After weeks of speculation on whether the pound will be devalued or floated, the Central Bank of Egypt (CBE) on Thursday decided to fully float the Egyptian currency. The exchange rate of the currency is now determined by supply and demand, a move aimed at putting an end to the parallel market. "This move will allow market demand and supply dynamics to work effectively to create an environment of reliable and sustainable provision of foreign currency," said a CBE statement.
It's a “historic move” said CBE Governor Tarek Amer in a press conference on Thursday evening.
Thursday night the dollar was trading at around LE16 in some banks, compared to LE8.8, the official rate before the floatation. CBE started off with a transitionary step, setting the pound at LE13, plus or minus 10 per cent, as a guidance rate until it auctioned $100 million at noon on Thursday. With the floatation, the CBE will no longer be carrying auctions and the rate will be determined through interbank transactions except when deemed necessary. “The purpose of these auctions is to support the process of market price stabilisation in the early days of adjustment,” noted Pharos Brokerage.
The floatation was accompanied by a package of other decisions which liberalise the currency exchange market. These include no limits or conditions on foreign currency deposits or withdrawal for both individuals and firms except for importers of non-essential goods. The latter has a cap of $50,000 in cash deposits per month and $30,000 in withdrawals per day.
To attract depositors, banks will remain open until 9pm as well as on weekends. Furthermore, commission on expatriate remittances through banks was cancelled.
“We have to enable banks to attract hard currency within the banking system,” said Amer during the press conference, adding that hard currency flows increased eight-fold over what they had been in the past weeks. He did not specify how much that figure was.
Egypt has been facing a foreign currency shortage since the January 2011 revolution with political turmoil driving away tourists and foreign investors. International reserves which stood at $36 billion in January 2011 have fluctuated over the past five years, falling to around $14 billion on several occasions before being salvaged temporarily. The global drop in oil prices the past year affected remittances of Egyptians working in the Gulf as well as the limited flow of Gulf aid which acted as a lifeline for the economy in the three years following the toppling of former president Mohamed Morsi. The Central Bank tried to keep the rate of the dollar under control by introducing restrictions on dollar deposits and regulating imports but the measures backfired.
The CBE devalued the pound in March 2016 by 14 per cent and its official rate had stood at LE8.88 since. In the meantime, the scarcity of dollars resulted in it being traded at a premium of almost 100 per cent to its official value in recent weeks.
The weakest point was reached earlier this week when it changed hands at LE18. Several factors came into play to cool the rate down to LE13.5 on Wednesday. Among those is an agreement by the Federation of Chambers of Commerce to boycott the parallel market for two weeks and to halt unnecessary imports for three months. Furthermore, there was the announcement of a handful of investment friendly regulations by the Supreme Investment Council. The latter granted tax exemptions and cuts on industrial and agricultural investments for import replacement as well as export purposes in certain locations including Upper Egypt. Furthermore, it postponed the application of a capital gains tax on shares for three years after it had been scheduled to be implemented in 2017.
For the past few weeks the market had been anticipating that the CBE will devalue the pound. In August, the government reached a staff-level agreement with the IMF over a $12bn financing deal. However, the deal was not going to be reviewed by the IMF board of directors for approval before a devaluation and subsidy cuts took place, IMF Managing Director Christine Lagarde had told reporters in Washington during the annual IMF/World Bank meetings.
“[Floating the currency] is statement of intent to the Fund that the government is willing to undertake the economic reforms that will form the conditions of the package,” noted Capital Economics, the London-based research consultancy.
“It is a timetable of measures and benchmarks that are drawn from the programme of the government itself,” Masoud Ahmed, director of the IMF's Middle East and Central Asia Department, told journalists in Washington.
The floatation was well received by many. “We welcome the Central Bank of Egypt's decision to liberalise the foreign exchange system and adopt a flexible exchange rate regime," said IMF Mission Chief for Egypt Chris Jarvis in a statement.
"This will make more foreign exchange available. 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 market cheered the devaluation as the EGX30 jumped by 8.3 per cent during the first hour after the step was taken, making it the largest gainer among the world's stocks on Thursday. It limited its gains by the end of the day to 3.35 per cent to close to 8,810 points, its highest level in 19 months.
Egypt had been delaying such a step for fear it would add to inflationary pressures and stir social unrest. In fact, many had been expecting a devaluation rather than a floatation. “A full float is preferred from a macroeconomic perspective, but a managed float looks to be more politically appropriate,” Pharos said in a recent note. Capital Economics estimated that every 10 per cent drop in the currency will cause inflation to jump by 1.5-2.0 per cent. “On that basis, if the pound were to fall to LE13 per dollar, then inflation could rise by as much as six per cent over the next 12 months,” said Capital Economics.
“Higher inflation will erode the real incomes of households and weigh on consumer spending,” wrote Jason Tuvey of Capital Economics.
This may further be augmented by the fact that the CBE has said that banks will no longer be responsible for prioritising the hard currency financing of basic goods. However, the CBE has already provided $1.2 billion in financing for a six-month stock of basic goods, Amer told journalists.
In an attempt to limit the inflationary impact, the CBE has raised interbank deposit and lending rates by three per cent minutes after the floatation decision to 14.75% and 15.75% respectively. This aims at increasing the appeal of investments in the pound versus the dollar.
Moreover, state-owned banks, the National Bank of Egypt, Banque Misr and Banque du Caire, issued certificates of deposits at a rate of 20 and 16 per cent for certificates maturing after 18 months and three years respectively.
Egypt's inflation rate has been on the rise, reaching 14 per cent in September. Analysts expect the rate to reach 18 per cent by the end of this year considering the floatation and the expected fuel subsidies cut.
“By floating the pound, the Central Bank will eventually be able to fully dismantle FX restrictions, reducing disruptions to activity. A weaker currency would also boost external competitiveness and encourage foreign investors back to the country,” said Capital Economics.
