity for the economy by forcing individuals to not operate in (or simply hold) dollars in the country. The results point however to a still inflated naira. Officials and some investors worry a fully floated naira could take a great hit in the initial few months.
Yet, if the Egyptian story is any indication or lesson for success, letting the naira hit rock bottom on a fully-floated basis will generally result in greater investment in the country and consequently a recovering naira over time.
As one local put it, Nigeria should be able to do this (and many other things) better than Egypt. Maybe this is the opportunity to back up such bold statements.
Kurt Davis Jr. is an investment banker with private equity experience in emerging economies focusing on the natural resources and energy sectors. He earned a law degree in tax and commercial law at the University of Virginia’s School of Law and a master’s of business administration in finance, entrepreneurship and operations from the University of Chicago. He can be reached at [email protected]