Brace for a devaluation of the Egyptian pound, say economists

Deya Abaza , Wednesday 10 Feb 2016

The Egyptian pound could be allowed to fall to as low as 8.4 against the dollar within ‘weeks’ in the first of several devaluations as Egypt steps up battle against FX shortage

Dollars Pounds exchange	(AP)
Dollars for Egyptian pounds at an exchange bureau in Cairo (AP)

Egypt will allow a sharp devaluation of its currency in the first half of this year as it has run out of options in the midst of an escalating foreign currency shortage crisis that has slowed economic activity, according to bankers and economists surveyed by Ahram Online.

Since the January 2011 mass uprising that overthrew Hosni Mubarak, the Central Bank of Egypt (CBE) has propped up the Egyptian pound, which was officially traded at 5.8 pounds to the US dollar at the time.

Today, the Egyptian pound is changing hands at 8.7 to the US dollar on the black market according to traders surveyed by Reuters on Tuesday, compared to an official rate of 7.73.

But with a collapsing tourism sector, falling Suez Canal toll revenues, lower-than-expected foreign direct investment, and stagnating export receipts, Egypt, which relies heavily on imported food and fuel, has come under increasing pressure to let its currency weaken.

“A matter of weeks”

Some expect the exchange rate to be adjusted within weeks.

“We expect the central bank will let the pound depreciate to 8 (against the dollar) by end of March, if not sooner,” said one senior Cairo banker who spoke to Ahram Online on condition anonymity.

Eman Negm, economist at Cairo-based Prime Holding, expects the CBE will hold a "mega auction" in the first quarter of this year, to devalue the pound to 8.40 against the dollar.

“It’s a matter of weeks rather than months” before the Central Bank makes a “swift move towards an exchange rate regime,” said Hany Genena, head of Equities at Cairo-based Beltone Financial, in an emailed note dated 9 February.

The fallout from the 31 October crash of a Russian airliner over Sinai has already cost Egypt hundreds of millions of dollars in revenue, and Suez Canal receipts were down $290 million in 2015 compared to the previous year due to the slowdown in the global economy.

Foreign investment has also not materialised as expected, with Egypt pulling in $6.4 billion in FDI in the last fiscal year compared to a previously stated target of $10 billion.

Egypt also has obligations of billions of dollars of external debt maturing this year, which makes it necessary to devalue the pound to attract private capital inflows from abroad, Jason Tuvey, Middle East Economist at London-based Capital Economics, told Ahram Online in a phone interview.

According to Genena, the CBE’s depletion of foreign currency reserves could have sent the reserves down to $12.5 billion by the end of December, hardly enough to cover two and half months of Egypt’s imports and external obligations, if commercial banks had not deposited $3.6 billion worth of foreign currency customer deposits at the Central Bank.

The fact that the CBE raised caps on monthly cash deposits for importers of essential goods in January from $50,000 to $250,000 a month, can be seen as a “partial devaluation,” said Genena.

"By lifting the caps, even for certain sectors, the CBE is acknowledging the parallel market and allowing people to deal with it," said Mohamed Abu Basha, economist at regional investment bank EFG Hermes based in Cairo.

"Egypt’s government seems to be coming around to the view that maintaining an overvalued exchange rate is doing more harm than good to the economy," said Tuvey.

Cash cushion

A devaluation can be expected “maybe towards mid-year," according to Abu Basha, who hinted, unlike others surveyed, that it would be steep but gradual. 

"We expect devaluation to take place in the first half of this year, in a one-off move to an exchange rate of 8.5 pounds against the dollar," said Tuvey.

The timing of the move depends on how soon the CBE can build a strong enough foreign currency base.

“The CBE needs cash at hand to be able to stabilise the markets once it devalues, or people will continue to be wary of further EGP weakening,” says Abu Basha, estimating that reserves would need to be “at least $4 billion higher” than the current $16.5 billion.

Since Governor Tarek Amer took the helm last November, the Central Bank has received $500 million out of a $1.5 billion soft loan from the African Development Bank, and $900 million of a $1 billion loan from China, which also pledged loans $800 million to Egypt’s two largest public sector banks.

The government has also signed a $3 billion loan agreement with the World Bank, $1 billion of which was expected to be disbursed last month.

Saudia Arabia has also pledged some $20 billion in loans to finance Egypt’s petroleum imports over five years, and Minister Sahar Nasr told Ahram Online last month that China was negotiating $15 billion of investments in Egypt.

Tuvey expects the Central Bank will need to devalue further, ideally adopting a more flexible exchange rate regime.

"Egypt has a relatively higher inflation rate than its trading partners so the currency will come under continuous pressure to weaken in order to maintain external competitiveness," he explains.

“To solve the foreign currency shortage Egypt needs two things: a different monetary policy and working to generate foreign exchange,” said former Finance Minister and World Bank economist Ahmed Galal.

“Whatever the monetary policy regime, the exchange rate or the pound has to be more flexible,” Galal recently told Ahram Online over email.

Foreign cars and Lupini beans

Egypt has taken steps to curtail non-essential imports, making it more difficult for importers of such goods to obtain letters of credit by requiring them to register their foreign suppliers with the government or face a ban; and hiking up customs tariffs on hundreds of products.

The aim beyond these meassures is to reduce the country’s imports bill, which amounted to $61 billion last year, by $20 billion, Governor Tarek Amer told Bloomberg last month.

Egypt imports $3 billion worth of passenger cars a year, and $2 billion worth of lupini beans, a nationally popular snack, according to one senior banker who spoke to Ahram Online on condition of anonymity.

“The government is building up its reserves of foreign currency before the devaluation to help pay for its import bill,” said Negm.

But the import controls are “a temporary band-aid” for the FX crisis, the banker believes.

The devaluation will cause inflation, already in the double digits, to rise, Tuvey expects.

But the central Bank is likely to try keeping a lid on inflation by hiking interest rates.

"Ever since Tarek Amer came to power, he has put a lot of emphasis on keeping a lid on inflation expectations and getting inflation down into the single digits," Turvey said.

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