Egypt needs more dollars before devaluation, warn experts

Reuters/Mohamed Abd El Ghany

• ‘Inevitable’ move likely after election
• Black market is flourishing
• ‘Meaningful’ reforms essential

Egypt will devalue its currency further after December’s presidential election, as the country needs more time to increase its dollar reserves and give it a better chance of stabilising its ailing currency, analysts told AGBI.

The Egyptian pound is linked to a basket of currencies in which the dollar is dominant. Policymakers have slashed the official exchange rate several times.

Today, the pound trades at 30.8 to the dollar. It was valued at 15.7 in early 2022 and 7.6 in 2015.

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A prolonged foreign currency shortage means the black market continues to flourish, where the pound trades at about 45 to the dollar – a near-50 percent discount on the official rate.

The pound’s slump has plunged import-dependent Egypt into a cost-of-living crisis. Annual inflation hit 38 percent in September, nearly triple that of a year earlier and the highest this century.

S&P Global forecasts Egypt’s real GDP will expand 4.1 percent this year, although in nominal terms it will shrink by 23 percent, the ratings agency estimates, describing Egypt’s economic risk as “very high”.

“Another devaluation is inevitable,” says Noaman Khalid, an economist at National Bank of Kuwait.

Egypt must devalue the pound further if it is to convince the International Monetary Fund to increase a loan programme from the multilateral body to $5 billion from the $3 billion agreed last December. Egypt received only $347 million initially.

Pandemic problems

Khalid traces Egypt’s currency woes to 2020 when the pandemic caused tourism receipts to plunge. Egypt could have devalued then, but with the economy seemingly resilient and inflation low, it did not.

Then, foreign investors’ repatriation of money following Russia’s invasion of Ukraine exacerbated a worsening foreign exchange shortage. Expat Egyptians turned to the black market to get a better rate on their remittances, causing a growing chunk of foreign currency to move outside the banking system. 

“The central bank is waiting for its liquidity buffers to become stronger, as this would provide a better foundation for merging the two exchange rates,” says Khalid.

Even if that were to succeed, the level at which the black market and official rates converge is uncertain, says Allen Sandeep, director of research at Naeem Holding in Cairo.

“In such a situation, it’s very difficult to confidently forecast a particular number,” Sandeep says.

“It could be 35, or 30, or even 45. We don’t know because this is a liquidity-driven market, it’s not based on fundamentals. When you have tight foreign exchange liquidity conditions, the sky’s the limit on the upside and the floor is unknown on the way down.”

In a late-September note, Monica Malik, chief economist at Abu Dhabi Commercial Bank, predicts that the next devaluation would be to 37-38 to the dollar and would occur after December’s presidential election.

“Another devaluation without meaningful reforms will not address the underlying challenges facing the economy,” Malik wrote. “Such a scenario would likely result in the parallel market re-emerging at a weaker rate and ongoing foreign exchange shortages.”

The hard road ahead

Should Egypt struggle to make the official and black-market exchange rates converge, the result will be higher inflation and even less trust in the pound among Egypt’s public, says Khalid.

“When the devaluation happens, the central bank needs to convince people to sell their dollar savings for pounds.”

As of March 31, the most recent data, Egypt’s external debts totalled $165.3 billion, up $9.6 billion over the preceding nine months. US dollar debt represents 68.4 percent of the total.

The IMF wants Egypt to privatise state-owned businesses and transition to a “flexible” exchange rate. As of mid-September, Egypt had raised $1.9 billion from selling stakes in government-owned companies, according to Abu Dhabi Commercial Bank.

Yet Malik wrote in September that this amount was insufficient to clear “Egypt’s foreign exchange backlog or meet its large financing needs”.

Khalid said Egypt is attempting to raise foreign currency funds from multilateral institutions, the Gulf states and government asset sales, which are settled in dollars.

If Egypt can increase its dollar reserves by up to to $8 billion – from $34.4 billion as of March 31 – that could weaken the dollar on the black market and pave the way for an official devaluation, said Khalid.

Egypt has to settle an import backlog of about $5.5 billion, according to Fitch. Egyptian banks combined also have around $16 billion in short-term foreign currency loans from international banks upon which they need to pay interest and principal in dollars, National Bank of Kuwait notes.

“One of the most important requirements for Egypt to achieve macroeconomic stability is a shift towards a flexible exchange rate,” says a September report by the Institute of International Finance, which urges the country to target a current account surplus of 1 percent of GDP.

Egypt’s current account deficit will be about $3.8 billion in 2023, down from $10.5 billion in 2022, S&P estimates.

“Egypt’s continuous current account deficits are unsustainable,” the Institute of International Finance report adds.