Levelling with the dollar

This week's sudden devaluation of the Egyptian pound signals a new way of managing the exchange rate.

20 March 2016

This week's sudden devaluation of the Egyptian pound signals a new way of managing the exchange rate, reports Niveen Wahish.
In a surprise move, the Central Bank of Egypt (CBE) auctioned off around $200 million to the banks at LE8.85 to the dollar on Monday. The move represented a de facto devaluation of the Egyptian pound by 13 per cent on the previous exchange rate of LE7.73 to the dollar. With this most recent drop in value against the dollar, the pound has depreciated by around 50 per cent since 2011.

The CBE said in a statement that it had decided "to adopt a more flexible exchange rate regime that better reflects the underlying forces of supply and demand and, in turn, leads to greater transparency and foreign exchange liquidity through attracting greater investments and the correction of asset prices."

This means that the market should expect to see the value of the pound change more often than was previously the norm and depending on factors of supply and demand. The success of the move will depend on whether the CBE has enough dollars to meet demand, said one banker who preferred to remain anonymous. The CBE auctioned off a similar amount on Tuesday.  And on Tuesday, as Al Ahram Weekly was going to press there was news that the CBE would auction off $1.5 billion on Wednesday to cover all the back log of dollar demand. Egypt's hard currency reserves currently stand at $16.5 billion.

The CBE move was applauded by different market players. "A positive step and one that should help to improve the country's balance of payments position," was how Capital Economics, a London-based research company, described the move.

CBE Governor Tarek Amer had earlier done his best to indicate that there would be no devaluation in the near future. "Not before we have $25 billion in reserves," he said in a recent television interview, in an apparent attempt to keep the market off its guard.

Immediately following the devaluation, the dollar rate on the parallel market was around LE9. Cairo resident Noha Abdullah, who had wanted to buy dollars to pay for an overseas purchase, was relieved that she had waited for the rate to cool rather than rush to buy when they reached LE10 to the dollar. She found the sum she needed at a nearby foreign exchange bureau, something that was not possible in a very long time.

"Aggressive" is how Mohamed Maher, vice-chairman and CEO of investment bank Prime Holding, described the size of the devaluation, which has considerably narrowed the gap with the black market rate. The new official rate could encourage the tourism and export sectors and those hoarding dollars to exchange them for pounds, he told Al-Ahram Weekly.

For investors, the devaluation is attractive because it means cheaper means of production such as land, labour and electricity and water. "A weaker currency would also boost external competitiveness and encourage foreign investors back to the country," added Capital Economics.

On the same day of the devaluation the stock market, the EGX 30 Index soared by 6.7 per cent, the most since July 2013 at the close on Monday, 23 per cent above a January low, Bloomberg said. All of the Index's 30 members climbed as investors traded 644 million shares, about three times the six-month average, it reported. On Tuesday it gained another 1.9 per cent.

However, the exchange rate is not the sole point of attraction for investors, Maher pointed out. There must also be coordination with fiscal policies, and there is a need to revisit the investment law to ensure that Egypt is attractive to foreign and local investors when compared to neighbouring markets.

Maher is not worried that the value of the pound against the dollar will drop again on the black market. "We may see some slight hikes next week as some traders who had bought the pound at above LE9 try to make up their losses, but this should not last," he said. He is expecting that measures taken by the CBE to attract dollar deposits will provide it with a cushion that will enable it to meet demand and thus there will be no need to revert to the black market.

The devaluation of the pound had been widely predicted, but commentators had not been sure of when it would happen. Last week, the black currency exchange market was rife with speculation, pushing the dollar to trade at up to LE10.

News of the devaluation had ordinary citizens worrying about prices. "This is a calamity," said Ahmed Mustafa, a pensioner. "It means everything will become more expensive."

However, people should not worry too much, Maher said, as many traders were already calculating prices according to the black market rate, so there should not be price hikes with the exception of an increase of two to five per cent on some imported items.

Capital Economics estimates that every 10 per cent drop in the currency will cause inflation to jump by 1.5 to two per cent. "Higher inflation will erode households' real incomes and weigh on consumer spending, which has been one of the key props to growth over the past few years," it said.

Devaluation will also come at a cost to the government and will mean an additional burden of around LE10 billion on the budget in the form of the higher cost of subsidies, debt repayments and the debt-service burden. Egypt is targeting a budget deficit of 9.9 per cent in the 2016-2017 budget.

It had targeted 9.5 per cent in the current fiscal year, but it now appears that this target is not attainable; in the first six months of the current fiscal year the budget deficit had already reached around six per cent.

The devaluation is "a good move that should have been taken some time ago to avoid the speculation and the pressure on the pound which we have seen in recent weeks," one professor of economics at the American University in Cairo told the Weekly.

