By Samantha Barnes, International Banker
With the United States leading the stringent contractionary monetary-policy regime prevailing across the world today as the global battle against inflation continues, the flight to safe markets and jurisdictions by investors over the last 18 months has left the bulk of emerging economies distinctly vulnerable, particularly as reflected by the ensuing weakening of their respective currencies. And few countries have demonstrated more vulnerability than Egypt.
Examining the state of Egypt’s increasingly dysfunctional economy over the last 18 months goes a long way toward explaining the dramatic slide in value the pound has suffered. Last year saw a mass exodus of funds from Egypt—more than $20 billion of “hot money”—following the outbreak of war in Ukraine in late February, when the US began to hike interest rates aggressively. This departure followed similar exits in recent years, with $15 billion leaving during the 2018 emerging-market crisis and almost $20 billion exiting at the onset of the COVID-19 pandemic in 2020.
But it was last year’s global flight to safety that thoroughly depleted Egypt’s foreign-currency reserves, with the resulting dollar shortage prompting Egyptian authorities to devalue the local currency not once, not twice, but on three separate occasions—in March, October and finally January 2023. These actions were taken partly to meet the International Monetary Fund’s (IMF’s) eligibility requirements for financial assistance, including a commitment to transition toward a floating exchange rate. A fourth such devaluation is now highly anticipated in the near future.
The devaluations have also sent prices to the heavens, particularly those of imported goods, thus triggering a significant cost-of-living crisis for the country’s 104 million citizens, 60 percent of whom are estimated to be below or near the poverty line, with 70 million already receiving subsidised goods. Inflation has remained well above the central bank’s target-range upper limit of 5 percent to 9 percent since early 2022, with last year seeing dramatic upticks in input costs for Egyptian businesses as energy prices soared and global supply-chain issues worsened following the outbreak of the war in Ukraine.
And with annual prices dramatically accelerating by more than 30 percent throughout this year—most recently, the annual inflation rate for May soared to 32.7 percent, up from the 30.6 percent recorded in April—the situation seems to be progressively worsening moving into the second half of 2023. The ongoing Russia-Ukraine war goes a long way toward explaining such persistently high numbers; with Egypt being the world’s biggest importer of wheat, and the bulk of this wheat acquired from both Russia and Ukraine, along with other key commodities, Egypt’s import costs have dramatically escalated as it has scrambled to unlock other global wheat sources. Indeed, May’s annual food-inflation rate was recorded at a whopping 60 percent, having peaked at 62.9 percent in March.
In increasingly dire need of financial assistance, Egypt has turned to the International Monetary Fund (IMF), which duly approved a 46-month arrangement under the Extended Fund Facility (EFF) for approximately $3 billion. The support facility is contingent upon “a comprehensive policy package to preserve macroeconomic stability, restore buffers, and pave the way for sustainable, inclusive, and private-sector-led growth”, notably including the completion of key privatisation deals for state assets. The IMF also calculated Egypt’s financing gap—the total amount of foreign exchange it needs to repay its debts—at around $17 billion over the next four years. “IMF financing of the program is expected to close part of this gap, but in addition, the IMF-supported program is expected to catalyze additional financing of the multilateral institution, bilateral partners, private sector investors to close the remaining gap,” confirmed Ivanna Vladkova Hollar, assistant director and mission chief for the IMF’s Egypt, Middle East and Central Asia Department.
The package additionally requires a “permanent shift” to a flexible exchange-rate regime for the Egyptian pound as a solution for greater resilience against external shocks, rebuilding external buffers and avoiding “the build-up of a chronic imbalance in the demand for and supply of foreign currency in Egypt and preserve the FX reserves of the central bank”. The IMF further highlighted in December how the two-way movements of a floating exchange rate will bring additional benefits. “It would help Egypt’s domestic economy adjust more smoothly to external shocks, support the ability of Egyptian businesses to sell their goods and services abroad, and encourage greater investment by reducing the likelihood of large abrupt changes in the exchange rate. In addition, it would help preserve the financial buffers of the central bank.”
The Egyptian authorities have resisted the exchange-rate demands, however, preferring to maintain the exchange rate at 30.90 per dollar as it has done throughout much of 2023, despite trading close to 37 per dollar on the black market. In June, the Central Bank of Egypt (CBE) also maintained its benchmark overnight deposit rate unchanged at its five-year high of 18.25 percent, which has been in effect since April. But Cairo faces growing pressure as foreign-currency shortages persist. The rising inflation trajectory, moreover, is “adding pressure on the Egyptian Pound, which has traded relatively flat since the devaluation in early January despite clear signs of ongoing FX liquidity shortages,” Goldman Sachs’ economist Farouk Soussa wrote in a research report on March 9, also noting that inflation would peak at around 36 percent during the third quarter should there be no additional devaluations. “The risk of further Pound weakness in the immediate term is high, particularly within the context of the first review under the IMF programme.”
And with the state-owned asset sale worth around $2 billion taking longer than expected, Moody’s also placed Egypt’s B3 foreign-currency and local-currency issuer rating on review for a downgrade on May 9. The rating agency noted that this slow progress is weakening Egypt’s foreign-exchange liquidity, further eroding confidence in the pound.
A few weeks earlier, fellow rating agency S&P Global Ratings took a similar view of Egypt, downgrading its outlook to negative and predicting further currency depreciations on the horizon. “Egypt’s funding sources may not cover its high external financing requirements” for this fiscal year and the next, which S&P calculated at around $37 billion cumulatively. And similar to Moody’s assessment, S&P also mentioned the failure to complete privatisation reforms in compliance with the IMF’s requirements as a key factor in its overall assessment. As such risks are elevated, Egypt’s backers “potentially delay or do not provide Egypt with the agreed funds, with implications for imports, inflation, interest rates, and the government’s debt stock and interest payments”. Indeed, billions of dollars promised to Egypt by its Persian Gulf Arab neighbours have yet to arrive.
On a more positive note, however, the weak pound has turned Egypt into a global tourism hotspot this year, with analysts now expecting the most populous Arab nation to welcome the highest annual number of tourists this year in its entire history. According to Egyptian Minister of Tourism and Antiquities Ahmed Issa, incoming tourist numbers to Egypt reached 1.3 million in April, a monthly high, while the first quarter of this year experienced a 43-percent jump in tourists compared to the same three-month period last year. According to the Chinese news outlet Xinhua, Issa expects Egypt to receive around 15 million visitors this year, which would beat the previous record set in 2010 of 14.7 million and be a hefty 28 percent higher than last year.
Such numbers also bode well for Egypt’s economic recovery. September of this year will see the IMF conduct a review of its assistance programme to Egypt before the IMF’s and World Bank’s annual meetings are held a month later in Morocco. Any decision by Cairo to implement another currency devaluation will most likely be made around this time, according to Citigroup. “We’ve reached a little bit of a peak pessimism when it comes to Egypt,” Luis Costa, the global head of emerging-market sovereign credit at the US bank, told Bloomberg in early June, adding that a rebound in tourism and the hopeful completion of the sales of state-owned assets, as well as efforts to ease the foreign-currency crunch and diffuse investor concerns over a potential debt restructuring, had prompted Citigroup to “establish a more positive view” of the Egyptian pound.
“This summer season can be an important short-term stabilizer until we start getting serious reviews again in September and October,” Costa noted. And although the pound is expected to remain “reasonably stable” until that time, Citigroup forecasts a further weakening to as much as 36 against the dollar by the end of 2023 and to 37 next year. It is presently in a “neutral valuation range,” Costa added.