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Friday, 4 November 2016

So, what exactly happened yesterday?

Welcome to the free float: The Central Bank of Egypt (CBE) took action early yesterday morning (pdf) to devalue EGP to 13.00 per USD 1.00, allowing it to trade within a 10% up / down band until leaving it to the market to decide the currency’s fair value after a 1pm auction. The central bank said it was moving “with immediate effect, to a liberalised exchange rate regime to quell any distortions in the domestic foreign currency market … [to] allow market demand and supply dynamics to work effectively in order to create an environment of reliable and sustainable provision of foreign currency.” Domestic banks, it said, have the green light to bring back the interbank market to price FX.

The EGP has gone from being the fourth most expensive currency in global emerging markets to the third cheapest, according to data from Renaissance Capital provided in an emailed research report. By its real effective exchange rate (REER) valuation, RenCap sees only Mexico and Columbia as cheaper than Egypt among the EM in its coverage universe.

So what’s the USD worth in EGP terms right now? The short answer: EGP 15.75-16.00.

The long answer: By the end of yesterday’s 1pm auction, the CBE had sold USD 98.7 mn at an average bid price of EGP 14.65. Reuters says the cut-off price at the auction was EGP 14.30 per USD 1 and the maximum rate was EGP 15.60. Banks, however, are free to offer the greenbacks to the market at the price of their choice. The domestic press reported last night that theNational Bank of Egypt and Banque Misr, both state-owned banks, were selling greenbacks for EGP 15.75 to USD 1.00. AAIB was reportedly selling at EGP 16.00 just before 9:00pm, while the EGP closed the day at EGP 15.75 in branches of private-sector leader CIB, according to its website.

Longer term: Bloomberg reports that 12-month non-deliverable forwards for the EGP had sagged to a record low of 16.55 per greenback.

Okay, does this mean the cap on using my credit card or debit card outside Egypt will be raised? Probably, if this brief statement posted last night on CIB’s website is any indication: “Dear Valued Customer: Due to the current changes in the foreign currency markets, we will be looking to enhance the spend limits on CIB cards, which will be communicated shortly.” A similar message was dispatched to CIB clients overnight via SMS, and Al Mal is reporting that the National Bank of Egypt raised the maximum FX it would sell travelers by more than 3x to USD 1,000 from USD 300. Yehia Aboul Fotouh, a member of the bank’s board, made the announcement on Lamees El Hadidy’s Hona El Assema last night.

The float is part of the Ismail government’s economic reform programme, the CBE said. Liberalising the exchange rate aims to bring foreign currency dealing back into the banking system, stabilising rates through clear supply and demand mechanisms. Besides the complete exchange rate liberalisation, the CBE also increased overnight lending and deposit rates by 300 bps, bringing the deposit rate to 14.75% and lending rate to 15.75%. The CBE’s main operations rate and discount rate now stand at 15.25%.

The CBE also allowed (read: forced) banks to stay open until 9pm yesterday and through the weekend to handle FX transactions and to disburse remittances from abroad. Most banks appear set to open 1pm-9pm today and 10am-9pm tomorrow. The central bank assured the market that it would not enforce any conditions on those wanting to sell FX. The bank said it guarantees depositors’ savings in any currency (in other words: No forced conversion of FCY accounts into LCY). Neither retail nor corporate clients face restrictions on withdrawals or deposits of foreign currency,although importers of “non-essential goods” are still bound by the USD 50,000 monthly limit for deposits and a USD 30,000 daily limit for withdrawals.

No fees or commissions on remittances; priority access list for FX goes into the dustbin of history: In a separate directive sent to banks, the CBE instructed them not to levy fees or commissions on any remittances from abroad that they disburse to their local clients. It also ordered that bank branches execute only FX-related transactions in the extended opening hours. The CBE scrapped the priority access list for foreign currency it had imposed on banks, giving them instead free rein on FX transactions. The CBE said the FX market is now the local banks’ responsibility.

