Simon Williams, HSBC’s Chief Economist for Central and Eastern Europe, the Middle East, and Africa, said, “We are optimistic that yesterday’s policy announcements, along with large-scale financial support, can mark the start of a new cycle for Egypt, paving the way for economic stabilization and growth.”
This hope partly reflects the scale of policy adjustment – the 40% fall in the official value of the currency was the biggest of the four devaluations Egypt has undergone in the past two years, while the 600bps rate hike was more than we expected. The FX move has almost closed the gap with the parallel market rate, and the hike may have made the policy rate positive in real terms. Importantly, these actions are linked to a wider set of policy commitments in the improved IMF programme agreed upon at a staff level yesterday, which include promises to rein in fiscal excess and align monetary policy and the FX regime with an inflation-targeting regime. The chances of fulfilling these promises have been increased by the expansion of Egypt’s IMF programme from $3bn to $8bn – an amount that not only encourages policy discipline but also boosts Egypt’s ability to manage change when combined with the $35bn investment deal signed with the UAE in February. More pledges of multilateral and bilateral support are expected soon.
In a statement with yesterday’s special MPC, CBE said that it would “let the exchange rate be determined by market forces” – a theme stressed by the prime minister, central bank governor, and the IMF. We are curious to see what this means in practice, but for now, note FX restrictions are already being lifted, and we are hopeful of dollar inflows to restore the interbank market, end the parallel market, and gradually clear the large dollar backlog and the banks’ strained NFA positions. These flows will likely be driven by public entities, but as confidence in the new FX regime grows, we anticipate remittances and portfolio flows to return to the market.
Risks and policy uncertainties persist, and it will take time for EGP to find its level but for now, we maintain our view that the currency will settle in the 40-45 range. We expect a slight rise in near-term inflation, but see prices stabilising in Q2, creating room to ease some of the monetary tightenings before the year’s end. Growth will take longer to recover, however, as new fiscal and monetary tightening affects and real wages stagnate. FX depreciation and higher interest rates will increase the budget deficit, ensuring pressure to reduce primary spending remains high.
