Why Did the Egyptian Currency Lose 17% Of Its Value Overnight?

Adham Hamed | 2 years ago

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On March 21, the Egyptian street woke up to a central bank decision to raise interest rates by one percent for deposit and lending.

This led to a 17% decline in the exchange rate of the Egyptian pound against the US dollar in the International Trading Index (Forex) hours after the central bank's decision.

The Egyptian pound fell against the dollar from 15.72 to 18.57, calculating unofficial trading data.

 

Second Floating

At the end of 2016, Egypt decided to float the pound in response to the demands of the International Monetary Fund (IMF), in order to be able to obtain a loan of $12 billion.

Chris Jarvis, head of the IMF's mission to Egypt, commented on the decision, saying that floating the pound would contribute to higher growth rates, create more jobs, and improve Egypt's financial position with the outside world.

As a result, the value of the pound fell, starting from nine pounds per dollar before the float of the pound until it reached a historic low of about 19 pounds to the dollar, at the beginning of 2017.

The flotation decision meant that the exchange rate system must become fully flexible, so that no one has power over the value of the currency in the market, and because the Egyptian currency is not a "hard currency", the asset fluctuates significantly in short periods.

But throughout the last 15 months the Egyptian pound was stable at approximately 15.6 pound for 1 dollar, which is an indication that the pound has not floated as officially announced, but rather is controlled by the central bank even informally and undeclared, or at least this is the analysis supported by the movement of the pound in the market.

The recent news about the need to lower its price, support this claim, which means that it is valued above its real value (the value of the pound if left to determine its value freely in the market).

 

Reasons of Decline

Before the latest decline in the Egyptian currency, analysts at investment bank JPMorgan warned that a sharp decline of Egypt's pound was expected, and that the country may seek further IMF support if financial market pressures worsen.

They tracked the reasons for this decline to two main reasons: the combination of considerably higher commodity and food costs (due to the Ukrainian war), as well as a projected decline in Russian tourist numbers, both were expected to wreak additional havoc on Egypt's already-strained finances.

Russia and Ukraine are the primary wheat suppliers to Egypt, which is frequently the global highest importer, that’s why Egypt is experiencing greater prices for its significant wheat import demands.

According to research released last week by the International Food Policy Research Institute, rising wheat prices may nearly double annual state spending on wheat imports to $5.7 billion, straining government budgets and fueling inflation pressure.

Additionally, scarcities of US dollars have resulted in port blockades in Egypt, according to bankers, after importers were unable to secure the requisite foreign cash for letters of credit to clear their products.

 

Short-Term Victory?

During Sisi’s 9-year governance, the economic stability of his system was preserved thanks to the foreign funding particularly from Saudi Arabia, UAE and the IMF.

This has not altered recently, since Saudi Arabia renewed a $2.3 billion deposit with the CBE until October 2026 on March 9.

Other Arab Gulf dollar deposits at the CBE include $5.7 billion from the United Arab Emirates and $4 billion from Kuwait.

Sisi’s Egypt preserves a model of a high interest rate, effectively being the highest real interest in the world, which is the interest rate minus the inflation.

This model surely draws foreign investment, particularly in the near term, helps to strengthen the country's currency and economy, and also helps to provide loans

But high interest rates also have risks; they make borrowing difficult for many sectors of the economy, cannot afford high interest rates, and they cost the state high, and the local state's debt will also be at a high interest rate, as long as the central bank decides to keep them high.

Even the aim of attracting hot money seems ambiguous, a Reuters article on March 2 cited unidentified sources as indicating that foreign capital outflows exceeded $3 billion since February 24.

Outflows of hot money should come as no surprise, since fund managers seek safe havens during times of crisis, such as the one currently underway in Ukraine.

Consequently, there are concerns about an exodus from emerging markets, including Egypt, which may face a number of financial and economic challenges in the short and medium terms.

 

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