Bitter pill

Sherine Abdel-Razek , Wednesday 3 Aug 2022

Recent rises in US interest rates are driving the dollar higher against other world currencies, including the Egyptian pound.

Bitter pill
Bitter pill


The US dollar was trading at LE19 against the Egyptian pound this week, the lowest-ever level for the pound.

The new rates came a few days after the US central bank the Federal Reserve raised interest rates by another 0.75 per cent, marking the fourth rise — since the beginning of the Ukrainian-Russian war and causing the greenback to rise in value against even the world’s strongest currencies.

Most analysts believe the pound will be trading at LE20 against the dollar before the end of 2022, with the currency already losing more than 20 per cent of its value since March.

However, this is not all bad news, as the decline in the value of the pound means that the Central Bank of Egypt (CBE) is adopting a more flexible exchange rate with minimum intervention, a demand that has been made by economists and the International Monetary Fund (IMF) as part of the structural reforms needed to shore up the economy.

According to this logic, a flexible exchange rate helps to stabilise trade balances by making the exchange rates for currencies change as the supply and demand for them change. Over time, the flexible exchange rate acts as a regulator of foreign exchange, balancing imports and exports.

A day before the Federal Reserve’s move, the IMF released a report assessing Egypt’s economic performance after it received the $5.2 billion Stand-by Arrangement (SBA) loan in 2020 to help mitigate the effects of the Covid-19 pandemic.

While most of the reforms coming as conditions for the SBA were successfully implemented, according to the report, “decisive progress” on deeper reforms was needed. The report calls for a more flexible exchange rate together with a wider role for the private sector in the economy.

“Greater exchange rate variability could have been entrenched to avoid a buildup of external imbalances,” the report says.

It is believed that further liberalisation of the pound is one of the demands the IMF is putting on the table before it can provide Egypt with the new loan that is currently being negotiated. It is not clear whether Egypt is willing to take the step with the expected inflationary pressures it would bring in its wake.

Mohamed Maait, the minister of finance, told Al-Arabiya TV channel on Wednesday that Egypt is working out its disagreements with the IMF to get the loan. “There are always two different perspectives. We agree on certain issues and disagree on others,” he said.

The government is wary of the inflationary pressures that would come with any further depreciation in the pound. The sharp increase in prices, especially of food items, has been widely discussed since March, with many people sceptical about official annual inflation figures of only 13 per cent.

But further depreciation seems inescapable given the pressures, external and internal, weighing on the pound.

Foreign currency liquidity in Egypt continues to deteriorate at a rapid pace, said Pascal Devaux, an economist covering the Middle East at French bank BNP Paribas.

He said that the banking sector’s net foreign assets, including those in the commercial banks and the CBE, showed a deficit of $16.6 billion in May 2022. This surpasses the level reached during the 2016 crisis before the devaluation of the pound, when it was negative $13 billion, according to Devaux.

He wrote in a recent report that the deterioration comes as no surprise, as the effects of the war in Ukraine on commodity prices have only exacerbated pre-existing trends. “Given a large recurring current account deficit of at least $20 billion this year and significant external debt repayments of around $9 billion over a whole year, the Egyptian economy relies heavily on volatile portfolio investments,” he said.  

Since the third quarter of 2021, Egypt has been trying to increase the appeal of its sovereign and carry trade by increasing interest rates but without the hoped-for success. The value of portfolio investment outflows since the war started in March has been put at around $20 billion.

The government does not seem to be willing to introduce further increases in interest rates. Gihan Saleh, an economic advisor to the prime minister, told TV anchor Lamis Al-Hadidi last week that an increase in US rates did not necessarily mean that Egypt would follow with an equivalent hike of its own.

The rise in local currency bond yields across the emerging markets poses a particular risk to fiscal positions in these markets that have large government financing needs and a short average debt maturity. Egypt, Pakistan, and Ghana stand out as those most vulnerable, said Capital Economics, a macro-economy research group based in London.

“Higher interest rates will raise government spending on debt-servicing costs and could worsen debt dynamics,” it said.

What exacerbates the risk is the fact that Egypt has a high public-debt-to-GDP ratio and that the real interest rates it offers on its sovereign debt instruments are the second-highest in the world, according to Capital Economics.

The short maturity of government debt is another weakness, it said. “The shorter the maturity, the more debt that will need to be rolled over at higher interest rates,” it added, ranking Egypt at the top of the most vulnerable emerging markets as a result of the US increase in interest rates.

However, the situation remains sustainable in the short term as the CBE’s gross foreign exchange reserves remain equivalent to around five months of goods and services imports, according to Devaux.

However, “further external support is essential to avoid the uncontrolled depreciation of the pound,” he added.

The Gulf countries have been generous in their support to Egypt, with the UAE pumping around $2 billion in investments into the country in addition to the Saudi Sovereign Wealth Fund projecting $10 billion worth of investments.

Maait said that the country might offer Islamic sukuk bonds on the local market for the time being and would consider an international offer when market conditions improve.

The agreement with the IMF is expected to help, though the value of the deal is not expected to be large as Egypt has exhausted its borrowing quota. The country has borrowed $20 billion from the IMF since 2016.  (see p.5)  

*A version of this article appears in print in the 4 August, 2022 edition of Al-Ahram Weekly.

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