Hello, friends. Remember how we suggested a few hours ago that today was set to be a slow news day — and that we might be able to slide gently into the weekend? What the hell did we know? As it turned out:
IT’S FLOAT + IMF AGREEMENT DAY
Hassan Abdalla and the Central Bank of Egypt moved at 8:30am CLT to a new “durably flexible foreign exchange rate regime” that will let market forces “set the value of the EGP against other foreign currencies.” The CBE also hiked interest rates and said it would phase out the requirement to finance imports with letters of credit. You can read the statement for yourself in English (pdf) or in Arabic (pdf).
FROM THE DEPT. OF GOOD NEWS- Today’s interbank market saw about 10x more USD changing hands than the average day in the past couple of months. That’s a strong indication that something around EGP 22.50-23.50 is the market clearing rate for the USD.
Hours later, officials in Cairo revealed that we reached a staff-level agreement with the IMF for a USD 3 bn, 46-month extended fund facility (EFF). IMF Egypt Mission Chief Ivana Holler broke the news at a press conference alongside Abdalla, Prime Minister Moustafa Madbouly, Finance Minister Mohamed Maait, and Planning Minister Hala El Said. The package will be Egypt’s fourth loan from the IMF in six years.
THERE’S A KEY WORD ABOVE: “Durably” before “flexible” in reference to the exchange rate. We think that’s code to the International Monetary Fund (IMF) that there’s no going back. All fall long, IMF officials have been sending the message to banks and the CBE that it knows we had effectively re-pegged the currency after the 2016 float (and again after it was allowed to slide against the greenback in March) — and that they weren’t having any of it.
The CBE also made clear it has two overarching priorities:
- Price stability is still Job #1 at the central bank, even as it says that it accepts inflation will be well above its 7% (±2%) band in 4Q 2022;
- It will be working to rebuild a “sustainable, adequate level” of FX reserves, it said in its statement. Abdalla later said that the idea is to double FX reserves within the next four years. Reserves were largely unchanged in September from the previous month, coming in at USD 33.2 bn.
THE STOCK MARKET CHEERED the news: The benchmark EGX30 rallied following the CBE’s announcement of a flexible FX policy and the IMF agreement, rising 4.9% by the closing bell.
As have our elected representatives: “The new agreement will turn a new page in the long relationship between Egypt and the IMF” and will go a long way to bolster Egypt’s creditworthiness, House Budget and Planning Committee Chairman Fakhri El Fiqi previously told Enterprise. The majority of MPs in the House of Representatives had previously “highly welcomed” the prospect of a fresh IMF package and agreed that it “comes at the right time to help Egypt shore up FX resources,” House Budget and Planning Committee Deputy Chairman Yasser Omar told us.
SO, WHAT HAPPENED TODAY?
#1- The EGP was at 23.03 to the greenback at dispatch time this afternoon after having closed the day yesterday at 19.75, a drop of 16.6% so far today.
#2- In parallel, the CBE hiked interest rates by 200 bps across the board, setting the overnight deposit rate at 13.25%, the overnight lending rate at 14.25% and its main operations rate at 13.75%.
State-owned banks followed up with three-year, high-yield CDs: State-owned Banque Misr (pdf), the National Bank of Egypt, and Banque du Caire each brought to market three-year 17.25% certificates of deposit today alongside other savings instruments with variable interest rates. NBE and Banque Misr had rolled out one-year high-yield CDs in March, suggesting that this time around, high interest rates may not be as transient.
Egypt’s USD bonds rallied to outperform most of their EM peers on the announcement before falling later in the day, Bloomberg reported at around noon. The newswire cites optimism that the IMF agreement will assuage fears of a default. Bonds due 2032 jumped 5.1% earlier in the day before falling 4.8% at noon, which Bloomberg attributes to the size of the IMF agreement, which was at the lower end of investors’ expectations. Even after Thursday’s rate increase, the nation’s real interest rate is still below zero, at -1.75%, the newswire said.
#3- IMPORTERS, THIS ONE IS FOR YOU- The central bank will drop the requirement to finance imports with letters of credit. The CBE is going to “gradually” roll back the measure, imposed by the former governor in February, that all imports be financed through letters of credit rather than documentary collection. The phaseout will be complete before the end of the year, Abdalla said at the presser today (watch, runtime: 11:27).
