The weak pound is proving a distinct obstacle to Egypt’s struggling economy

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By Samantha BarnesInternational banker

WThe U.S. presides over the tightest monetary-policy regime around the world today as the global war on inflation continues, and the flight by investors to safe haven markets and jurisdictions over the past 18 months has made much of the emerging economies particularly vulnerable. Reflected by the subsequent weakness of their respective currencies. And few countries have shown more vulnerability than Egypt.

An examination of the state of Egypt’s increasingly dysfunctional economy over the past 18 months goes a long way to explaining the dramatic decline in the value of the pound. Following the outbreak of war in Ukraine at the end of February last year and the US aggressively raising interest rates, more than $20 billion in „hot money” left Egypt. The departure follows similar outflows in recent years, including $15 billion in outflows during the 2018 emerging-market crisis and nearly $20 billion in 2020 at the start of the COVID-19 pandemic.

But last year’s global flight to protectionism completely depleted Egypt’s foreign currency reserves, and the resulting dollar shortage prompted Egyptian authorities to devalue the local currency not once, not twice, but again. Three Separate occasions in March, October and finally January 2023. These measures were taken in part to meet International Monetary Fund (IMF) eligibility requirements for financial assistance, including a commitment to shift towards a floating exchange rate. A fourth such demonetisation is now highly anticipated in the near future.

Demonetization has triggered a significant cost-of-living crisis for the country’s 104 million citizens, 60 percent of whom live below or near the poverty line, an estimated 70. Millions already receive subsidized goods. Inflation has been above the central bank’s target range of 5 percent to 9 percent since early 2022, after last year saw a dramatic rise in input costs for Egyptian businesses, higher energy prices and worsening global supply chain problems following the outbreak. War in Ukraine.

With annual prices rising dramatically above 30 percent throughout the year—most recently, the annual inflation rate for May rose to 32.7 percent, from 30.6 percent recorded in April—the situation appears to be gradually worsening in the second half. The year is 2023. The ongoing Russia-Ukraine war goes a long way to explain such persistent high numbers; Egypt is the world’s largest importer of wheat, and with much of its wheat sourced from both Russia and Ukraine, along with other key commodities, Egypt’s import costs have risen dramatically. In fact, May’s annual food inflation rate was recorded at 60 percent, as against 62.9 percent in March.

Increasingly in need of financial assistance, Egypt has turned to the International Monetary Fund (IMF), which formally approved a 46-month arrangement under the Expanded Financial Facility (EFF) of around $3 billion. This support facility is contingent on a comprehensive policy package to „secure macroeconomic stability, restore buffers and pave the way for sustainable, inclusive and private sector-led growth”. The IMF calculated Egypt’s fiscal gap — the total foreign exchange it would need to repay its debts — at about $17 billion over the next four years. „IMF financing for this project is expected to close part of this gap, but in addition, the IMF-supported program is expected to encourage additional financing from multilateral institutions, bilateral partners, private sector investors, to close the remaining gap,” Ivanna confirmed. Vladkova Hollar is Assistant Director and Head of Mission for the IMF’s Egypt, Middle East and Central Asia Department.

In addition to this package, a flexible exchange-rate regime for the Egyptian pound requires „permanent transition” to greater resilience against external shocks, rebuilding external buffers, and „avoiding the creation of long-term imbalances in demand and supply” while preserving foreign currency and central bank FX reserves in Egypt. In December the IMF also highlighted how two-way movements of a floating exchange rate could bring additional benefits. „This will help Egypt’s domestic economy adjust more smoothly to external shocks, support the ability of Egyptian businesses to sell their goods and services abroad, and encourage more investment by reducing the likelihood of large sudden changes in the exchange rate. In addition, it will help protect the central bank’s financial buffers.”

Egyptian officials resisted the exchange rate demands, however, preferring to maintain the exchange rate at 30.90 per dollar as it has done throughout 2023, despite trading near 37 per dollar on the black market. In June, the Central Bank of Egypt (CBE) also kept its overnight deposit rate unchanged at a five-year high of 18.25 percent, which has been in place since April. But Cairo faces growing pressure as foreign currency shortages persist. And the rising inflation trajectory „adds pressure to the Egyptian pound, which has traded relatively flat since the devaluation in early January despite clear signs of ongoing FX liquidity shortages,” Goldman Sachs economist Farouk Souza wrote in a research note in March. 9, and inflation will peak at 36 percent in the third quarter, if there are no further demonetisation. „The risk of further pound weakness in the immediate term remains high, particularly in the context of the first review under the IMF programme.”

Moody’s revised Egypt’s B3 foreign currency and local currency issuer ratings to downgrade on May 9 as the sale of $2 billion worth of state-owned assets took longer than expected. The rating agency noted that this slow progress is debilitating. Egypt’s foreign exchange liquidity crunch further erodes confidence in the pound.

A few weeks ago, fellow ratings agency S&P Global Ratings took a similar view of Egypt, downgrading its outlook to negative and predicting further currency depreciation on the horizon. „Egypt’s financial resources will not cover its high external financing needs for this fiscal year and next,” S&P calculated, totaling $37 billion. Like Moody’s rating, S&P cited failure to complete privatization reforms in line with the IMF’s requirements as a key factor in its overall rating. As such risks are high, Egypt’s backers may „delay or not provide agreed funds to Egypt, with implications for imports, inflation, interest rates and the government’s debt stock and interest payments”. Indeed, billions of dollars promised to Egypt by its Persian Gulf Arab neighbors have yet to arrive.

On a more positive note, however, the weaker pound has made Egypt a global tourism hub this year, with analysts now expecting the most populous Arab country to welcome the most annual tourists this year in its entire history. According to Egyptian Tourism and Antiquities Minister Ahmed Issa, the number of tourists arriving in Egypt reached 1.3 million in April, a monthly increase, while the number of tourists in the first quarter of this year increased by 43 percent compared to the previous three-month period. year. China News Agency reported XinhuaIssa expects Egypt to receive around 15 million visitors this year, breaking the previous record of 14.7 million in 2010 and 28 percent more than last year.

Such numbers also bode well for Egypt’s economic recovery. In September of this year, before the IMF and World Bank annual meetings in Morocco, the IMF will review the assistance program for Egypt. According to Citigroup, any decision by Cairo to implement another currency devaluation would most likely be made at this time. „We’ve reached a peak of pessimism when it comes to Egypt,” said Luis Costa, global head of emerging market sovereign debt at Bank of America. Bloomberg In early June, a rebound in tourism and the optimistic completion of the sale of state-owned assets, as well as efforts to ease the foreign currency crisis and dispel investor concerns about a possible debt restructuring, prompted Citigroup to „establish.” A very positive view of the Egyptian pound.

„This summer will be an important short-term stabilizer until we start getting serious reviews again in September and October,” Costa noted. While the pound is expected to remain „reasonably stable” until then, Citigroup predicts it will weaken to 36 against the dollar by the end of 2023 and 37 next year. It is currently „in a neutral valuation range,” Costa added.