Egypt will likely avoid the inflationary implications of a weaker currency as the pound depreciates ahead of a much anticipated investor conference in March, economists said.
The Central Bank of Egypt allowed the pound to depreciate three times this week, the first such move for six months. The pound reached 7.29 per dollar on Tuesday on the official market, while the black market rate averaged 7.856 per dollar, according to two traders.
Depreciation has long been feared amid concerns it could lead to an uncontrollable rise of prices across the economy, since Egypt is a net importer of goods, but analysts say that those fears are unlikely to be realised in the immediate future.
Favourable circumstances, mainly the fall in oil prices globally, means that the cost of imported goods is dropping, Hany Genena, chief economist at investment bank Pharos Holding said. Oil prices have fallen to $48.99 a barrel on Tuesday for Brent on oversupply and weak demand from Europe and Asia.
Egyptian households have seen their expenses grow after the government partially removed fuel subsidies in July, raising prices at the pump by up to 78 percent – leading to a hike in the general price level in the economy. Inflation spiked to 11.8 percent in October before easing to 10.13 percent in December.
No official comments were announced regarding the change in policy, but analysts see it as an effort to boost foreign reserves, investments and Egypt's competitiveness in exports markets.
Orthodox Economic Policy
The central bank defended the pound against sharp devaluations after the 2011 popular uprising caused investors to flee and tourism revenues to tumble. This has led to the creation of a currency black market. The gap between the official and unofficial exchange rates widened more than 80 percent in 2014.
London-based Capital Economics predicted that the CBE will closely manage further devaluation of the pound through 2015. "We forecast the pound to end this year at 7.50/US$ and fall to 8.00/US$ by end-2016," Jason Tuvey, Middle East economist at Capital Economics, said in a policy note yesterday.
In November, central bank governor Hisham Ramez said he plans to eliminate the currency black market in less than a year. Eliminating the black market is seen as necessary step to encourage investors, especially before March's economic summit which the government banks on to attract at least $10-12 billion worth of investments.
"As preparations are stepped up for March’s investor conference, by loosening their grip on the pound the Egyptian authorities may be signalling a shift towards more orthodox economic policy," Tuvey said.
The CBE also cut key deposit and lending interest rates by half a percent last week to 8.75 percent and 9.75 percent respectively.
Trading with Europe
Letting the pound depreciate would also boost the competitiveness of Egypt's trading with the European Union, its main export destination.
"Since the pound has been pegged to the US dollar, it has strengthened by almost 20% against the euro, a result of the latter’s slide against the dollar," Tuvey said.
The euro reached its weakest level against the dollar since 2003 last week. It is currently traded at 1.1577 per dollar.
Egyptian "policymakers may have anticipated further euro weakness ahead of an expected announcement later this week by the ECB of a full-blown quantitative easing (QE) programme," Tuvey said.
Egypt’s $10.1 billion worth of exports to the EU made up 40 percent of its total exports in 2013/14, according to central bank data.
Defending the currency has proved to be a costly affair for Egypt as the central bank burnt through more than $20 billion of foreign reserves doing so since 2011.
Egypt's foreign reserves reached $15.3 billion at the end of 2014, from about $36 billion at the beginning of 2011.
"The Egyptian authorities may have judged that the FX scarcity associated with maintaining an overvalued exchange rate was taking too heavy a toll on the economy," Tuvey said in an emailed answer to questions on Monday.