Fitch Solutions believes that Egypt’s reaching an agreement on the International Monetary Fund (IMF) loan will help stabilise economic conditions in the short term.
They added in a report: Contrary to our expectations, authorities proceeded with an immediate rather than a gradual weakening of the currency. Indeed, on 27 October, the Central Bank of Egypt (CBE) held an unscheduled meeting of its Monetary Policy Committee (MPC) during which it hiked its overnight deposit and lending rates by 200 basis points (bps) to 13.25% and 14.25%, respectively, and announced the introduction of a flexible exchange rate.
“While we had long argued that the period of stable exchange rates in Egypt is behind us, we had thought that the authorities would allow this to happen gradually to avoid intensifying inflationary pressures and social discontent,” the report indicated.
However, downside risk materialised, with the exchange rate weakening from EGP 19.72 per dollar on 26 October to EGP 22.80 per dollar at the time of writing, effectively closing the gap with the black-market rate of about EGP 23 per dollar.
First, Fitch Solutions believes the Egyptian pound will continue to weaken until the IMF agreement comes into force in December due to imbalances in the currency market.
They explained that the currency will breach EGP 23/USD in coming days as the market adjusts but it is unlikely to exceed EGP 24/USD as the CBE will attempt to avoid a significant overshooting of the pound. In 2023, they believe foreign inflows will increase in the form of bilateral and multilateral funding, portfolio investment and FDI, which is likely to ease depreciation pressures or even allow the currency to regain part of its losses.
Second, given the currency sell-off, Fich Solutions now expects more pronounced inflationary pressures in coming months. Indeed, we see inflation reaching close to 20.0% y-o-y in December 2022 and January 2023, and will likely remain in double-digits throughout 2023.
“We have increased our 2022 forecast for average inflation to 13.6% and we anticipate it will average around 14.0% in 2023, especially if authorities adjust electricity tariffs in July 2023 and continue to increase administered prices. Having suspected that the CBE might adjust its current inflation target of 5.0% -9.0%, the CBE governor confirmed that the Bank will do so and the new targets are set to be announced by the end of the year,” the report read.
Third, against this backdrop, the report indicated that the CBE will keep financial conditions tight. The unscheduled October hike is the CBE’s third rate increase this year after 100bps in March and 200bps in May, resulting in a 500bps cumulative increase so far this year.
“While we were expecting a 100bps hike during the remainder of the year, the extent of the CBE move was a surprise, to ourselves and the markets, but we believe it is consistent with the floating of the currency. We suspect that the CBE will hold rates in the short term to assess the impact of tighter financial conditions on inflation,” the report added.
Fourth, Fitch Solutions has cut our growth forecast for Egypt in FY2022/23 to just 3.0%, the weakest rate since 2014. While part of the subdued growth is driven by slow activity between July 2022 and December 2022 due to the distortion in the market from import controls that brought manufacturing activity to a halt, additional problems derive from weak tourism activity and an increase in the cost of living that is weighing on consumption. As a result, the recovery between January and June 2023 once the shortage of foreign currency in the market is addressed and the import restrictions removed will be flattered by base effects. We will likely reduce Egypt’s score on our Short-Term Political Risk Index to highlight the social risks from rising inflation. However, the government’s new social programme, announced on October 26, might mitigate some of the social discontent from the economic pain in the short term.
