Economists and bankers have welcomed the Central Bank of Egypt's decision to adopt a more flexible exchange rate policy after a sharp devaluation of the Egyptian Pound as much-needed measures to address a foreign currency crunch.
"The CBE decided to adopt a more flexible exchange rate regime that better reflects the underlying forces of supply and demand and, in turn, lead to greater transparency and foreign exchange liquidity through attracting greater investments and the correction of asset prices," the bank said on Monday in a statement explaining the move.
The statement came on the heels of an exceptional auction in which the CBE sold $198 million to local banks on Monday, allowing the Egyptian Pound to depreciate by over 14 percent of its value to EGP 8.85 against the US dollar.
"It's a step in the right direction," a senior banker told Ahram Online on condition of anonymity. "It is a prelude to having a flexible exchange rate and letting the market decide where the pound is."
Stagnating foreign investment and export revenue, plunging tourism revenues, and dwindling Suez Canal receipts have contributed to a shortage of hard currency and the rise of a resilient parallel market over the past years.
"Investors need to see a flexible exchange rate regime, because Egypt is not a country which can afford to peg its currency against the dollar, like oil-rich economies which have massive inflows of foreign currency income," Mohamed Abu Basha, a Cairo-based economist at investment house EFG Hermes, told Ahram Online.
To attract foreign currency into the country, Egypt's largest two state-owned banks National Bank of Egypt and Banque Misr announced on Monday the launch of three-year EGP-denominated investment certificates for individuals, at a 15 percent yield, to be paid for in hard currency.
Some Egyptian public banks have recently begun offering US dollar and Euro-denominated certificates of deposits to Egyptian expats. Also lately, the CBE has lifted restrictions on dollar deposits at Egyptian banks for individuals and companies importing essential goods.
"The decision this morning by the Central Bank of Egypt to devalue the pound and move to a more flexible exchange rate regime is a positive step and should help improve the country's balance of payments position," said Jason Tuvey, Middle East Economist at London-based Capital Economics in an emailed note.
The bank, which has controlled the exchange rate through a regime of weekly foreign currency auctions since December 2012, did not elaborate on what mechanism it would adopt, though it affirmed that it "will continue to closely monitor developments and will not hesitate to use all its tools and authority to maintain an orderly foreign exchange market and ensure price stability over the medium-term."
"Effectively, I think it means a return to a managed float, reflecting market dynamics, as was Egypt's exchange rate regime between 2004 and 2011," said Abu Basha, "though it would have to be gradual, because you need the interbank market to function properly."
Under such a regime, said Abu Basha, the pound would be linked to a basket of currencies rather than being pegged to the dollar as it has in recent years.
"This does not hint at further devaluation as much as it hints at increased volatility in the exchange rate," he said, "as the currency increasingly reflects market dynamics: the currencies of Egypt's trading partners, FX inflows, etc."
Some believe that the pound should and will fall further than the level it reached on Monday in order for the devaluation to have a lasting impact on the FX crunch.
"The magnitude of the move is not sufficient to clear the market or fully resolve all challenges, because if you look at the Non Deliverable Forwards (NDF) on the Egyptian Pound, the market expects the pound to reach around EGP 10.45 against the dollar by year's end," said Hani Farahat, senior economist at Cairo-based CI Capital.
Welcoming the move towards a flexible exchange rate that will allow the currency to further depreciate, Tuvey said, "We still think the pound has a bit further to fall – we think a level of closer to 9.5/$ would help to restore external competitiveness."
Abu Basha noted that the central bank is operating "under many constraints: slowing global economic growth, slow global trade, the weakening currencies of most of its trading partners, and falling oil prices which negatively affects grants and private investments, tourism and remittances, from the GCC countries."
Egypt's foreign currency reserves, which have been used to prop up the pound since the country's 2011 uprising, have stagnated at around $16.5 billion in recent months.
"Given all these constraints, it's a very positive move which notably reduces the premium on the parallel market against the official rate," Abu Basha said.
An outright floating of the pound "would require stronger and sustainable sources of FX which Egypt currently lacks," according to Farahat.
In a televised interview last month, CBE Governor Tarek Amer ruled out floating the pound until FX reserves recover to at least $25 billion.
Interest rate hike
CBE is expected to hike up interest rates to combat inflation at its next Monetary Policy Committee (MPC) on Thursday.
However, analysts differ over the impact a weaker pound will have on inflation, which had eased for the second consecutive month in February to 9.1 percent after a rate hike in December.
"There will inevitably be some short-term pain – inflation is likely to rise and we’ve now pencilled in a 100bp rate hike at Thursday's MPC meeting (previously 50bp)," said Tuvey.
Egypt's overnight deposit rate, overnight lending rate, and the CBE's main operation rate currently stand at 9.25 percent, 10.25 percent, and 9.75 percent, respectively.
Farahat also expects a rate hike of "at least 50 basis points," yet he does not believe the devaluation will have a significant impact on inflation.
"Local suppliers were already pricing the dollar at a much higher price," he said, referring to the black market rate.
Monday's move will have an impact on inflation, argues Abu Basha, "as certain sectors, such as importers of strategic goods, source most of their hard currency needs from the banking system."
Nonetheless, the impact is likely to be gradual, he said, as consumer companies are likely to gradually pass on the increased cost in order to avoid any negative impact on their volumes.