Let’s be clear about this: It is not a devaluation, but a free float. Yesterday’s 1pm auction put just USD 100 mn on the market, and our friends in the banking industry tell us the Central Bank of Egypt’s rationale was simple: It was effectively a price discovery session for the banks. As one put it: “The bankers were chickens starting helplessly at oncoming cars. The auction set a guide price, but the message was clear: We can put whatever buy / sell prices we want on our screens.”

Is FX flowing into banks at yesterday’s rate? Anecdotally, yes. A senior banker with whom we spoke reported his institution had pulled in “more in the last few hours than we have in the past six months. The momentum is very positive.”

What about the USD 4 bn infusion the market expected yesterday morning? It’s not coming. We were all wrong: The CBE isn’t going to use the IMF facility or third-party financing to flood the market with FX liquidity. The CBE defied expectations by going for a full float of the EGP, and they’re essentially removing capital controls and then leaving it to the banking system to bring the USD to a market-clearing rate that will create liquidity by prompting hoarders to sell. As one of the nation’s most respected bankers told us late yesterday afternoon: “What they’re doing is saying, ‘You were begging for a free float — go knock yourselves out. Go get your own money.’ It’s a free market now, and it’s absolutely right that they shouldn’t subsidize us by making FX available to banks at a discount.”

It is possible, though, that the CBE will inject liquidity at some point in the future to smooth-out dry spells of volatility. “The central bank needs to shepherd its liquidity so they have the flexibility to inject a bn here or there if something were to happen to tourism or if anything else should cause inflows [of FX] to dry up,” a banker suggested.

Which brings us to what should be obvious, but still: Expect volatility in the FX market over the next few weeks. Bankers with whom we spoke agree the coming three or so weeks could be volatile, but as one said: “The balance of power is now with the banks. We have the dealers: If the USD overshoots [relative to the greenback], the dealers can underprice to bring it back to its fair value based on what we see as supply and demand. But it could take the USD overshooting two or three times before things smooth-out.” At least one money changer agrees, telling Ahram Online the USD had tumbled to an average of EGP 12.90 in the parallel market after the decision and adding that “traders are waiting for the final price of the US currency to be set by local lenders.”

And the equity market could be just as bumpy: RenCap hit the nail on the head on the volatility front in an emailed research note in which equity strategist Daniel Salter tentatively moved his recommendation on Egypt to overweight from underweight: “…the equity market could be bumpy for several months: 1) as investors determine whether a clearing exchange rate has been established; 2) as previously trapped capital may choose to exit; and 3) if local investors who have been using equities as an FX hedge unwind their positions.”

Inverted yield curve? Following the CBE’s decisions yesterday, state-owned banks National Bank of Egypt and Banque Misr announced they are offering 18-month certificates of deposit carrying an interest rate of 20%. They are also offering three-year certificates carrying 16%, Reuters said. A pretty good offer we think — probably too good to be true, even, and definitely not an instrument that will be around for a long time. So, if you’ve bought USD at EGP 14.00 per buck (assuming no compounding) the returns from holding the 18-month CD keep you in the money even if the exchange rate dropped to EGP 18.20 per USD 1 by the time it matures. With the three-year CDs, you’re making money even if greenbacks were selling for EGP 20.72 in three years’ time.

Don’t expect the NBE / Banque Misr offer to last: Private-sector bankers tell us they wouldn’t be surprised if the two were to call-off the offer early in the new week, speculating that the move isn’t a bid to siphon liquidity from the system to cool inflation (or to on-lend to the state), but rather that the NBE and Banque Misr have maturity gaps they needs to plug. The CDs could temper attempts at dollarisation, but are also likely to pile up pressure on private banks. Banque Misr chairman Mohamed El Etriby told Lamees El Hadidy on Hona El Assema last night that BM and the National Bank of Egypt had recorded combined inflows of EGP 1 bn into their two CD products yesterday.

Private banks are unlikely to match those rates. To be able to make payments on a 20%-interest CD, banks would have to be lending to the government at rates north of 25%, a highly unlikely proposition.

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