The upside of floatation

Niveen Wahish , Tuesday 17 Jan 2023

Central Bank of Egypt moves to completely free the foreign exchange market maybe starting to pay off, writes Niveen Wahish

photo: AP
photo: AP


In a press release on Monday, the Central Bank of Egypt (CBE) reported increased hard currency inflows from the local market, remittances and the tourism sector, and foreign investments exceeding $925 million entering the market in just three days. The CBE also said interbank currency trading had increased more than 20-fold in the last few days.

After losing ground against the dollar last week, the Egyptian pound has remained stable at LE29.6 for the last two days.

“I never thought I would be relieved to see it settle at that figure, but given that it had reached LE32 last Wednesday, I am,” said computer engineer Omar Hussein.

The CBE allowed the pound to depreciate on 4 January for the third time in 10 months. Before the latest floatation it stood at LE24.79. Allowing the currency to be traded flexibly is part of Egypt’s agreement with the International Monetary Fund (IMF).

Recent falls in the pound should improve Egypt’s external balances over the coming months, says Capital Economics, a London-based macro policy think tank. The devaluation process is reminiscent of what happened in 2016 and if the same scenario is repeated, Egypt’s current account deficit should narrow by the equivalent of five per cent of GDP.  

Prior to the 2016 devaluation, Capital Economics explained in a note, Egypt’s non-hydrocarbon exports declined as the authorities’ grip on the currency eroded competitiveness. A year after devaluation the weaker currency had reduced production costs in dollar terms, allowing manufacturers to reduce prices. Service exports also picked up, largely on the back of tourism. The overall impact was a narrowing of the current account deficit from 6.5 per cent of GDP in the fourth quarter of 2016 to 2.2 per cent of GDP by mid-2018.

“At the same, a weaker currency made it more attractive to foreign investors to return to Egypt, there was a surge in portfolio investments into local treasury bills and a steady increase in foreign direct investment too,” said Capital Economics.

The floatation, however, is coming at a high cost to Egyptians and the government. Annual headline inflation rose to 21.3 per cent in December 2022, up from 18.7 per cent a month earlier and 6.5 per cent in December 2021.

The government is spending more to maintain subsidies on items such as bread. Prime Minister Mustafa Madbouli said this week that the higher exchange rate means a loaf of bread now costs LE0.9 instead of LE0.65, yet continues to be sold at LE0.05. Likewise, diesel, which should be sold at LE11 per litre, is being sold at LE7.25, with the government paying the difference. The Letter of Intent which Egypt submitted to the IMF said most fuel product prices will be allowed to rise to make up for a slowdown in such increases over the last fiscal year.

The CBE is moving in the right direction to bridge the external financing gap, says Mohamed Abdelhamid, an analyst at Dcode Economic and Financial Consulting. The exchange rate is currently in an adjustment period and given that Egypt is committed to a fully flexible exchange rate regime, current global economic dynamics mean further volatility is to be expected.

He predicts greater volatility until the FX market clears and the demand for FX through the official banking system can be fully satisfied, eliminating the parallel market that is driving speculation and disincentivising foreign investments.

The CBE press release also noted that the banking sector has met more than $2 billion worth of importers’ requests, hailing the figure as evidence of the sector’s ability to meet demand.

Over the past year, import restrictions have resulted in a backlog of unsatisfied demand for FX which needs to be cleared, explains Abdelhamid. In the medium to long term, assuming that expected FX inflows materialise and the parallel market is eliminated, DCode projects the value of the Egyptian pound to stabilise a little lower than the current spot rate of LE29.6 per dollar.

Abdelhamid stresses that the external financing gap, estimated by the IMF at $17 billion over four years, targets rebuilding international reserves agreed with the Egyptian authorities – reserves have been depleted by around $7 billion over the course of 2022 — so it is not just about due payments.

The sale of state-owned assets to either strategic investors or through an Initial Public Offering (IPO), which the government estimates will bring in around $2 billion by the end of June 2023, is one of several possible sources of FX.

According to Bloomberg Al-Sharq, the Sovereign Fund of Egypt has added five state- and military-owned companies to its pre-IPO list as a first step to offering 20-30 per cent stakes. The companies include bottled water producer Safi, fuel station operator Wataniya, and Banque du Caire. A road show to promote the IPO in Arab and international markets will take place this month.

Natural gas also promises to be a huge export opportunity given the opening of new markets in Europe and the government’s focus on increasing production and exports. On Sunday, the Egyptian Natural Gas Holding Co (EGAS) announced a new natural gas discovery in the Eastern Mediterranean.

Moving forward, Abdelhamid says to stabilise the economy effective implementation of the structural reforms that the government has announced is essential: they will provide more room and growth opportunities for the private sector and improve the investment environment to attract more long-term foreign investments.

An efficient monetary policy which permanently adopts a flexible exchange rate is also needed to prevent the re-accumulation of external imbalances and enhance the competitiveness of Egyptian products in international markets, he stressed.

Abdelhamid also wants to see more focus and incentives directed towards increasing industrial and agricultural production and exports “in order to enhance Egypt’s sustainable foreign currency income and reduce vulnerabilities to external shocks”.

Last week the prime minister revealed a new initiative to extend LE150 billion worth of loans to the industrial and agricultural sectors at a subsidised interest rate of 11 per cent. The initiative aims to enhance local production and cement Egypt’s ability to withstand global crises.

Additional reporting Sherine Abdel-Razek

*A version of this article appears in print in the 19 January, 2023 edition of Al-Ahram Weekly.

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