Cash & Liquidity ManagementFXEgypt attempts to plug FX hole

Egypt attempts to plug FX hole

Coronavirus exposes cracks in Egypt’s macroeconomic stabilisation

The state of Egypt’s security and macroeconomic stabilisation has been further weakened by the global coronavirus pandemic, according to think tank the Arab Reform Initiative (ARI).

The organisation’s August 2020 research paper reported that while the country remains stable on the surface, it continues to have deep structural problems with militarisation of the economy, claims of corruption and a shortfall in remittances from Egyptians working in oil-rich Gulf countries.

This frailty has created a huge foreign exchange (FX) hole despite the International Monetary Fund’s (IMF’s) call for further reforms. Reuters reported that the Extended Fund Facility (EFF) prompted “a pound float and a 50% devaluation” in the Egyptian pound.

The ARI is therefore concerned that Egypt’s largely successful security and macroeconomic stabilisation, following the granting of a $12bn loan agreement with the IMF in 2016, could arguably push Egypt back to where it was before the 2011 revolution.

The authors of the ARI’s research paper comment: “Egypt is now back to square one, in a situation broadly similar to that before the 2011 revolution: stable on the surface, but with deep structural problems and simmering social grievances, and buffers available to mitigate them depleting.”

2016 IMF Extended Fund Facility

The aims of the 2016 IMF Extended Fund Facility were to address the country’s economic challenges “to boost growth and create jobs while protecting vulnerable groups”, an IMF report said, adding that it allowed for an immediate disbursement of about US$ 2.75 billion.

Stepping forward to 2020, the ARI report claims that the pandemic has hit Egypt hard, “…exacerbating the country’s main source of weakness – its international earnings. While Egypt has enough foreign reserves to be able to cope in the short term, the shock is a reminder that, unless current economic trends improve, its future remains vulnerable and uncertain.

“Egypt’s dependence on fragile external revenues has never been higher. In 2019, the country needed to raise nearly $100bn to pay for its FX needs. et, after decades of pro-market reforms, and a recent mega-devaluation in 2016 of 50 percent, it managed to export only $30bn of goods (including about $10bn of gas as Egypt became a net exporter of oil and gas in late 2018).”

Egyptian pound devaluation

Since March 2020, the Egyptian pound has been further devalued. In April 2020, Capital Economics said that it expects it to continue to decline by approximately 7.5 percent by the end of 2020 to E£17 to the US dollar. However this prediction was very much dependent on the Egyptian authorities loosening their grip on the country’s currency.

Further to that, Reuters reported in The National on June 5 that the  Egyptian pound fell to the lowest level in seven months. The currency slipped to E£16 to the U.S. dollar. This was its fifth straight day of losses. With Egypt being viewed as being amongst one of the five riskiest emerging market countries (alongside Bahrain, Pakistan, Lebanon and Mongolia), this may have been caused by investors ditching whatever they see as risker assets in response to the coronavirus pandemic.

Policy rates unchanged

To avoid a prolonged economic slowdown and to help speed the recovery once the outbreak is contained, the Central Bank of Egypt (CBE) said in a press release on April 2 that it decided to “keep key policy rates unchanged” to achieve “the inflation target of nine percent (±3 percentage points) in 2020 Q4 and price stability over the medium term.”

“The Monetary Policy Committee (MPC) decided to keep the Central Bank of Egypt’s (CBE) overnight deposit rate, overnight lending rate, and the rate of the main operation unchanged at 9.25 percent, 10.25 percent, and 9.75 percent, respectively. The discount rate was also kept unchanged at 9.75 percent,” the CBE said in the release.

The central bank has continued to keep rates the same since that meeting, Egypt Today reported. Interest rate rises would be potentially problematic as external debt already exposes Egypt to “an important source of vulnerability – it will become much more onerous should interest rates rise, or the Egyptian Pound devalues further”, said the ARI in its research paper.  Yet most of the country’s debt is internal.

IMF emergency support

To try to improve matters and fill the FX hole, the Egyptian government approached the IMF again. In May the IMF’s executive board approved US$2.772bn in emergency support to enable Egypt to address the pandemic.

The country needed the IMF’s support to meet its balance of payments needs and prevent a blow to its macroeconomic stability. It is hoped that the funds will enable the country to alleviate its financing needs, as well as to support health, social protection, the most impacted economic sectors and vulnerable groups.

Further to this, in August the Egyptian government made a request to the IMF for a 12 month standby arrangement as the country’s external accounts have come under pressure, caused by capital outflows as well as by the fall in tourism and remittances. Along with the emergency support, the arrangement is designed to mitigate the economic and social impact of the pandemic, to safeguard past achievements and to maintain macroeconomic stability.

Government response

To this end, the IMF said the Egyptian authorities have “responded with a broad package to scale up the health system’s capacity to the support the people and the economy” of Egypt. However, the ARI concludes that while the country may have “the reserves, international political and financial backing to overcome short-term bumps”, it has to do more to address in the medium term its serious fragility by changing course.

Change requires more market liberalisation, less military involvement in the country’s economy and to widen participation in political affairs while giving the private sector a more central role than it has in the Egyptian economy. Such reforms could prove positive by reducing social unrest, attracting foreign direct investment, bolstering its currency and filling its foreign exchange hole.

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