After a weekend of swirling rumours of a major devaluation of the Egyptian pound following a report released by Beltone Financial and a speech by President Abdel Fattah Al-Sisi of which analysts claimed the president hinted at an exchange rate reform, Arqaam Capital released a report detailing the specifics of what that reform may look like.
Arqaam Capital’s published paper, titled “Devaluation Balloon Popping Soon”, states that the expected “aggressive” devaluation is set to coincide with the International Monetary Fund (IMF) board meeting scheduled to run from 3-9 October. The Egyptian pound could see devaluation at EGP 12 to the dollar, allowing minimal movements in the rate thereafter as it moves to a free float which signals to investors that the pound is no longer overvalued.
Arqaam expect the new exchange rate to reflect a hybrid system, which will combine some traits of a managed exchange with a free float in order to accommodate the challenges facing the Central Bank of Egypt (CBE). The risk that the exchange rate will slide past EGP 13.65, squeezing the government’s budget to finance basic goods while inflation soars, will likely prevent the government from enacting a fully liberalised system.
Arqaam states that the devaluation should be followed by a 1-3% interest rate hike, coupled with the lifting of banking sector exchange restrictions. A one-point increase in interest rates costs the budget about EGP 18-20bn in additional financing the following fiscal year. Arqaam states that the removal of the exchange overhang will outweigh these fiscal aspects in the short term.
If the CBE opts for a managed float of the pound they will take certain steps to mitigate the cost of the devaluation. Egypt, a net importer, will require the CBE to inject large amounts of liquidity into the official market to satisfy household demand, clear investors’ backlog, and address backlog which has been accumulating for months, specifically from the corporate sector.
Arqaam states that the financing requirements in supplemental financing, which the IMF demanded, would definitely exceed $5-6bn—by $2-3bn. This is due to the expected pressure on international reserves which currently sit at $19.59bn, while CBE governor Tarek Amer had targeted $25bn before the exchange reform.