What is happening immediately: An easing of the requirements: The Central Bank of Egypt raised the ceiling for exemption from using L/Cs for imports, saying in a circular (pdf) today that shipments worth up to USD 500k will be allowed to rely on documentary collection. This is a massive jump from the previous USD 5k limit.
#4- AND- The customs USD is coming back for at least one month, a senior government official tells us. Expect an announcement tomorrow that regardless of where the EGP settles, officials will use a fixed rate to calculate the customs and fees owed to the state on imports for at least the next four weeks.
#5- PLUS- We’re getting FX forwards, currency swaps, and non-deliverable forwards: The CBE amended regulations to allow banks to use FX forward contracts, engage in foreign currency swap agreements for corporate clients, and scrap restrictions on non-deliverable forwards for corporate or retail clients, according to a separate circular (pdf). FX swaps and FX forward contracts will be allowed provided they are used to cover documentary collection, L/Cs, repatriation requests from foreign investors, or clients’ proceeds from exporting goods and services. We have a nifty explainer on forwards, which are a type of derivative.
Why does that last bit matter? The idea here is that the tools will allow banks and businesses to start behaving like institutions in developed markets — giving them tools to better manage a substantial portion of their FX risk.
THEN … THE IMF CAME IN-
Details on the funding package: The 46-month EFF is designed to “provide Egypt with balance of payments and budget support while catalyzing additional financing from Egypt’s international and regional partners to maintain economic stability, address macroeconomic imbalances and spillovers from the war in Ukraine, protect livelihoods, and push forward deep structural and governance reforms to promote private sector-led growth and job creation,” the IMF said in a statement.
How does this compare to our previous rodeos? For starters, this package is on the smaller end of the spectrum in comparison to the previous ones Egypt has secured from the IMF. In 2016, we secured a three-year, USD 12 bn Extended Fund Facility. Fast forward a little less than four years, and we locked down a combined USD 8 bn — including a USD 2.8 bn rapid financing instrument and a USD 5.2 bn standby arrangement — to address the economic fallout from the pandemic.
It’s a bit more than Tunisia got: Our neighbor to the west lined up a USD 1.9 bn, 48-month EFF earlier this month. There are nearly 30 countries that have asked the IMF for a helping hand in recent months, as we noted just over a week ago.
WE’RE EXPECTING A TOTAL OF ABOUT USD 9 BN
In addition to the USD 3 bn EFF agreement, Egypt is getting a separate USD 1 bn from the IMF’s resilience and sustainability trust along with another USD 5 bn we expect to unlock from a group of unspecified “development partners” and other international lenders, Madbouly said at the presser. The IMF set up its resilience and sustainability trust earlier this year to help “low-income and vulnerable middle-income countries build resilience to external shocks and ensure sustainable growth, contributing to their longer-term balance of payments stability.”
More importantly than its size, however, are the terms of the financing. Our 2016 bailout package brought with it a far-reaching economic reform program that included a liberalization of the FX system, adjustments to monetary policy aimed at containing inflation, enforcing fiscal consolidation to make our debt sustainable, and instituting structural reforms to promote more inclusive growth and greater labor market participation for women and youth.
This time around, the main focal point of the reforms is fiscal policy… The government will implement “broad fiscal reforms” grounded in a medium-term revenue strategy “that aims to improve the efficiency and progressivity of the tax system,” the IMF statement says. The program also includes “broad fiscal structural reforms [that] will also aim to further improve the budget composition, strengthen governance, accountability, and transparency, and support climate mitigation goals.”
…As well as structural reforms to boost private sector participation in the economy: The new program will bring into action “policies to unleash private sector growth including by reducing the state footprint, adopting a more robust competition framework, enhancing transparency, and ensuring improved trade facilitation.”
This is good: To the extent that we need an IMF package at this juncture, it is more about keeping up pressure to drive home reforms than it is about giving Hassan Abdalla dry powder to fight an overshoot or make debt payments. We have an unfortunate habit of waiting until the last minute to make difficult decisions, then breathing a sigh of relief after ripping off the metaphorical bandaid — and then not learning our lesson.
Policymakers need to stay the course on building a new Egyptian economy with a focused program to build export industries and attract meaningful foreign direct investment (FDI). We published a five-step recipe for doing just that last week, and we’re looking forward to speaking with many of you out there about this in the weeks to come.
