The resignation of Tarek Amer, governor of the Central Bank of Egypt, a day before a CBE meeting to decide whether or not to change interest rates and a year earlier than the end of his second four-year term in office, is being seen by many as an indicator of divisions among policy-makers on the way monetary policy should be used to deal with Egypt’s persistent economic problems.
The spillover from the war in Ukraine has magnified the trade deficit, with increased commodity and oil prices adding billions to Egypt’ import bill while at the same time reducing tourism revenues. Before the war, the Russian and Ukrainian markets accounted for 30 per cent of tourists visiting Egypt. As if this wasn’t bad enough, the increase in interest rates worldwide has limited the appeal of local sovereign debt and led to an outflow of portfolio investments, with some putting the figure north of $20 billion since March.
External financing conditions have become increasingly unfavorable, noted London-based macroeconomic research house Capital Economics. “It has become more costly to finance the current account shortfall and roll over maturing external debts which will amount to more than $25 billion over the next year.”
All these factors have exacerbated pressure on the Egyptian pound, a problem the CBE, under Amer, dealt with by drawing on foreign reserves to support the exchange rate. Foreign reserves in July stood at $33.1 billion, down from more than $40 billion at the start of the year.
In the wake of the war in Ukraine, when it became clear that maintaining a stable exchange rate would only worsen Egypt’s external imbalances, Amer eased his grip on the pound, allowing it to slide 22 per cent against the dollar.
The devaluation, from LE15.8 to the dollar to more than LE19, has failed to satisfy financial institutions, starting with the IMF and international rating agencies, who are calling for a more flexible exchange rate and further devaluation.
According to Bloomberg Economics, the currency needs to fall a further 23 per cent to help the economy adjust and reduce Egypt’s funding gap. Deutsche Bank AG and Goldman Sachs Group Inc are slightly less pessimistic. They estimate that the Egyptian pound is overvalued by 10 per cent.
While CBE’s new governor, veteran banker Hassan Abdallah, is expected to be more responsive to a flexible exchange rate, how fast and deep the devaluation will be remains unclear.
Egypt is likely to allow the pound to devalue “gradually” to minimise the inflationary shock, Moody’s rating agency said in a report released earlier this week. It added that, in the short-term, financial inflows, mainly from Gulf countries, would determine the pace of devaluation.
Gulf countries, which thanks to the increase in oil prices have seen their budget surpluses grow, remain interested in supporting Egypt, but not in the form of loans or grants. Increasingly they are looking for opportunities to invest in profit-making state-owned companies.
By the end of July, Egypt’s exposure to Gulf Cooperation Council states reached $25.9 billion of its $33 billion liquid international reserves, according to Moody’s.
Moody’s and Capital Economics both refer to the business ties the new CBE governor established with the Gulf during his tenure as the head of the Arab African International Bank (AAIB) as an asset that could help in securing better deals.
As well as looking towards investments, the government has introduced other measures — restricting imports and rationalising electricity consumption to free gas used in power stations for export — in an attempt to support the pound.
But such moves, say analysts, are only short-term solutions.
“They need to accept more currency weakness,” Edwin Gutierrez, head of emerging-market sovereign debt at Aberdeen in London, told Bloomberg. “No one wants to enter with an incomplete foreign exchange policy adjustment.”
Capital Economics expects the CBE to let the pound fall “to LE25 per dollar by end-2024, and hike interest rates.”
While the CBE kept interest rates at 11.25 per cent last Thursday, “with pressure mounting on the pound, interest rate hikes will come back on to the agenda in the coming months,” said Capital Economics.
The decision to keep rates unchanged came despite annual inflation rising to a three-year high of 13.6 per cent in July. A CBE press release following the meeting noted that high inflation “will be temporarily tolerated”, leading Capital Economics to conclude that the bar to raising interest rates in response to further increases in inflation has been set high.
The key risk now, says Capital Economics, is that policymakers will try to retain a tight grip on the currency and not devalue it, leaving a great deal to depend on the approach Abdallah adopts to dealing with Egypt’s external imbalances.
While Moody’s warned that an inflexible exchange rate policy could further delay agreement on a new IMF programme and hinder access to global debt markets, Capital Economics’ alarm bells rang louder. If past experience is anything to go by, an overvalued currency could push officials to resort to restrictions on access to foreign currency that will lead to shortages of goods and disrupt economic activity, it warned.
Larger and more disorderly falls in the pound would then be required further down the line, representing a threat to Egypt’s public finances given that the share of government debt denominated in foreign currency has increased to 28 per cent of GDP.
“Sharp and disorderly falls in the pound could ultimately knock the debt position onto an unsustainable path and raise the risk of default.”
A flexible exchange rate policy seems to be topping the list of IMF demands before it signs a new agreement with Egypt. Last month it called on the government to make “decisive” fiscal and structural reforms to reduce its exposure to external shocks.
Should the CBE let the pound to depreciate further, it will suggest the government is ready to meet the IMF’s demand for a more flexible exchange rate. Finance Minister Mohamed Maait was recently quoted as saying that policymakers are now more tolerant of a weaker currency.
On Monday, Prime Minister Mustafa Madbouli said Egypt is close to finalising an agreement with the IMF on a new loan, though he released no further details.
If finalised, it will be the third IMF loan to Egypt in six years. Egypt agreed a three-year $12 billion loan in late 2016 that involved a currency devaluation and sweeping reforms.
In 2020, Egypt received a $5.2 billion loan under stand-by arrangements, and $2.8 billion under the IMF’s Rapid Financing Instrument to help withstand the economic impact of the COVID-19 pandemic.
An IMF deal would not only provide external finance but also rebuild anchor investor confidence, say analysts.
*A version of this article appears in print in the 25 August, 2022 edition of Al-Ahram Weekly.