Egypt central bank leans on currency devaluation

A series of moves by the Central Bank of Egypt (CBE) to devalue the pound and limit dollar activity are expected to help shore up foreign reserves and eliminate black-market currency trading.

The controlled devaluation of the currency earlier this year from 7.14 to 7.62 pounds to the dollar has helped narrow the distance between the official exchange rate and that found on parallel markets. In tandem with the currency devaluation, the CBE imposed daily and monthly limits ($10,000 and $50,000, respectively) on dollar deposits in local banks in an attempt to stifle the black market for foreign exchange.

The IMF praised the CBE’s move, with Masood Ahmed, the IMF’s director of the Middle East and Central Asia Department, saying in April that a more unified market “would help to create the basis for more investment, and better functioning of the exchange markets, and as a result encourage investment and growth”.

Shore-up hard currency

Devaluation is also likely to slow the drain on foreign exchange reserves, which shrank by about 10% in a year to $15.4bn in January, according to Jean-Michel Saliba, an economist at Bank of America Corp. Reserves have dwindled from about $36bn before the 2011 revolution, dropping to a 10-year low of $13.4bn in March 2013.

To ward off further declines, Egypt’s neighbours from the GCC, including Saudi Arabia, Kuwait and the UAE, have over the past four years provided billions of dollars in transfers, grants, aid and concessionary loans. The IMF has also recommended that Egypt raise its foreign exchange reserves to 4.5 months of imports, up from approximately two and a half months now. The authorities, however, said they would aim for 3.5 months of imports within the next five years.

Another key aim of the CBE measure was to shore-up confidence ahead of the key Economic Development Conference, which took place in March. Egypt secured investment contracts worth $36.2bn, an additional $18.6bn in infrastructure contracts to set up power plants, and $5.2bn in loans from international financial institutions.

Investment Minister Ashraf Salman noted in March that a shortage of hard currency was making it difficult for foreign portfolio and industrial investors to repatriate profits, a problem that has also impacted foreign direct investors. The shortage of foreign currency is affecting local business, especially those companies that rely on imports of goods, feedstock, cars or electronics.

The devalued pound should help also stoke activity more broadly in some of Egypt’s key revenue-earning sectors, including manufacturing, agriculture and tourism. Egypt is also looking to stay competitive on exports to the EU, its largest market, while the newly weakened Egyptian pound will make the country a more tempting travel destination. Tourism accounts for more than a tenth of Egypt’s GDP and nearly a fifth of foreign currency revenues. Since the revolution, vital sources of hard currency revenue, such as tourism, have been hit hard. Tourism revenues came to $5bn in the 2013/14 financial year, compared to around $12bn in 2010.

Inflation to rise

The flip side to the currency devaluation has of course been an increase in consumer prices, with the cost of imports rising as a result. Given the country’s large price-sensitive population, with roughly a quarter of the population classified as poor according to the state statistical bureau CAPMAS, this is cause for concern as 60% of all goods sold in Egypt are imported. In recent years, the government has managed to roll back subsidies on a number of key items – which has helped to reduce the budgetary burden – and low petroleum prices have at least partially insulated Egyptians from rising import costs, but the price of wheat and other imported items may increase.

Consumer inflation rose for the second consecutive month in March, increasing to 11.5% from 10.6% the previous month according to CAPMAS, although this is still lower than the high of 18.3% y-o-y that the country saw in 2008. Food and utility costs pushed inflation higher, linked to the falling currency. Inflation has also accelerated after the government slashed subsidies last summer, pushing up fuel prices by as much as 78%.

According to UK-based Capital Economics, inflation is set to remain in the double digits until the third quarter of the year, at which point it is likely that the central bank will cut interest rates.