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Devaluation has mixed effects

The Central Bank of Egypt (CBE) has devalued the Egyptian pound due to pressures on the FX market that had become
unsustainable and were driving the development of a black market. This decision was accompanied by an increase in interest rates
in order to attract deposits into the official banking system. This is a first stage in the stabilisation of the FX markets: the rebuilding
of the CBEs foreign exchange reserves and a further depreciation are necessary conditions. In the short term, the rise in interest
rates will have relatively little effect. However, despite the devaluation, the current account balance remains under pressure. It is
essential that Egypt remains on the path to reform and continues to receive external help.
Despite external financial support, foreign currency liquidity has
declined continuously since 2011. Faced with the growing rationing
of foreign currencies, the development of a black market and the
increase in external debt of the whole banking system, a
devaluation of the pound had become necessary.

Devaluation of the pound: a first step

The 13% devaluation of the pound against the US dollar on 14

March 2016 was an initial response to the growing shortage of
foreign currencies. Given the low level of forex reserves at the
central bank and the external debtor position of the banking system
as a whole since the beginning of the year, dollar liquidity had
become a real problem for economic agents. This resulted in the
blockage of imports waiting for payment and caution amongst
foreign investors given the difficulty of repatriating funds and the
prospects of a depreciation of the pound. The FX black market
allowed a certain continuity for business, but at a rate well above the
official one (EGP 9.5 per USD against EGP 7.8 prior to devaluation).
This market, which may have accounted for 70% of activity on the
FX market, deprived the official banking system of a substantial
volume of foreign currency liquidity. The aim of the CBE was
therefore to introduce to the market a substantial volume of foreign
currency at a sufficiently attractive price to encourage a transfer of
foreign currencies to the official banking system.

1- Summary of forecasts*
2014 2015 2016f 2017f




Inflation (CPI, y ear av erage, %)





Gen. Gov . balance / GDP (%)

-12.6 -11.5 -11.6 -10.6

Gen. Gov . debt / GDP (%)





Current account balance / GDP (%)





Ex ternal debt / GDP (%)

Real GDP grow th (%)





Forex reserv es (USD bn)





Forex reserv es, in months of imports





Ex change rate EGP/USD (y ear end)





(*) Fiscal y ears T-1/T (July -June)

f: BNP Paribas Group Economic Research estimates and forecasts

2- Real Effective Exchange Rate


Egypt Emerging countries average


Before the devaluation decision, caps on foreign-currency bank

deposits were lifted. Alongside the devaluation, the CBE made a
record volume of foreign currency (USD 1.5 bn) available on the
market at a rate of 8.85, and significantly raised the interest rate on
deposits in Egyptian pounds. The two main public-sector banks
increased the rate paid on 3-year deposits by 250 basis points (bp),
whilst the CBE increased its main deposit rate by 150bp to 10.75%.


It is still too early to say whether or not the devaluation has achieved
its goals. Initial indications are mixed. Having risen slightly, the black
market exchange rate continued its depreciation, reaching an
estimated level of 10/USD. At the end of March, the central banks
forex reserves were stable at USD 16.5 bn. Moreover, the banks
governor announced that non-resident portfolio investment (equities
and fixed income securities) increased by USD 0.5 bn following the
devaluation. The Cairo stock market gave the devaluation a warm
welcome, gaining 14% over 2 weeks, but leading indicators of
economic activity remain in negative territory. The PMI index
dropped to 44.5 in March (from 48.1 in February), its lowest since
August 2013.


This devaluation is the first stage in the process of restoring foreign

currency liquidity. The scale of the devaluation so far is still a fair



Sources: JP Morgan, BIS




way short of what would be needed to restore the external

competitiveness of the Egyptian economy. Before the devaluation,
the trade-weighted real exchange rate of the pound had increased
25% in 18 months against a background of a widespread real-terms
depreciation of emerging market currencies. The uptrend in the real
exchange rate is likely to continue, given the structurally high level
of inflation in Egypt (relative to its main trading partners). Two
factors seem necessary before one can conclude that the FX
market have normalised (that is to say the black market has been
almost suppressed and restrictions on currency movements
removed): a further depreciation of the pound and the rebuilding of


2nd quarter 2016


adequate foreign exchange reserves. The CBEs aim is to build

reserves of USD 25 bn, the equivalent of 3.8 months of good and
service imports.