WHAT’S NEXT- The funding package still requires final sign-off from the IMF’s Executive Board, which is scheduled to meet to discuss the agreement in December, according to the statement.
HOW SHOULD YOU BE THINKING ABOUT THIS?
We’ve spoken with four of the nation’s smartest bankers, and the consensus is that it’s 2016 all over again. (For the youts among us: That’s a good thing.) Abdalla’s moves this morning were aggressive — and just what the market needed.
We need to hit a market-clearing rate for FX that restores liquidity and allows the economy to start moving again. Yes, that will see us import additional inflation for a period of time, three of the four agree, but that’s inevitable, and the only long-term counterweight is for us to ramp up exports.
And doing this now, before the IMF arrives in town, tells investors and business alike that we’re serious this time. As we note below, there are plenty of investors — strategics, public markets investors, private equity folks, debt investors and the carry trade — that have been sitting on the sidelines for months. No investor is going to buy something they cannot price — and there’s been no way to know the real price of an investment in Egypt when you have the threat of a devaluation of unknown magnitude hanging over your head. Devaluing today will encourage investors of all flavors to consider moving ahead with plans to commit capital here.
Caveat #1- Hassan Abdalla has done his part… Hassan’s move today was gutsy, but the worst is now (isA) behind him. He’s taken that critical first step to start restoring liquidity to the FX market in an orderly manner — and he’s done it without allowing the black market to come back. What’s more, he is introducing new mechanisms that will allow both banks and companies to manage FX risk — and showing importers a light at the end of the tunnel. Exactly the type of thinking you’d hope for from the guy who helped create the interbank FX market in the first place.
…now cabinet has to do the same. Hassan’s race isn’t over, but he’s finished that critical first lap. Cabinet is, in many ways, just barely out of the starting blocks. Having worked with the CBE to bring home an IMF facility, they need to fully embrace the reform program that IMF package is going to demand. From ending the crowding-out of the private sector to making it fundamentally easy to do business here, they have miles to go before they sleep — and little time in which to get it all done. As we noted in our five-step recipe to build a new Egyptian economy based on exports and FDI: We have a once-in-a-lifetime opportunity — and lots of competition from countries that are moving much faster than we are.
Caveat #2- We take issue with the rate hike. More on that below.
ALL THAT REMAINS-
WE THINK THERE ARE A HANDFUL OF BIG (IMMEDIATE) QUESTIONS, though obviously there are dozens more that we’ll all be asking ourselves in the coming days.
#1- The most immediate question: What’s the market-clearing number? As was the case in 2016, there is a value at which buyers and sellers are both willing to transact. Too low, and sellers won’t move out of USD and other FX positions. But if those sellers are too greedy? Buyers won’t buy. Bankers and corporate treasury departments alike are looking for signs that the EGP is hitting a plateau at which sellers find buyers without there being an overshoot.
#2- How much FDI has been sitting on the sidelines, waiting for the float? Investors can’t buy what they can’t price — we know of six transactions worth just over a combined USD 1.5 bn that are ready for execution, but where the foreign investor won’t pull the trigger until they have clarity on what the EGP (and thus their investment here) is really worth. The investors are a mixed bag of European and GCC corporates.
#3- Will the float unlock other Gulf money? There’s a sense among our GCC allies that we need to have our feet kept to the fire if we’re going to press ahead with structural reforms. In addition to warehoused investments, it’s possible there is other assistance from the UAE and KSA that we might unlock on the back of the IMF agreement, as the institution itself explicitly noted (above).
#4- What are the conditions in the IMF facility? We won’t know the specifics until the two sides move beyond a staff-level agreement and get sign-off from the IMF Executive Board.
#5- Is the end of subsidized interest rates one of those conditions? There has been plenty of chatter in recent months about the IMF wanting the CBE to get out of the business of directing banks to offer subsidized interest rates to SMEs / tourism businesses / you name it. The argument is that those types of programs should be run (and paid for) by folks on the fiscal side of the house.
AND THE BIGGEST ONE OF THEM ALL: Will we stick to the regime? We hope the use of the word “durably” ahead of “flexible” in the CBE’s release is sending us down that path rather than see us simply re-pegging at 23.xx.
