Egypt is pressured to liberalise currency exchange rate

The main condition for Egypt obtaining a $12bn loan from the International Monetary Fund (IMF) was heavily dependent on liberalising the exchange rate in order to end the informal currency market and to encourage investment.

However, it may not be the IMF alone that would force Egypt to devalue, and eventually liberalise its exchange rate. A more pressing concern may be changes occurring in the United States (US) own central bank, the Federal Reserve.

President of the Federal Reserve Bank of New York Willian Dudley said on Monday that markets should not rule out a rate hike again this year, as the US economy returns to growth after the 2008 financial crisis. Dudley stated that a 25 basis point rate hike by 2017 was “too complacent”, and that if growth continues, “US monetary policy will need to move at a faster pace than implied by future prices to a more neutral posture, as the labour market tightens further and US inflation rises”.

The last time the Federal Reserve increased rates in December, the fallout from the decision sent a shock wave of instability through the global emerging market. Rates were set to increase when the Federal Reserve met last week, but policy makers postponed due to increased volatility, following the Brexit vote and continued instability and shaky growth in many emerging markets.

“The Federal Reserve’s mandate points primarily to domestic objectives, but the reserve must take account of international conditions and repercussions as well,” said Edwin Truman, a non-resident senior fellow at the Peterson Institute for International Economics.

An increase in the Federal Reserve’s interest rates could result in a number of issues for emerging markets, which could have a particular sting if fiscal conditions are already tight. In a working paper published by an economist at the Institute for International Finance, Rebin Keopke, it was claimed that the Federal Reserve policy could even spawn a banking or debt crisis in developing countries.

Tightening US monetary policy can contribute to increased capital flight, decreased asset value, decreased investment incentives, constrained availability of finances, more expensive lending rates, and higher debt repayments, which could spell doom for countries that do not have the fiscal health to weather the storm.

“The countries that are most vulnerable are those whose own economic and financial conditions are in less good shape… countries with large current account deficits, large fiscal deficits, higher rates of inflation, and exchange rates that are not being allowed to respond to current economic and financial conditions,” according to Keopke’s report.

Egypt’s current account deficit has expanded to 5% of GDP, fiscal deficit to 10% of GDP, and a likely increasing inflation rate of 10.5%. “The Central Bank of Egypt may feel compelled to follow the Federal Reserve”, says Truman.

source: Daily news Egypt