The expected effects

3- Central Bank of Egypt FX reserves

USD bn Months of G&S imports (rhs)

In the short term, the devaluation of the pound will result in an

increase in inflation, even though part of the devaluation had been
included in prices for several months. Evidence of this comes from
the fact that car importers had increased their prices by more than
5%, and a further 10% rise is likely over the next few months.
Average annual inflation is likely to remain above 10% at least until
2016-2017. Part of the political impact of this inflation will be
dampened by the maintenance of food subsidies.







Another consequence of the devaluation is that it has been

accompanied by a widespread increase in treasury notes and bonds
rates across all maturities. Although there has been a slight easing
since the end of March, issue yields have risen by between 120bp
and 200bp relative to pre-devaluation issues. Given that the bulk of
financing of the budget deficit is achieved on the local market, and
debt service accounted for 45% of total fiscal receipts in 2014-2015,
the negative consequences of the devaluation on the budget deficit
will not be negligible. We estimate that the apparent interest rate on
government debt is likely to climb by 50bp in 2016-2017 and that
debt service is likely to reach nearly 50% of receipts. The
consequences of the devaluation for total government debt
dynamics will probably be limited, as only 9% is issued in foreign
currency. Moreover, despite continuing to run large deficits (10.7%
of GDP expected in 2016-2017), government debt is likely to
continue to fall as a percentage of GDP, reaching 80% in 2017-2018
(from 89% in 2014-2015), given the relatively strong economic
growth and persistently high inflation.


The effects of the devaluation on the current account deficit will

probably be fairly limited. The potential gain in price competitiveness
generated by the devaluation looks unlikely to be enough to offset
the real-terms rise in the exchange rate since 2014. More
significantly, the increase in the current account deficit since 20132014 (to -3.8% of GDP in 2014-2015) is due mainly to the fall in
tourist numbers and the rising deficit on energy. The devaluation will
have only a marginal effect on these factors. After rallying in 20142015, tourism is likely to decline steeply this year. In the year to
February 2016 it had already fallen 41%. Tourism revenues
contracted by one third in the first half of 2015-2016. Given the
lasting geopolitical tensions in the region, any recovery in tourism
will come only very slowly. Meanwhile, oil exports have suffered as
a result of lower prices, whilst domestic consumption is driving an
increase in imports. In the first half of 2015-2016 the deficit on
energy increased by 40%. In all, the current account deficit could hit
5% of GDP in 2015-2016. However, the energy deficit could
improve faster than currently expected. According to ENI,
production from the Zohr gas field could begin in 2017, thus helping
cut the energy deficit. In addition, the agreement with Saudi Arabia
for the supply of USD 20 bn in oil products over the next five years
(equivalent to around of the annual energy bill) is also likely to
ease pressure on the balance of payments.

Sources: CBE, BNP Paribas



virtually zero. The increase in the yields on government debt and

the ability to hedge against exchange rate risks are likely to
encourage a return by foreign investors. However, until the situation
is fully stabilised, with a credible level for the pound and a rise in the
CBEs currency reserves, this return will remain slow.
These early stages of a positive trend of reform are a factor in the
improvement of Egypts economic prospects. However, advances in
the fiscal position remain hesitant and the restoration of adequate
foreign currency liquidity has not yet been achieved. The country
faces another difficult year in 2016-2017, with rising interest rates,
continued geopolitical tension in the region and a growing energy
deficit. Bilateral and multilateral financial support remains essential
to ensuring Egypts economic stability.
Pascal Devaux

The government has high hopes for the return of foreign investors to
the local sovereign debt market. In 2010, the stock of treasury notes
held by non-residents was USD 6.7 bn. Since 2011 it has been



2nd quarter 2016