The Egyptian pound strengthened to an average of LE15.7 to the US dollar in interbank dealings this week from an average of LE18.5 to the dollar registered at the beginning of the year. The upturn in the local currency comes ahead of expectations for the IMF's first review under the three-year $12 billion loan agreement with Egypt that should take place at the end of March. Reforms have been announced at an accelerated pace in the past couple of months to put the country on track to receive the second tranche of the IMF financing programme. Egypt started an economic reform programme in July 2014 that includes subsidies cuts and the introduction of new taxes. The government secured the IMF loan in November last year to fund its economic reform plans. President Abdel-Fattah Al-Sisi said last month that he expected the pound to attain what he believed would be its fair value in about six months. According to analysts, the exchange rate could ease to as low as LE14 to the dollar by the end of June. This is expected as long as the reforms remain on track, though the adjustment will be painful in the short term. Overall, the foreign-exchange market is still volatile, with bankers saying it will take time for dollars to be absorbed into the banking system after the floatation of the pound. The dramatic story of the pound began on 3 November last year when the Central Bank of Egypt (CBE) decided to liberalise the exchange-rate system, float the local currency by nearly 50 per cent, and raise key interest rates by 300 basis points (bps) in a bid to attract inflows of capital and close down a booming black market for dollars. Following the decisions, the banking system attracted $1 billion of inflows in the first month, while the liberalised foreign-exchange system helped the government to acquire $12 billion from the IMF as well as further billions from other donors. In fact, the pound has received strong support from the increasing inflows since the liberalisation of the exchange rate. The introduction of the floatation has eliminated the need for currency controls and enabled capital inflows into equities and the bond market. Most recently, the government sold $4 billion of Eurobonds with different maturities amid strong investor demand. Investment flows were also encouraged following the signing of the IMF deal. In January alone, the CBE raised LE11.5 billion ($732 million) from the sale of government securities, according to government sources. Non-resident investments in equities and treasury bills issued by the government gained momentum and jumped to $2.5 billion in the three months since the pound's floating in November. Yields on government securities dropped, at some points by two bps, due to high demand. The rate of foreign investment in the mentioned three months is the highest since 2009. Government treasury bill and bond auctions will likely continue. The Finance Ministry borrows from the domestic market on a regular basis to cover the state budget deficit, which exceeded 12.2 per cent of GDP in the 2015/16 financial year. It has revealed a plan to borrow LE299 billion in the third quarter of the 2016/17 financial year in order to finance the budget gap. The question is: will investors' appetite remain as high as it has been over the past few weeks? It could be yes, but it is unlikely to be higher. In addition to increased capital flows, the decline in demand for imports was another factor which supported the easing of the exchange rate. Egypt relies heavily on imports, particularly of food, and the devaluation caused a massive increase in import prices compared to a strong reduction in purchasing power. This led to the halting of imports of several commodities, thus reducing demand for the dollar. Imports are expected to decrease by 20 per cent this year. Foreign reserves held by the CBE that were previously used to finance the import of basic commodities, especially food, have increased substantially, reaching $26.36 billion by the end of January, their highest level since June 2011. The sharp increase in the reserves is also the direct impact of the liberalisation of the exchange-rate regime as the CBE does not now need to spend its reserves in supporting the value of the pound. In addition, the country has received inflows from international lenders the IMF, the African Development Bank and the World Bank. The current correction of the pound's value can be attributed to the rationing of many market players, including producers, consumers, entrepreneurs and foreign investors, comments Dalia Tadros, executive director of the Egyptian Private Equity Association (EPEA). Producers are trying to replace imported inputs by local ones, or at least rationalise their inventory of imported inputs, she says. Consumers, hit by high inflation rates, have started to rationalise their consumption. Entrepreneurs have looked for import substitutions, have explored exporting opportunities, and have become more interested in the competitiveness of local production. Foreign investors have stopped their excessive demand for the US dollar with the objective of repatriating their profits. This has all been attributed to the increasing confidence in the local economy amid optimistic sentiments of the availability of foreign currency in the formal market, Tadros explains. Looking ahead, the exchange-rate system is likely to improve given the government's success in implementing its reform plans with minimum social discontent. Increased levels of production, improvement of export levels in terms of value and quantity, as well as the balanced control of the government of the market will definitely, among other factors, be supportive in the medium term. The writer is a political analyst based in Jeddah, Saudi Arabia.