He hopes that the CBE will "put its money where its mouth is" and allow real flexibility in the exchange rate. "Interference has cost us over $20 billion in reserves, let alone the foreign assistance that we have been receiving," he said. Since 2011, Egypt's reserves have fallen from $36 billion to hit $16.5 billion this month. Moreover, Egypt has received some $40 billion in assistance mainly from the Gulf.

"All this has gone down the drain," he said, adding that instead of following a clear monetary policy the CBE moves had been "mere reactions" to the market. Now that the CBE has taken the decision to devalue the pound, it should not go back to business as usual, he said, saying that it is important that the CBE start implementing the monetary policy it had earlier established, which is to focus on price stability.

Capital Economics believes the pound has further to fall. "We think a level of closer to LE9.5 per dollar would help to restore external competitiveness," it said.

Raising the rate in itself will not mean more dollars will be immediately available. The CBE has been taking measures to encourage dollar transactions through the banking system and to increase its dollar reserves. This week Banque Misr and the National Bank of Egypt both offered new savings certificates in Egyptian pounds at an interest rate of 15 per cent.

As the move is aimed at boosting demand for the pound, the certificates can only be bought by those exchanging dollars for the pound. Subscriptions for the new certificates are only open for two months.

Before the launch of the new certificates, the three state-owned banks --the National Bank of Egypt, Banque Misr and the Banque du Caire -- had offered other products aimed at attracting dollar savings. They raised interest rates on three-, five-, and seven-year dollar-denominated certificates of deposit by 4.25 per cent and 5.25 per cent and 5.75 per cent respectively.

Special certificates for Egyptian expatriates were also offered with an interest rate of 3.5 per cent for one-year certificates, 4.5 per cent for three-year certificates and 5.5 per cent for five-year certificates. The three state-owned banks also offered Euro-denominated savings certificates for Egyptian expatriates, with one-year certificates carrying an interest rate of two per cent, three-year certificates three per cent, and five-year certificates 3.5 per cent.

These new products could attract some $2 billion to $3 billion into the banking system, Maher said. "The CBE targets international reserves at $25 billion in 2016 on the back of the expected direct and indirect foreign inflows as confidence is restored," a CBE statement said this week.

There have also been reports that Egypt will be going to the International Monetary Fund (IMF) for a loan soon. While the CBE governor has denied this, his comments are being met with some sceptisim as he also earlier denied that there would be a devaluation any time soon. Since 2011, Egypt has begun loan negotiations with the IMF several times, but these have not yet resulted in a loan.

Egypt also expects to receive the first tranche of a $3 billion loan from the World Bank once it is approved by parliament. Another source of replenishing the dollar reserves could be a $1.5 billion bond issue planned for May.

Egypt is also planning to launch this week an option product that lets foreign investors hedge against currency risk, Bloomberg reported. This new product "could allow Egypt to attract billions of dollars, boosting reserves and cutting the government's borrowing costs," it said.

The CBE has had to be innovative to attract dollar savings, given that the sources that traditionally replenish the CBE with hard currency are not doing well. Tourism, which brought in $12.5 billion in 2010, has been limping along for the past five years, with the hardest blow coming following the Russian airplane crash in Sinai in October 2015. Egypt's tourism income dropped to $6.1 billion in 2015, compared to $7.3 billion in 2014.

Earnings from the Suez Canal currently range around $5 billion, and there has not been any increase since the opening of the new canal in August. This is attributed to a slowdown in global trade and to lower oil prices, which have meant that ships can take the longer route around the Cape of Good Hope at a cheaper cost. Exports only brought in $22 billion in 2014-2015 at a time when imports reached $60 billion.

Foreign direct investment came in at $6.4 billion in fiscal year 2014-2015, its highest since 2011. But very little of the investment that was promised at the Egypt Economic Development Conference, which took place a year ago this week, has materialised. Continued dissatisfaction with the investment climate and the exchange rate regime has kept investors away.

A move by the CBE to lift all caps on deposits and withdrawals by individuals and importers of strategic goods late last week was also aimed at encouraging people and companies to use the banking system. It eased the pressure on the dollar, causing it to drop to LE9 on the black market before this week's devaluation.

"These steps were vital to resolving market imbalances and allowing an orderly foreign exchange market to re-attract foreign exchange inflows through the official banking sector channels in a regular and sustained manner after a year of interruptions," said a CBE statement.

The CBE decision partially removes the restrictions placed by former CBE governor Hisham Ramez in February 2015, when he capped daily deposits at $10,000 and monthly deposits at $55,000. Ramez's decision was intended to prevent black market transactions, but it later triggered a severe scarcity in the availability of the dollars in the banking system."

It also remains to be seen what direction the CBE monetary policy committee will take at its next meeting, scheduled for 17 March. The CBE "is likely to tighten monetary policy further in order to limit any second-round effects on inflation from currency weakness," according to Capital Economics. It expects the CBE to raise interest rates by around 100 basis points to 10.25 per cent.

© Al Ahram Weekly 2016

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