The recent appreciation of the Egyptian pound against the US dollar, after a long period of stability, recorded EGP 17.86 for buying, and EGP 18.02 for selling, to draw attention on the prospects for the currency in the medium term.
Goldman Sachs believes that despite the downward pressure on the pound which is emanating from high domestic inflation relative to Egypt’s trading partners, developments in the balance of payments should be
supportive in the medium term, according to a research note released by the bank.
On the other hand, Morgan Stanley stated in a report that although there is no immediate pressure for the currency to weaken, the uncertainty introduced over the exchange rate may lead to fewer foreign inflows, while inflation and an EGP real effective exchange rate (REER) trends suggest a gradual nominal EGP weakness. It may also lead to higher external bond issues, weighing on spreads.
External dynamics to prop up Egyptian pound
According to Morgan Stanley’s report, Egypt is now starting from a position of strength, resulting from an improved balance of payments, a current cheap foreign exchange (FX), and a moderating inflation. As such, any FX reform is unlikely to result in large currency depreciations as seen in the past, including the 48% devaluation in November 2016, and the 15% depreciations in March 2016 and January 2015.
In line with the same point of view, Goldman Sachs indicate that positive trends in the oil and gas sector, as well as tourism and remittances, should continue to support the current account balance, which they forecast will break into surplus territory in the fiscal year 2019/20.
“We do not expect that the abolition of the repatriation mechanism will necessarily bring about more volatility in the pound, despite the recent EGP’s appreciation. The majority of portfolio flows into the local bond market over the past two years have taken place outside the repatriation mechanism, but the Egyptian pound has remained stable. Should this change, following the abolition of the repatriation mechanism, in our view it would tell us more about the Central Bank of Egypt’s evolving tolerance for volatility than about the fundamental FX dynamics,” the report added.
Consequently, Goldman Sachs believes that this view is supportive of the Egyptian local bond market in 2019, which they think will provide one of the highest Sharpe ratios in the emerging markets space.
However, the bank highlighted the presence of material tail risks, including security, political, andeconomic uncertainties which might lead to volatility in the coming year.
On the other hand, Morgan Stanley believes that the majority of investors in Egyptian T-bills invest because they value the currency’s stability, as well as the high short-term yields.
Moreover, the report indicated that although there is no immediate pressure on the currency to weaken, yet the uncertainty introduced over the exchange rate will likely lead to fewer foreign inflows, while inflation and EGP REER trends suggest a gradual nominal EGP weakness over time.
However, the report indicates that the REER is still relatively cheap, and stands below its 10-year average, while the external position has improved in recent years.
However, in order to preserve external stability, the exchange rate regime may need to shift to target stability in real rather than in nominal terms. Of course, this would mean allowing the currency to adjust in line with inflation differentials. With inflation still in double-digits, this would mean nominal weakness. One factor that could ease the pressure would be any weakening trend in the US dollar.
