Financial sector surprised by new strategy
- The Central Bank of Egypt directs banks to appreciate Egyptian pound and increase interest rates
- It is also distributing $1bn to mitigate a shortage of hard currency
- The moves have taken the financial sector, which was expecting devaluation, by surprise
The Central Bank of Egypt has instructed state-owned banks National Bank of Egypt and Banque Misr to raise interest rates on deposits to strengthen the Egyptian pound. Other smaller banks will be told to follow suit.
From the 11 November, the rate is E£7.83 to $1, compared to E£8.03 on 10 November. Three-year bonds are being issued with an interest of 12.5 per cent.
Local and regional financial experts were surprised by the moves, as pressure to devaluate was growing. It is widely that the strategy is intended to bring black market and dollar savings into the official system, and avoid a dollar crunch.
Increasing interest rates on deposits aims to reduce local liquidity to reduce the availability of local currency compared to foreign currency and therefore provide support to the Egyptian pound, says Hany Farahat, senior economist at local CI Capital. Its a short-term measure to induce holders of US dollars to exchange them for Egyptian pound to benefit from the higher yield.
The Central Bank has also injected $1bn in to the market to ease the shortage of hard currency, around a quarter of importers and banks needs. Manufacturers have been complaining that they are unable to obtain letters of credit to import raw materials, while foreign investors are unable to repatriate profits.
Such a move will draw down reserves rapidly. Egypts official foreign currency reserves were at $16.4bn in October, only enough to three months of imports.
How long this can continue depends on how many dollars they have and are willing to inject into the local market, says a Cairo-based financier. But someone might be supplying them with a new source of dollars.
Supporting the currency should increase yields on investments, but it is unclear if the new measures will boost confidence enough for investors to commit.
Further devaluations of the Egyptian pound are expected in 2016, as the underlying trade deficit remains.
In the long term the pressure to devaluate the pound will be too strong to resist through artificial measures, says Farahat. But in the short term, we believe the Central Bank wouldnt have taken this measure without a predetermined plan, so we expect other measures to follow.
This appears to be the first move by new Central Bank Governor Tarek Amer, who will officially take charge on 27 November.
There will be some negatives for the Egyptian economy, as higher interest rates could adversely affect lending and investment as returns on business cannot keep up with interest charges.
Currency support could also be more damaging than a slow depreciation.
Its a dangerous policy, says the financier. It depletes reserves and encourages speculation on the currency. The Bank of England took this bet in 1992 and lost.
Until Egypt can increase its foreign currency earnings, the Central Bank will be in a very difficult position. The three main sources, remittances, tourism and foreign direct investment, are all expected to decline in the short term.
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