On August 11, 2015 the Chinese government unexpectedly devalued the renminbi by 2%. Despite the modest change in the value of the currency, the move negatively impacted stock exchanges around the world. The move also resulted in a depreciation of emerging market currencies, with declines ranging from 20% to 50% since June 2014. The devaluation occurred after economic data was released pointing to weakness in the Chinese economy, evidenced by the 8.3% drop in exports in July and 0.8% drop year-to-date. In the following section I will attempt to assess the implications of this Chinese crisis on emerging economies, with a particular focus on Egypt.
During the 2008-09 global financial crisis, China started a quantitative programme worth $600bn. This investment programme was directed towards new productive capacities, big real estate and large infrastructure projects. As a result, debt mushroomed from 130% of GDP in 2008 to 280% currently.
However, this investment boom also necessitated the importation of raw materials from other emerging countries in increasing quantities, creating economic growth in those countries. These countries, in turn, invested heavily to increase their export facilities and meet Chinese demand, largely financing these investments with dollar borrowings, taking advantage of the low cost of financing due to the near-zero interest rate policy of the US. This borrowing was aided by the belief that Chinese growth would continue forever. As a result, outstanding emerging market debt doubled since 2010, reaching $4.5trn. However, unlike in the debt crisis of 1997, most of this debt has been issued by the private sector, not the government.
So, how does all of this affect the Egyptian economy? First, Egypt will not be impacted like other emerging markets that have large exports to China. On the contrary, Egypt will benefit from the global decline in the prices of industrial commodities and capital goods. However, it may suffer from the overall slowing of the global economy and the contraction of global trade. Second, a continued weakness in the price of oil, even though beneficial to Egypt’s balance of payments, will affect capital flows from its Gulf allies. Third, China will reduce its investments in US government bonds and may also reduce some of its holdings, putting pressure on US government bond yields. Fourth, Egypt will, like other emerging markets, witness a decline in investments from emerging market funds in its stock market. It is also a concern that the collective exodus of emerging market bond funds will add extra pressure on countries like Egypt. Fifth, China may export its deflation to other countries, triggering a currency war to safeguard economic activities by preserving export markets.
What does this mean for economic policy in Egypt? First, the global economic environment will put Egyptian policymakers in a difficult position as they may be required to adopt a loose fiscal and monetary policy at a time of high budget deficit and escalating prices. Second, Egyptian policymakers will face pressure maintaining Egypt’s competitive position in exports at a time when most countries have devalued their currency, making it difficult to maintain the status quo. A gradual devaluation of the Egyptian pound may be the solution for this complicated problem. Third, the government is already following a loose fiscal policy with budget deficits reaching 12% of GDP. This leaves very little room to increase public spending. However, better tax collection and extending the tax umbrella to include sectors that are currently not taxed is a way to improve government finances. Over-taxing current tax payers does not solve the problem and will yield negative results. On the other hand, rationalising government spending and improving management efficiency will reduce waste and add to government resources. Fourth, Egypt will have to improve its economic environment and make itself an attractive investment destination through improving its laws.
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