The action taken recently by the Central Bank of Egypt (CBE) is meant to support the Egyptian pound, absorb liquidity from the domestic market, and restore price stability, according to experts. Yet, the effects may not be felt immediately, meaning that inflation may continue to rise.

Inflation in Egypt has been rising as a result of shortages in the supply of many imported commodities as well as the almost 60 per cent depreciation of the pound against the US dollar in 2022. Inflation rates jumped to 21.3 per cent in December compared to 18.7 in November, their highest in five years.

In a move aimed at sucking up liquidity from the market as well as encouraging dollar hoarders to abandon the greenback, the National Bank of Egypt (NBE) and Banque Misr last week issued new certificates of deposit (CDs) with an annual yield of 25 per cent, the highest yield Egyptian banks have ever offered on them.

The proceeds of selling the CDs, which are still available to purchase, has surpassed LE100 billion since their issuance on 4 January.

A few hours after announcing the introduction of the certificates, the pound started to experience a third wave of devaluation, losing over 10 per cent of its value against the dollar, according to prices announced by the CBE and major banks in Egypt.

This fresh depreciation takes total losses of the pound against the dollar to over 60 per cent since the onset of the war in Ukraine. On Tuesday, the official rate at the CBE was LE27.5 for the dollar.

Aya Zohair, head of research at Zilla Capital, a local investment bank, said that the recent action by the CBE, starting with the abolition of the letters of credit (LCs) system for imported goods on 29 December, had been anticipated, especially after the International Monetary Fund’s (IMF) approval of a new loan programme for Egypt last month.

On 17 December, the IMF approved a $3 billion loan deal under its Extended Fund Facility (EFF) over 46 months to address imbalances in the economy due to the repercussions of the war in Ukraine that have led to the exit of around $25 billion of foreign investments in local debt instruments.

“The fresh IMF-backed economic reform programme for Egypt stipulates that Egypt will adopt a flexible exchange-rate regime. This means that the fluctuation of the Egyptian pound against the US dollar will remain high until it reaches stability,” Zohair said.

Controlling the parallel market and attracting foreign direct investments and Gulf support, as well as the issuing of the 25-per cent CDs, are expected to play a role in reaching local currency stability,” she told Al-Ahram Weekly.

The EFF is designed to provide assistance to countries experiencing serious payment imbalances because of structural impediments or slow growth and an inherently weak balance-of-payments position.

A loan under the EFF provides support for comprehensive programmes, including the policies needed to correct structural imbalances over an extended period.

Zohair said that a fair value of the pound against the dollar at present was LE29, expected in the current quarter of 2023 (January-March).

In a research note issued this week, international bank HSBC projected that the dollar would maintain its strength against the pound to reach LE32.5 over the short term, ascribing this to a shortage of capital inflows and increasing demand for the greenback needed to meet the country’s financial needs.

As part of the EFF programme, the IMF said that adopting a flexible exchange rate regime would be a significant step towards unwinding external imbalances, boosting Egypt’s competitiveness, and attracting foreign direct investment.

It would be a cornerstone policy for rebuilding and safeguarding Egypt’s external resilience over the long term.

The EFF agreement will also support the CBE’s efforts to improve the functioning of the foreign exchange market, increase foreign reserves, and further improve monetary policy transmission.

Monetary policy, firmly rooted in the CBE’s price stability mandate, will aim to gradually reduce inflation to within its inflation target, according to the IMF.

Zohair added that the issuance of the 25-per cent CDs aimed to withdraw liquidity from the local market in a bid to curtail rising inflation.

But she said that the package of actions would not necessarily have positive effects on inflation, price stability, and the local currency in 2023, as the war in Ukraine is continuing and global inflation is still high while fuel prices in Egypt are expected to rise as a result of decisions taken at the upcoming meeting of the Automatic Fuel Prices Committee.

The MPC maintained its target inflation rate of seven per cent (± two per cent) through the fourth quarter of 2024 at its meeting in December, while it reduced the target to five per cent (± two per cent) on average by the fourth quarter of 2026.

It hiked interest rates in December by three per cent, attributing this action to the inflationary pressures of the Ukraine war.

Economic expert and head of the Development and Added Value Forum, an NGO, Ahmed Khozaim stressed that the negative impacts of the 25-per cent CDs could surpass their positive ones, as they would increase the debt owed to the banks that is currently around a record of LE6 trillion.

Khozaim said that the Egyptian economy needs more reform to address the imbalances it suffers from, but this should not include raising interest rates or issuing new CDs with unprecedented yield rates.

He did not expect these actions to have positive impacts on the market over the short or medium terms amid the shortage of staple goods and the declining purchasing power of individuals because of the soaring prices of commodities and services and the depreciation of the local currency.

He expected the CBE to hike interest rates at the MPC’s forthcoming meeting, scheduled for 2 February, predicting the issuance of new CDs with yields exceeding 25 per cent amid rising inflation.

As the government expands its efforts to maintain market stability over the current 2022-23 financial year that ends at the end of June, Prime Minister Mustafa Madbouli issued 11 regulations on Monday obliging state bodies to rationalise public expenditure amid the ongoing global economic crisis.

The regulations include halting new projects that need US dollars and pausing construction that has not yet started. 

* A version of this article appears in print in the 12 January, 2023 edition of Al-Ahram Weekly