Egypt: Will the new central bank governor create fiscal-monetary harmony?

“In order for the state to benefit from a new IMF loan, there has to be harmony between fiscal policy and monetary policy,” Amr Elalfy, head of research at the Cairo-based Prime Securities tells The Africa Report. “This has been absent.”

The most anticipated step under the new acting governor Hassan Abdalla, who President Abdel-Fattah al-Sisi installed hours before Thursday’s scheduled meeting of the CBE’s Monetary Policy Committee (MPC), is to implement a more flexible exchange rate, for which the IMF has been pushing as Egypt seeks to take out a new loan from the global lender.

A weakening Egyptian pound is widely expected to boost portfolio investments and prevent macroeconomic imbalances. Keeping a relatively tight grip on the exchange rate was behind the “tension” between the CBE and the finance ministry, a prominent analyst has said.

“One of two things have to happen for portfolio investors to come in, or a combination of both: either the FX has to weaken significantly to give some upside to investors, or yields have to go up,” said Farouk Soussa, vice-president of MENA economics research at Goldman Sachs, in an interview with Bloomberg TV last June. “The central bank doesn’t want to let the FX go, and the ministry of finance doesn’t want to raise yields.”

‘Gradual’ depreciation

Upon tendering his resignation last Wednesday as the CBE governor, Tarek Amer reportedly said he had stepped down a year before the end of his second and last four-year stint to give way to new blood. The general consensus, however, is that he was forced to leave for being out of step with the government.

Shortly after the Ukraine war erupted and its trickle-down economic repercussions started to unfold, Egypt devalued the local currency by over 15% in March. Since then, the pound has been slightly – yet constantly – sliding, exceeding 19.1 against the US dollar thus far.

We expect the CBE to allow further gradual exchange rate depreciation and increase exchange rate flexibility, helping pave the way for an IMF programme.

Several days before Amer was replaced, his deputy Gamal Negm told state-run paper Al-Ahram that the CBE was not likely to weaken the pound by a great percentage, a prospect that will not be realised under the new governor, Abdalla.

Elalfy believes there will be more flexibility, yet rules out the possibility of a free float, with which he says: “Egypt cannot really survive economically in the world today.” London-based Capital Economics expects the pound to fall to 25 against the dollar by end-2024 with Abdalla at the CBE’s helm.

“We expect the CBE to allow further gradual exchange rate depreciation and increase exchange rate flexibility, helping pave the way for an IMF programme,” Krisjanis Krustins, director of sovereigns at Fitch Ratings, tells The Africa Report.

Other IMF-dictated reforms

Despite far exceeding its IMF lending quota, the dollar-hungry Egypt has been negotiating with the Fund – since March – over another extended fund facility, whose value and terms have yet to be disclosed. Both sides have so far been unable to break a stalemate.

“Egypt’s discussions with the IMF likely centre not just on exchange rate policy, but also on structural reforms, in particular, relating to the large role of the state and the military in Egypt’s economy,” says Krustins.

To boost Egypt’s depleted private sector, the IMF also advocates the removal of import restrictions that the CBE has imposed over the past months. “Manufacturing and exporting are contingent on inputs brought in from abroad, which makes the Egyptian economy greatly reliant on importing,” says Elalfy.

The import-crippling measures kept the black market from prevailing in Egypt during the current liquidity crunch. A liberalised pound should serve the same purpose by deterring conversions outside the interbank.

“Structural reforms to modernise Egypt’s economy and improve its competitiveness would be critical to reducing Egypt’s current account deficit, financing needs and reliance on hot money flows over the medium term,” Krustins says.

Consecutive shocks

Foreign debt investments in Egypt were nearly estimated at $28.8bn last December, down from an all-time high of $34bn in September 2021. Another $20bn worth of foreign holdings went out of the Egyptian market so far this year.

“The shock of the Ukraine war came at a time when investors already had growing concerns about the sustainability of Egypt’s financing model after the end of its [2016] IMF programme amid tougher market conditions,” says Krustins.

During the 2018 emerging markets meltdown and the peak of the pandemic two years later, some $15bn and $20bn foreign debt investments exited the Egyptian market respectively, according to finance minister Mohamed Maait. The Ukraine war, once again, fended off interest in emerging markets, including Egypt.

Maait, who survived a ministerial reshuffle days before Amer parted ways with the CBE, said last June that Egypt can no longer rely on hot money after suffering three consecutive investor exoduses in the past four years.

Instead, he says, Egypt must bolster foreign direct investment, which increased 52.9% year on year in the first nine months of the past 2021-2022 financial year ending 30 June, valued at a mere $7.3bn.

More bond issuances

Billions injected by Gulf nations into Egypt – in the form of deposits, financial support, and acquisitions – have relatively buoyed the most populous Arab nation this year, offsetting the war’s abysmal impact.

However, with financing needs amounting to $30bn covering the current account deficit and debt maturities in the ongoing 2022/2023 fiscal year, Egypt will still need to attract foreign portfolio investors.

“Some further depreciation, higher rates and more certainty over the IMF programme could be sufficient to win back some non-resident investors in Egypt’s debt, providing a near-term boost to foreign reserves”, which stood at $33.143 in July, shrinking by over 19% since February.

“This could also support investor confidence enough to enable an international bond issuance, although that will also depend on broader market conditions,” Krustins says.

The government indeed plans to issue international bonds worth $6bn this year, Bloomberg Asharq reported this month.

Rate hikes a necessary evil?

In its first Abdalla-led meeting on Thursday, the MPC held overnight deposit and lending rates at 11.25% and 12.25%, respectively, for the second time on the trot, citing a drop in commodity prices, namely oil and wheat whose war-induced soaring cost caused Egypt’s inflation to accelerate.

Prior to the CBE governor replacement, analysts mostly expected the MPC to opt for rate hikes in order to rein in inflation, which rose in urban areas to 13.6% last month up from 13.2% in June. Right on cue, some analysts reversed their forecasts upon Amer’s departure.

With cumulative 300 bps rate hikes since March under Amer, Maait has voiced concerns. He said each 100 bps rise adds roughly LE30bn ($1.567bn) to the budget deficit, thanks to corresponding increases to the debt service and yields, which analysts believe can do little to lure investors back amid the US Federal Reserve’s monetary tightening.

Nevertheless, inflationary pressures, further stoked by a weakening pound, will most probably prompt the CBE to once again raise rates this year. “We … expect some further rate hikes by [the] CBE, although it is not clear that there is a large misalignment between rates and inflation fundamentals,” Krustins says.

“At the moment, while the CBE policy rate is lower than spot inflation, overall CPI 14.6% year-on-year in July, inflation reflects large base effects and a forward-looking projection of inflation would likely be lower, particularly given the recent retreat of commodity prices,” he says.