Dubai: In mid-March the Central Bank of Egypt devalued the Egyptian pound by 14 per cent, with the current account deficits seen widening further, depreciation pressures expected to persist on Egyptian pound.

Analysts say widening current account deficit will add further pressure on the country’s net international reserves. Although further currency devaluation carries the risk of exacerbating already-high inflation levels, it could support adjustment in the trade balance and preserve scarce international reserves.

“Devaluation and a more flexible exchange rate policy will make exports more competitive and reduce pressure on foreign reserves. To contain the impact on inflation, the CBE decided to raise its key policy rate, the discount rate, by 150 basis points to 11.25 per cent. Headline inflation was 9.1 per cent in February 2016, and inflationary pressures from domestic supply bottlenecks are likely to be aggravated by the devaluation,” said Dr Garbis Iradian, Chief Economist, Middle East and Africa at the Institute of International Fiannce (IIF).

The significant real exchange rate appreciation as a result of Egyptian pound’s peg to the US dollar has exacerbated the decline in exports.

Investor sentiment

Investment flows have also stagnated following recent positive trends as capital controls and import restrictions prevented repatriation of earnings and import payments, and dampened investor sentiment. Tightening external liquidity has made it difficult to import raw materials and this has hampered industrial activity. A more flexible exchange rate regime could offset some of the above challenges. A weaker currency is likely to improve trade competitiveness. Accompanying the adjustment in the currency regime is a removal of limits on foreign currency cash deposits and withdrawals for the import of essential goods, which had been in place since February 2015. Together, this action will support a revival in economic activity and investment. The combination of improving external dynamics and a better growth outlook should reduce balance of payments pressures which have resulted in Egypt’s net international reserves, stagnating at around $16.5 billion (Dh60.5 billion).

Foreign exchange controls

According to the IIF, CBE’s recent actions including the decision to lift caps on withdrawals and deposits of foreign currencies for individuals and companies importing essential goods, easing foreign exchange controls imposed a year ago and combined with a plan to launch of a new investment product that would allow foreigners to invest in the local Treasury bill market would stabilise international reserves.

“Such a move, together with a much better valued exchange rate, may encourage the return of foreign portfolio investors. Even with the depreciation, it will remain challenging to finance the large twin deficits,” said Iradian.

The recent devaluation of the Egyptian pound against the US dollar will likely be supportive of foreign currency liquidity in the domestic banking sector, Fitch Ratings says. At the same time, the Egyptian banks’ almost negligible foreign currency positions and regulatory restrictions against lending in foreign currency to corporates without foreign currency revenue should mitigate the short-term impact of the weaker pound on the banks’ asset quality.

International reserves

The CBE’s ability to increase foreign currency liquidity in the banking sector is a function of its net international reserves. International reserves in turn rely heavily on Suez Canal, tourism revenues and foreign direct investments (FDI), which have come under pressure since 2015, as well as grants, predominately from Gulf Cooperation Council (GCC) countries. International reserves stood at $16.5 billion at end-February 2016, down from $35.2 billion at end-June 2010.