Fitch Says Egypt’s New FX Regime Positive Step In Tough Circumstances
Fitch Ratings stated in a report issued on Thursday that Egypt’s new exchange rate regime has brought greater transparency and a depreciation of the pound but also highlights a serious shortage of foreign exchange.
For the system to work, confidence needs to be restored quickly, starting with agreement on an IMF program, it added.
According to the ratings agency, a more market-determined exchange rate, arising from the central bank auction system introduced on December 30th, is potentially positive.
Fitch also indicated that allowing depreciation can boost competitiveness and indicates that the Central Bank of Egypt (CBE) will not defend the currency at all costs. It added that the auction runs in parallel with the existing interbank market, but has quickly become the market’s new reference rate.
CBE can change the frequency and size of auctions giving it some control over the exchange rate but making its interventions transparent. At the end of the third auction on Wednesday, the pound had fallen by 3.3% against the dollar since the change in policy, bringing cumulative depreciation over the last two years to 10%, Fitch said.
An agreement with the IMF is essential for more substantial and sustainable external support and for restoring domestic and external confidence in the pound. The IMF has endorsed the decision to maintain an appropriate level of reserves, but may take a less favorable view on capital controls.
The Egyptian authorities have indicated their keenness to re-engage with the Fund in January, after asking it to delay signing off on an agreed program last month. The fragility of the reserve position will be weighed against the political impact of introducing agreed fiscal measures ahead of February’s parliamentary elections.
Fitch also expected the modest depreciation in the pound so far not to provide much support to the balance of payments, which has suffered from the impact of political unrest on tourism and capital inflows.
Suez Canal receipts, remittances and oil export revenues (55% of total current external receipts) are not sensitive to movements in the pound and currency weakness will deter foreign portfolio investors in the short term. However, if the pound stabilizes and capital controls are removed, uncertainty for foreign investors and local companies will reduce.
Depreciation is likely to have little fiscal impact, owing to roughly balanced dollar-denominated revenue and expenditure. The effect on inflation will be more pronounced. Some retailers have already adjusted prices in anticipation of higher costs for imported goods and further rises will occur as depreciation works through the supply network. Measures in the IMF program will also add to inflation, according to Fitch.
Containing the inflationary impact is crucial if the nominal depreciation is to boost real export competitiveness. Nonetheless, with weak demand helping reduce inflation to a six-year low of 4.3% in November, an abrupt surge in prices appears unlikely.
