Egypt’s Currency Moves Show Promise, with Possible Inflation, Social Risks

Recent moves by the Central Bank of Egypt to devalue the Egyptian pound and the possibility it will float the currency will work to improve the nation’s sovereign credit profile (‘B’/Stable). But in a new report, Fitch Ratings believes these adjustments may be tempered by the social and political risks Egypt faces.

Egypt’s Central Bank also last week raised its policy rate by 300bp to tighten monetary conditions, while the currency has since dropped further following the Central Bank’s March 13% devaluation of the pound, wrote Toby Illes, director of sovereigns at the ratings agency, and Mark Brown, senior analyst. The Egyptian government has also reduced fuel subsidies. The moves will likely be viewed favorably by the International Monetary Fund (IMF) board and could pave the way for it to approve the $12 billion Extended Fund Facility announced in August.

“We expect the IMF board to approve the deal when it meets to discuss it on Friday, Nov. 11, and release the first tranche of funding,” Fitch analysts said. The ratings agency believes the IMF funding should support the central bank’s foreign reserves stock and potentially lead to international bond issuance.

“Over the medium term, the exchange rate shift should also support external rebalancing, raise portfolio inflows, and ease FX shortages, which have weighed on economic activity, including domestic manufacturing,” Illes said.

However, FX changes could still be risky in that they could increase inflation—already at 14.1%, year-over-year, in September—and lead to exacerbated social unrest, the analysts said. “The fiscal impact of devaluation is mixed. Public sector external debt is low as a percentage of total public debt, but the weaker currency will increase the size of the debt, and the interest rate rise will push up the interest payment bill yet further. The weaker currency will also put pressure on the government's import costs. But the increase in fuel prices and the likely approval of the IMF program will help control spending (although the IMF loans themselves will also add to debt),” they said.

– Nicholas Stern, editorial associate

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