There are less immediate ones, too:
- When will we see chocolate chips, peanut butter, and cars back in shops? Importers will need time to re-stock — and we’ll get our first glimpses of the lasting damage that’s been done to our position in the global delivery delivery chain. (Global car manufacturers, in particular, have been furious with the effective blocks on imports and have redirected production previously earmarked for Egypt to other markets. It’s going to take time for distributors and assemblers to sort that out.)
- Will banks loosen the FX spending and cash withdrawal limits they imposed earlier this month?
HAVE WE OVERSHOT?
Today’s FX reality is more or less what most people in the community expected: Enterprise readers said last month they were planning to use an average figure of EGP 22.12 to the greenback in their 2023 budgets, while some 22% of participants said they expect the USD to be trading hands at EGP 23-24 next year. Business leaders speaking to Goldman Sachs earlier this fall said they see the EGP settling at 22-24 to the USD following the devaluation.
Consensus among analysts is that we’re not looking at anything worse than EGP 25 to the greenback:
- Goldman Sachs said in a note that it sees “the possibility of further FX weakening in the near term.”
- Capital Economics said in a note today that we’re likely looking at EGP 24 by the end of 2023, “if not sooner.”
- Naeem Brokerage has a similar outlook and is now penciling in an EGP 23.50 to the USD in its 2023 models, it said in a note.
- Economist Mona Bedeir expects the EGP to overshoot marginally to hit 23-24 / USD 1 for now, before settling at EGP 22 to the greenback at the end of the year. ”
- Long-time market watcher Hany Geneina sees the EGP overshooting to anywhere between 25-27 against the greenback and ultimately settling at EGP 25 / USD 1 by the end of 2022.
WHAT ANALYSTS ARE SAYING
We all knew this was coming: Analysts and economists Enterprise spoke with agreed that the CBE’s decisions today were “expected,” particularly in the run-up to the agreement on an IMF funding package. “The CBE raising rates was completely necessary as a preemptive measure to cap inflationary pressures and support the local currency,” Bedeir told us.
Most agreed that what’s most important is the symbolic weight of the IMF package — which is a declaration of trust from the IMF that will restore investor confidence and spur inflows. That message is far more important than the actual size of the funding, Pharos’ Esraa Ahmed, CI Capital Co-Head of Research Monsef Morsy, and HC Securities banking and macro analyst Heba Monir all agreed when Enterprise spoke with them earlier this month. Finance Minister Mohamed Maait also said as much in the lead-up to the package announcement, stressing that Egypt wants to signal to investors that it’s serious about working on reforms with IMF support.
WE’VE BEEN DOWN THIS ROAD BEFORE
Echoes of March, but not of 2016: At the time of the “big” float of 2016, the central bank had spent months lining up deposits and other foreign currency support from our Gulf allies and the IMF — even going so far as to do a currency swap with China. The CBE also imposed a 10% up / down limit on the EGP for an interim period after it pulled the trigger. In March of this year, the central bank went for a surprise rate hike and
floated re-pegged the EGP back in March, making its announcement as banks opened for the day.
This time around? As was the case in March, the central bank is going in without having cobbled together a stock of FX that it could effectively use to tamp down an overshoot — and it made no mention this morning of a limit on how far up or down it would allow the currency to move. With Hassan Abdalla in the driver’s seat, this smells an awful lot like a real float.
We’re now looking to double our FX reserves over the course of the next four years, Abdalla said at this morning’s presser. Egypt’s reserves stood steady at nearly USD 33.2 bn in September.
Where is the FX coming from? After the flight of the carry trade earlier this year, our primary sources of FX have been:
- Tourism receipts: More than doubled to USD 10.7 bn in FY 2021-22, despite the vaporization of the Russian and Ukrainian markets, which together accounted for c. 30% of our pre-invasion tourism market. Our overall tourist arrivals rose more than 85% y-o-y in 1H 2022;
- Other exports rose 53% y-o-y during the fiscal year to USD 43.9 bn;
- Remittances from Egyptian expats increased slightly to USD 31.9 bn, from USD 31.4 bn last year;
- Suez Canal revenues jumped 18.4% y-o-y to a record USD 7 bn for the fiscal year, and hit a monthly record of USD 744.8 mn in July.
The good news: Tourism has proven particularly resilient this year despite predictions of an apocalypse, while remittances and the Suez Canal have been booming.
OUR TAKE- WE COULD HAVE DONE WITHOUT THE RATE HIKE
While we’re cheering the float and all of the CBE’s accompanying policy measures, we’re not fans of the 200 bps rate hike.
