Egyptian Pound Stabilization Reflects Central Bank's Resolve to Tackle Inflation: BMI

CAIRO - 6 March 2024: Egypt's Central Bank is poised to maintain its benchmark interest rates steady for the remainder of the year, following a significant 600 basis points hike on March 6th, according to BMI – A Fitch Solutions Company. The decision reflects the Central Bank's commitment to tackling inflationary pressures, as Egypt grapples with soaring inflation rates.

BMI highlighted that with inflation potentially easing to below 25% on a yearly basis in February, the interest rate hike was deemed sufficient to restore positive real interest rates. Despite currency liberalization, inflation is expected to hover around 30.0% until 2024, keeping real interest rates close to positive territory.

Moreover, the report indicated that government bond yields are expected to turn positive as well. With diminishing foreign exchange risks, this is anticipated to lure portfolio investors back into the Egyptian debt market sooner than previously expected.

However, the agency anticipates exchange rate volatility in the short term as the market adjusts to the long-awaited currency devaluation. While the exchange rate is currently weaker than the agency's long-held range of 40.00 to 45.00 Egyptian pounds per US dollar, it remains close to the 50.00 Egyptian pounds per US dollar level.

Forecasts regarding the currency value in the short term will hinge on the amount of foreign currency provided by the Central Bank of Egypt through banks. Nevertheless, estimates suggest that the exchange rate will stabilize around 50.0 Egyptian pounds per US dollar by the end of the year if portfolio investments materialize as expected.

BMI believes that Egyptian authorities have sufficient foreign currencies to swiftly bridge the gap with the widely-used parallel market rate. Egypt recently received the first tranche of a new investment deal with the United Arab Emirates, with more expected in the short term through a new program with the IMF and portfolio investment inflows.

With tighter monetary policy and currency flotation, Egypt has now met the core requirements for a larger IMF program. The announced measures have been adopted as part of a comprehensive set of economic reforms in coordination with the government, and with consistent support from multilateral and bilateral partners.

While portfolio investments will alleviate short-term pressures, they will also expose Egypt to fluctuations in investor sentiment in the event of shocks.

Geopolitical risks arising from the conflict between Israel and Hamas, as well as the crisis in the Red Sea, remain elevated and pose a threat to Egypt's overall economic stability.

The agency views the political risks stemming from the announced measures as manageable, as the authorities' crackdown on currency traders and speculators, coupled with positive news such as the recent UAE investment deal, has bolstered the Egyptian pound in the parallel market from around 75.0 Egyptian pounds per US dollar in January 2024 to about 50.0 Egyptian pounds per US dollar.

The increase in the currency value in the widely-used parallel market has had a positive psychological impact on Egyptians, as they can now purchase dollars at a much stronger official rate compared to the parallel market rate of 75 Egyptian pounds per US dollar, making currency flotation more socially acceptable.

The report maintains its outlook that economic growth will decelerate from 3.8% in the fiscal year 2022/2023 to 3.2% in the fiscal year 2023/2024 before rising by 4.2% in the fiscal year 2024/2025, as tighter monetary policy than expected will lead to increased borrowing costs for companies and households, negatively impacting local consumption and investment.