Egyptian pound’s 16% drop against dollar will do good for the economy

In a bid to halt capital flight from its bond markets, which has accelerated since the Russian invasion of Ukraine, Egypt’s central bank hiked interest rates and allowed the value of the Egyptian pound to fall against the dollar. Egypt had a sharp devaluation in 2016 when it lost nearly half its value against the dollar overnight. The pound was floated at the time as part of a package of reforms in exchange for a $12-billion bailout from the International Monetary Fund (IMF).

The Central Bank of Egypt’s Monetary Policy Committee decided to raise interest rates by 1 per cent across the board, increasing the deposit rate to 9.25 per cent and the lending rate to 10.25 per cent. Alongside the interest rate hike, the central bank allowed commercial banks to set their own foreign exchange rate

“Being keen on safeguarding the achieved macroeconomic stability, the CBE stresses on the importance of exchange rate flexibility to act as a shock absorber to preserve Egypt’s competitiveness,” the CBE said.

Resetting the economy

Analysts said the central bank decision to hike rates and allow the pound to find its own level was necessary to reboot the economy, boost the forex reserves and get easy and viable terms for an IMF bailout.

“The decision by the Central Bank of Egypt to hike the policy rate by 100 basis points and allow the currency to depreciate will help safeguard the narrowing foreign exchange reserve buffer amid renewed capital outflows as a result of tightening global funding conditions, and the higher food and energy import bill triggered by the Russian invasion of Ukraine,” said Elisa Parisi-Capone, Vice President, Senior Analyst at Moody’s.

The rate hike on Monday has turned the nation’s real interest rate (nominal interest rate minus inflation) positive and making it attractive for depositors and investors. Large foreign investment outflows in recent months had made the pound’s exchange rate unsustainable as it remains overvalued. Analysts see the devaluation and interest rate hike should work in favour of Egypt as happened in 2016 when the pound lost nearly half of its value to the dollar, it resulted in huge capital inflows.

Investment destination once more

Analysts hope, high interest rates and a stable pound make Egypt once again an attractive destination for foreign capital. “It [devaluation] will help catalyse fresh inflows into the market as investors perceive a reduced risk of further devaluations, and even the possibility of some appreciation in the coming months,” Farouk Soussa, an economist at Goldman Sachs wrote in a note. “It also smooths the path for an IMF programme which we believe will help anchor confidence in Egypt’s fiscal and reform trajectory.”

The exchange rate flexibility is widely seen as a measure to boost Egypt’s competitiveness with temporary impact on government finances as it would inflate the socially sensitive subsidy bills. “We expect temporary fiscal slippage as a result of a higher subsidy bill to absorb part of the significant consumer price increases for socially sensitive staples like bread and energy, with the government likely to secure a new IMF programme to access concessional funding and anchor fiscal policy credibility,” Parisi-Capone.

While the recent measurers are likely to secure a new IMF programme, the high current account deficit will continue to be a threat to the pound’s stability that could hold back investors.