A long-awaited International Monetary Fund (IMF) deal was inked on 6 March, hours after Egypt complied with two IMF conditions.

The Central Bank of Egypt (CBE) finally allowed market forces to determine the value of the pound, unifying official and parallel market rates, and hiked interest rates by 6 per cent, meeting IMF demands to tighten monetary policy. Interest rates are now 27.25 per cent and 28.25 per cent for overnight deposits and lending, respectively.

Egypt’s deal with the IMF now amounts to $8 billion compared to the $3 billion agreed in December 2022 and, according to statements by Minister of Finance Mohamed Maait, the enhanced deal will be supplemented by an additional $3 billion in financing from the World Bank and $5-6 billion from the EU.

The official dollar exchange rate increased from LE30.9 to LE50 by the end of devaluation day. On Tuesday, the dollar was trading at around LE49 at some local banks. As for the parallel market, sources told Al-Ahram Weekly that traders are holding back activities in a wait-and-see mood.

In an indication of how the CBE’s moves have changed sentiment about Egypt among international financial houses, Moody’s upgraded its outlook from negative to positive. The American rating agency said that if the changes in policy are maintained they will support macroeconomic rebalancing.

Explaining its upgraded outlook, Moody’s noted the $35 billion Ras Al-Hekma deal, which includes $24 billion in new cash transfers over two months, will double Egypt’s foreign exchange reserves — they stood at $26.5 billion at the end of January — within weeks. This fresh dollar liquidity, says Moody’s, is sufficient to help close Egypt’s external financing gap until 2026. 

Egypt couldn’t have devalued in the absence of dollars to meet demand, said President Abdel-Fattah Al-Sisi on Saturday, and if it hadn’t it been for the foreign currency inflows from of Ras Al-Hekma deal, the IMF deal and loans from other international partners, the pound would have collapsed to LE80-90 to the dollar. 

UK-based macroeconomic think tank Capital Economics agreed, pointing out that the Ras Al-Hekma deal “gave the CBE confidence that it could devalue without the currency overshooting”. The move had been anticipated since the signing of the Ras Al-Hekma deal and was expected by many observers to occur ahead of Ramadan, which began on Monday. The Muslim fasting month is accompanied by increased household spending on food and, according to a Bloomberg analyst, the authorities “were unlikely to wait until then to hand Egyptians a sudden price shock”.

The unification of the parallel and official dollar prices is an important step towards containing inflation, say analysts, as most merchants use the unofficial exchange rate to calculate costs and prices.

One of the main reasons for the thriving parallel market for the dollar was the banking sector’s failure to cover importers’ demand for the greenback, pushing them into the arms of the unofficial market. President Al-Sisi has now asked banks to fulfill importers’ needs for dollars to release the estimated $7 billion of inventory stranded at Egypt’s ports. 

The release of imports stuck at ports will theoretically reduce the inflation rate as more commodities enter the market. Traders warn, however, that reduced prices will not be seen in the short term since there is a backlog of goods in warehouses bought when the dollar was trading on the black market at between LE65-LE70.

An economy professor, who asked for anonymity, said that the higher official exchange rate means an increase in the costs of custom clearance, which is calculated according to the official exchange rate, and that traders would seek to pass on the new discrepancy to consumers.

Inflation is one of the main side effects of devaluation which is why the CBE introduced the 6 per cent interest rate hike. The CBE statement announcing the rate increase said it had “decided to accelerate the monetary tightening process to fast-track the disinflation path”.

February inflation figures, announced on 10 March, showed an unexpected jump in the rate to 35.7 per cent. The surprise increase led JP Morgan to predict the CBE will hike rates by a further 2 per cent at its regular meeting later this month.

Higher interest rates makes borrowing more expensive, thus reducing consumer spending and business investment. “This decrease in spending and investment tends to lower aggregate demand in the economy leading to a decrease in the overall level of inflationary pressure,” economist Dina Al-Wakkad explained on her LinkedIn account.

“Additionally, higher interest rates can make saving more attractive, leading to increased savings and reduced consumption, which can also help to dampen inflationary pressures.”

With internal debt sovereign bonds and bills of LE8 trillion, however, every 1 per cent increase in the interest rate leads to an LE80 billion increase in interest payments meaning “a 6 per cent increase would result in upping interest payments by LE 480 billion per year” according to Al-Wakkad.

With an interest rate close to 30 per cent, Egypt offers the third-highest yield on local-currency bonds among the 23 developing economies tracked by Bloomberg. According to analysts who spoke to the news agency, this means foreign portfolio investments are likely to start pouring into the country. 

At a Treasury Bill auction on Thursday, Egypt sold LE87.8 billion ($1.8 billion) of one-year sovereign bonds at a yield of 32.3 cents. The issue was four times oversubscribed, suggesting that foreign investors’ appetite for local debt has been restored. Offering government bonds at such high rates, however, suggests that despite the influx of foreign currency Egypt needs still more to close its financing gap, clear the backlog at ports and cover debt services and arrears to oil companies.

Moody’s believes that the government’s commitment to reduced public investments and the slowdown in infrastructure spending agreed with the IMF will over time reduce inflation and support debt sustainability while fostering an enabling environment for private sector activity. 

The government has agreed with the IMF to cap infrastructure spending and end preferential tax treatments for public sector entities.

“Meanwhile, the removal of currency distortions by shifting to a managed float, and the shift to an inflation targeting regime, if maintained, should ease forex shortages, promote renewed remittance inflows through official channels, and incentivise foreign investment and portfolio inflows in the future,” says Moody’s.

* A version of this article appears in print in the 14 March, 2024 edition of Al-Ahram Weekly