Egypt devalues currency after a long wait; market responds positively to move

On 3 November 2016, the Central Bank of Egypt (CBE) moved to a more flexible exchange rate system and adopted significantly tighter monetary stance. The Egyptian pound was devalued to EP13 to the dollar, from EP8.9, and will be allowed to float within a 10% band on either side. The spot rate ended trading at 14.15 to the dollar—a loss of 37% on the day, and the 12 month non-deliverable forwards weakened to a record low of 17 to the dollar. The CBE’s key two policy rates, the overnight deposit and overnight lending rates, have been raised by 300 basis points to 14.75% and 15.75%, respectively. This follows the de-valuation that was done earlier in the year from EP7.92 to EP8.9. The devaluation of the currency was long-awaited by the market however the exact mechanics of the new system were still unclear. Egyptian authorities had intimated before that they would devalue the currency and regretting defending its peg to the Dollar. The country had been grappling with foreign exchange shortages and it was becoming difficult for corporates and individuals to source foreign exchange.

The flexible exchange rate regime and the tighter monetary stance are part of a broader package of reforms agreed in August of this year with the IMF staff. I expect the IMF’s Executive Board to approve the staff-level agreement for a three-year $12 billion Extended Fund Facility in the coming weeks. Such endorsement will also help to secure additional of $14 billion from other multilateral and bilateral sources and bonds issuance in the international markets to close the financing gap, which I estimate at $26 billion, for the next three years. The IMF had welcomed the decision stating that “…The flexible exchange rate regime, where the exchange rate is determined by market forces, will improve Egypt’s external competitiveness, support exports and tourism and attract foreign investment.”

The recent move to a flexible exchange rate and tighter monetary policy along with other reforms will help to restore competitiveness, reduce external imbalances, rebuild reserves, and alleviate investor uncertainty over what their pound assets will be worth. The higher interest rates will mitigate additional inflationary pressures that would arise from a depreciated exchange rate, and encourage adequate inflow of foreign capital to avoid disorderly conditions. Also, the IMF program would provide a framework to secure the macroeconomic stability and reforms necessary to move the economy to a higher and sustainable growth path.

The current black market rate of EP 17 per dollar is far from equilibrium value, which I estimated recently to be in the range of 14.5-15.0 per dollar. Under the assumption of an approval of the program by the Executive Board of the IMF and adequate external financing, the spread between the official and parallel rate is expected to narrow in the coming months and the two rates are likely to be unified by mid-2017. Inflation is expected to move higher, partly from subsidy removals and party because of exchange rate movement pass-through, although the market was largely operating on the black market rate.

Consequently this firmly puts South Africa as the largest economy in Africa once again.