The Central Bank of Egypt (CBE) surprised the global and local financial markets with a package of bold decisions on Thursday, on top of which was the complete liberalisation of the exchange rate and the adoption of a flexible exchange rate, raising interest rates by 2% at once and announcing the start of work on building a market for financial derivatives.
The CBE explained that the global economy faced many shocks and challenges that it had not witnessed for years, as global markets were recently exposed to the spread of the COVID-19 pandemic and closure policies, followed by the breakout of the Russian-Ukrainian War, both of which had severe economic repercussions.
Flexible exchange rate
In light of this extraordinary circumstances, these reform measures were taken to ensure macroeconomic stability and achieve sustainable and comprehensive economic growth, with the CBE pointing out that in order to achieve this, the exchange rate will reflect the value of the EGP against other foreign currencies by the forces of supply and demand within the framework of a flexible exchange rate system, with the top priority being price stability, as this will also enable it to work on forming and maintaining sufficient levels of international reserves.
Eliminating documentary credits
The CBE also promised the business community that it will gradually cancel the instructions issued on November 13, 2022, regarding the use of documentary credits in import operations, noting that they will be completely repealed by December 2022 and this measure will serve as an incentive to support economic activity in the medium term.
In its first steps to implement this plan, the CBE decided to increase the value of shipments that are imported with collection documents to $500,000 instead of $5,000 or its equivalent in foreign currencies.
Building and developing the financial derivatives market
Furthermore, the CBE revealed that it will work to build and develop the financial derivatives market to enhance the foreign exchange market and raise liquidity in foreign currency.
In order to achieve this, the CBE decided to allow banks to offer FX forwards to their corporate clients, provided that their purpose is to cover customer positions resulting from commercial operations represented in documentary credits, collection documents, supplier facilities, or profit transfers to foreign shareholders for a specific date abroad, or the goods and services export earnings received by the bank’s customers.
The bank would obtain proof that the operation is commercial while taking into account that customers are not allowed to carry out such operations for speculative purposes.
The CBE will also allow banks to carry out forward exchange operations with each other locally for non-speculative purposes, in addition to allowing them to carry out exchange rate swaps (FX swaps) for corporate clients, provided that their purpose is to cover customer positions resulting from the aforementioned commercial operations — which will be carried out through the same bank — emphasising the possibility of carrying out the same operations with local banks only.
Unbanning non-deliverable forward exchange transactions
Moreover, the CBE is lifting the previous ban on banks regarding non-deliverable forwards for clients that include banks, institutions, or individuals, while allowing banks to carry out these operations for corporate clients.
It also stressed that banks should observe the controls for granting credit, making sure not to offer credit facilities or provide financing to customers or any activity in foreign exchange unless they have fully ascertained that these clients have sources of payment in foreign currency and pledge to use them in payment.
Basic rate hike by 2%
Additionally, the CBE said that it aims to support the goal of price stability in the medium term and its Monetary Policy Committee decided in its extraordinary meeting last Thursday to raise the overnight deposit and lending rates and the price of the main operation of the CBE by 200 basis points to 13.25%, 14.25%, and 13.75%, respectively, and the credit and discount rate was raised by the same percentage to reach 13.75%.
According to the CBE, the increase in global and local prices is expected to lead to a rise in the general inflation rate from its target, which is 7% (±2%) on average during the fourth quarter (4Q) of 2022.
For its part, the MPC stressed that the objective of raising interest rates is to contain inflationary pressures caused by the demand side, the high rate of domestic liquidity growth, inflationary expectations, and the secondary effects of supply shocks, pointing out that it will continue to announce the inflation target rates — which started in 2017 — in a consistent manner, with the target being a downward trajectory in inflation rates.
According to the committee, the inflation policy succeeded in reducing inflation rates until the recent global shocks.
Finally, the CBE stressed that it will closely keep an eye on all economic developments and that it will not hesitate to use its monetary tools to achieve price stability.