Egypt: Local currency likely to hit new lows again, experts say

Egypt is likely to devalue its currency again in the “not-too-distant future,” and the pound may end the quarter 10% below current levels, experts at Societe Generale said.

The debt-distressed North African nation will need a cheaper currency as both its current-account deficit and dollar shortage are sizable, strategists including Phoenix Kalen and Gergely Urmossy said in a report.

Despite three devaluations that sent the pound 50% weaker over the past year, the currency hasn’t reached its “new short-term equilibrium,” they said.

“The lack of decisively hawkish action by the central bank of Egypt raises questions around the credibility of its commitment to deliver in accordance with its inflation-targeting mandate,” the strategists wrote.

“Real interest rates remain negative both on a backward- and forward-looking basis.”

Egypt is in the throes of an economic crisis and the worst foreign-currency crunch in years. It has been locked out of capital markets and downgraded deeper into junk-borrower status amid surging food inflation following the pandemic and Russia’s war in Ukraine.

The country is working to unlock a $3 billion bailout from the IMF even as it faces an external financing gap of $17 billion.

That’s put pressure on the pound, which was the fifth worst-performing currency in the world last year.

Societe Generale strategists see it ending the current quarter at 34 per US dollar, from 30.62 on Friday. They didn’t specify whether the devaluation impact was included in their prediction.

When portfolio flows resume, the central bank will need to prioritize building back its foreign-exchange reserves, and that will put additional pressure on the pound, they said.

“As a result, we stick to our USD/EGP forecast to express the heightened probability of another sharp devaluation in the near term.”

Record low

In January, the Egyptian pound fell to another record low, after the drop it witnessed in late October, a sign that authorities were pressing ahead with a shift to more flexible currency trading.

The currency then slumped as much as 14% to 32.1 per dollar before paring losses to close at 29.8 on 4 January, capping the largest single-day drop since late October. That’s narrowed the gap against prices quoted in the black market, the so-called parallel exchange rate of about 31, according to traders.

Egypt’s October devaluation, its third in less than a year, heaped further stress on the economy after authorities secured a $3 billion bailout package from the International Monetary Fund.

The IMF then said that Egypt is moving toward a flexible foreign-exchange policy, and any intervention by the central bank will be guided by the need to smooth out market volatility.

The IMF also warned that the durability of Egypt’s policy shift “remains to be proven and the central bank may face political and social pressure to reverse course” and said “fiscal consolidation in the context of rising living costs” could see similar pushback.

Foreign exchange remains scarce as the economy of the Middle East’s most populous country contends with soaring food and energy prices fanned by Russia’s war in Ukraine.

Egypt needs to unlock more financing from abroad as it tries to clear the logjam of imports at its ports that’s adding to a backlog of unfulfilled demand for dollars.

In early January, the cabinet announced that a total of $8.5 billion in goods and commodities has been released from ports since December and through the first 10 days of the year.

“The objective of the authorities should be to clear the FX overhang and ensure demand for FX is met in the official market, thereby unifying the exchange rate and eliminating the parallel market,” Farouk Soussa, an economist at Goldman Sachs Group Inc., said in a report.

Traders are hedging against the risk that the pound might depreciate further to around 33.4 per dollar in the next 12 months, according to the non-deliverable forwards market.

In local currency terms, Egyptian stocks have gone on a massive rally since the country began to move toward a more flexible exchange rate.

The benchmark EGX30 has soared over 50% in pound terms since the late October devaluation, making it the best performer globally among 92 other global benchmarks tracked by experts at Bloomberg. In dollar terms, however, the benchmark slid over 5%, one of the worst 10 indexes.

When Egypt devalued its currency twice last year, long stretches of stability in the pound followed bouts of depreciation.

Concerns about inflation, which is estimated by some experts at more than 102% on an annual basis, and the impact on social stability in the country of over 100 million people may be putting constraints on policy.

The IMF said the central bank “may occasionally step in during times of excessive exchange rate volatility,” but “there will be no recourse to foreign-exchange interventions or the use of banks’ net foreign assets with the intent to stabilize or guarantee the level of the exchange rate.”

The IMF estimates Egypt’s external financing gap at around $17 billion throughout the 46-month program, with the deal expected to unlock about $14 billion more from international and regional partners.

Gulf allies also stepped in to shore up the finances of a country that’s seen as a regional linchpin.

“The Egyptian pound will remain under pressure until more dollar inflows materialize, balancing foreign exchange demand and supply,” said Carla Slim, an economist at Standard Chartered Plc.

“Closing the parallel market gap will likely drive the pound to overshoot before it stabilizes.”