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Thursday, 18 August 2022

Foreign exchange policy will be job #1 for Amer’s successor as calls for devaluation mount

Tarek Amer left the central bank at a crucial time for the economy: A perfect storm of heightened commodity prices, rising interest rates, and global volatility (including both an economic slowdown and volatility in global capital markets) is putting the Egyptian economy and the EGP in a tight spot. Speculation has grown in recent days that the EGP will need to slide more against the greenback to manage the growing external imbalances and attract foreign capital back to the country.

The EGP is going to be top of the priority list for whoever takes charge, according to analysts and economists we spoke with yesterday. Hany Geneina, a long-time market watcher who is now an adjunct professor of business administration at AUC, characterized Amer-era monetary policy as one of “excessive stability,” which sent the wrong messages to investors and the government, which was given an incentive to take on more foreign debt.

Where is the EGP headed? Prime Securities’ head of Research Amr El Alfy says the new governor should give up tight control of the EGP and instead allow the currency to float against the greenback. Allowing it to go to EGP 20 or more against the USD will have a negative impact on our import bill and will see us import inflation, but will be critical to increasing exports and bringing FX back into the country, he says.

Watch for an overshoot: If the new governor does allow the currency to slide, it will likely be timed to either a new IMF facility or to additional deposits or investment from our allies in the GCC to give the institution some flexibility to release liquidity into the market in the case of an overshoot, as we saw when the CBE floated the pound in November 2016. Market watchers including local and international investment banks and research houses are all suggesting a fair value for the EGP is something in the 21.00-24.00 range against the USD.

Policymakers need to gradually liberalize the exchange rate over the next few years until our foreign reserves reach USD 100 bn, after which the rate could be gently pegged again. “This could take 10 years and be implemented over two phases, with the first seeing a flexible exchange rate until the state can ramp up exports and attract foreign direct investment, both of which will bolster reserves,” Geneina said.

The IMF is watching: Market watchers believe that is that policymakers have been split on whether to accede to the IMF’s demands for a more flexible exchange rate or rely on other policy tools (see: raising capital from the Gulf, rationing electricity to export more natural gas, and import restrictions) to mitigate external pressures. These moves, as well as the c.21% depreciation of the currency in recent months, “have failed to convince investors and it’s increasingly clear that there are tensions among policymakers about the best way forward,” Capital Economics economist Jason Tuvey wrote in a note yesterday. Where the CBE’s new chief stands on exchange-rate policy and how they negotiate policy disagreements with other areas of government will be key.

Inflation will likely be less of a point of concern for the next CBE governor: El Alfy suggests that inflation will naturally fall back to single digits in 2023, partially thanks to the base effect. Inflation hit a new three-year high in July, accelerating to 13.6% on the back of higher food and fuel prices. The suggestion is that any imported inflation will effectively be transient.

The drumbeat on devaluation is loud: Bloomberg, for example, has run three stories (here, here + here) in the past week on the topic.

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