First: The global environment is increasingly contractionary and still fraught. The Fed and other major central banks have raised rates further. As we noted this morning, Canada signaled yesterday that while the end may be in sight, tightening isn’t over — and the ECB will likely also hike rates later today.
This is a race that we, as an emerging market, cannot win — and shouldn’t have entered in the first place. Capital allocators looking for low-risk, high-yield fixed income returns have plenty of choices in “secure” developed markets. The CBE and the Madbouly government have both signaled that they think it’s better to build an economy on FDI and exports than on hot money. We agree. And that’s before you throw in the simple fact that rate hikes like this are NOT good for the state budget.
What’s more, rate hikes are bad for businesses. As we have repeatedly argued, Egypt needs to focus on a limited number of industries that can have great export prospects and that can bring in FDI. High rates limit access to funding, quash appetite for CAPEX spending, slow down restocking, and slam the brakes on activity in manufacturing that is already slow and challenged. With lending activity slowing down and state-owned banks sucking liquidity out of the market with high-rate instruments, rising rates aren’t great for the banking system, either. Continuous rate increases, and the reactionary issuance of instruments that target flows from retail clients, drive up the cost of funding, leaving banks facing the compression of NIMs, loss of market share, or both.
What’s more, rate hikes may be losing their domestic bite. The general public have been “stung” way too many times during previous currency “liberalizations” and the high-yield instruments that got pushed out in tandem (remember the New Suez Canal CDs? Or the ones that paid over 20%? Or even the 13+% from earlier this year?). Some savers with sufficient disposable income and EGP holdings will park their cash in the highest-yielding instruments available. But those who lost faith in having large EGP holdings will flock towards less liquid, traditional perceived “stores of wealth” — ie: real estate and gold. Pretty much nobody from the second group would be swayed by an extra 200 bps. Their trust in the system will have to be regained over time through sound monetary governance — for which we’re starting to see green shoots.
We understand the central bank is actively working on reducing the amount of money in circulation to curb the growth in inflation rates. Hassan Abdalla’s move to boost reserve requirements for banks was brilliant. Raising rates right now is not a strong enough tool to achieve that goal — and the collateral damage it creates is potentially greater than any good coming from it.
GLOBAL PRESS COVERAGE-
The foreign press is playing the “how low can the EGP go” game: The story has made a surprisingly small dent in the global financial press, with what little coverage there is focusing on the extent of the EGP’s drop in the immediate aftermath of the float. These are just simply tallies for the FX rate at various intervals with the majority being pickups from earlier newswire coverage.
There is concern about the float driving up inflation: A lot of the discussion on the inflation spike expected as a result of the float centered around whether the 200 bps rate hike was the right move. “Higher interest rates are needed given the acceleration in inflation and more strengthening expected in the coming months,” Monica Malik, chief economist at Abu Dhabi Commercial Bank, told Bloomberg. Analysts speaking to Sky News Arabia also said the rate hike was a quick fix to the expected inflation.
Opinions and analysis in Bloomberg’s more nuanced coverage point to cautious optimism, particularly in light of the IMF package. “We have to see the IMF program’s assumptions but an extra USD 5 bn from bilaterals will help plug external funding gaps,” Gordon G. Bowers, a London-based analyst at Columbia Threadneedle Investments, tells Bloomberg. “Seems that additional GCC support was contingent on IMF involvement. This is a positive,” he noted.
The question now is to what extent will investors in Egypt’s debt be reassured with the agreement. “The real driver of Egypt’s sovereign performance will be the IMF [agreement],” Todd Schubert, head of fixed-income research at Bank of Singapore, tells Bloomberg.
…And whether Egypt will stick to the new FX regime: “The key question is whether authorities will allow greater flexibility in the exchange rate or, like 2016, merely re-peg the currency to a weaker level against the [USD],” Ziad Daoud, Bloomberg’s chief emerging markets economist said.
LOCAL PRESS COVERAGE
The local press is broadly muted in its coverage of today’s events. The front pages of most local news outlets are now being led by the arrival of UAE Vice President and Prime Minister Mohammed bin Rashed Al Maktoum, pushing their coverage of the CBE’s moves and the IMF agreement further down. Some, including Al Masry Al Youm and Masrawy, have a play-by-play of market reactions and expectations of how the float and higher interest rates will impact inflation.