Egypt’s Devaluation and Record Rate Hike Put IMF Deal in Reach

(Bloomberg)-07/03/2024

Egypt delivered its biggest-ever interest-rate hike and allowed its currency to weaken more than 38% in a long-awaited devaluation that may pave the way for billions more in loans from the International Monetary Fund.

The series of moves included a 600 basis-point rate increase and came after Cairo struck a $35 billion deal late last month with the United Arab Emirates. A dire shortage of foreign exchange has until now hammered businesses and caused the cost of imported goods to soar. The Israel-Hamas war has added to economic pressures.

The devaluation may stoke inflation and hurt Egyptians in the short term. But President Abdel-Fattah El-Sisi and his officials are banking on the reforms attracting foreign investors back to the country of 105 million people — whose stability is seen as crucial for the wider Middle East — and ending its worst economic crisis in decades.

Egyptian media reported that a new deal with the IMF could be signed later on Wednesday. A team from the Washington-based lender is in Cairo this week. The new pact will likely increase Egypt’s current IMF loan of $3 billion — little of which has been disbursed — to more than $10 billion, an amount that will include funds from other partners.

The pound plunged and crossed 50 per dollar at 1:30 p.m. local time, having traded at about 30.9 for the past year. It started dropping minutes after the central bank raised its key rate to 27.25% at an unscheduled meeting and said it will allow the market to determine the exchange rate.

“We’ll have to wait to see where it settles,” said Farouk Soussa, an economist at Goldman Sachs Group Inc., referring to the currency. “We expect 45-50. The big surprise of the day was the mega hike, which over-delivered and has boosted confidence in the market.”

The devaluation brought the pound to a level around its value on the black market. The IMF has long encouraged Egypt to tighten monetary policy to counter inflation of almost 30% and adopt a more flexible official exchange rate.

What Bloomberg Economics Says…

“The arrival of the UAE bailout has unlocked the policy chain reaction in Egypt. The central bank has lifted interest rates. Authorities have floated the currency, and the gap with the black market should close. What’s next? A deal with the IMF is likely in the next few hours.”

— Ziad Daoud, chief emerging-markets economist. Click here to read more.

The central bank’s Monetary Policy Committee said it had “decided to accelerate the monetary tightening process in order to fast-track the disinflation path.”

Days earlier, El-Sisi said Egypt had received the first transfers from the funds pledged by the UAE, as part of a deal to develop parts of Egypt’s Mediterranean coast and elsewhere. Authorities described it as the biggest foreign investment ever secured by Egypt and the scale took investors by surprise.

“The combination of massive inflows from Abu Dhabi, a 600 basis-point rate hike, an IMF deal that now looks imminent, and the devaluation has got the market very excited,” said Carmen Altenkirch, an analyst at Aviva Investors Global Services Ltd.

Egypt’s dollar bonds rallied significantly. Government debt due in 2047 led the advance, gaining 4 cents on the dollar to around 82 cents. That led the yield to fall to around 10.6% from 11% earlier in the week.

The Muslim holy month of Ramadan, set to begin on Sunday, posed an informal deadline for authorities for a devaluation. It’s a period of big family gatherings and expansive evening meals, and authorities were unlikely to wait until then to hand Egyptians a sudden price shock.

“The most important thing to restore confidence completely is the commitment to this painful process,” said Hisham Ezz Al-Arab, chairman of Commercial International Bank, Egypt’s largest private lender.

“From a private sector perspective, it’s quite obvious that the authorities are delivering on their promises to take the right corrective action,” he said in an interview by phone.

The IMF has delayed two reviews of Egypt’s existing loan after the country appeared to fall short on promises to allow for a flexible exchange rate. Previous bouts of depreciation — in March 2022, October 2022 and January 2023 — were followed by long stretches of stability.

The IMF is keen to protect the $400 billion economy that’s been in crisis for much of the past two years. Russia’s invasion of Ukraine hit hard, leading commodity prices to surge. That meant higher prices for imports of wheat and fuel for Egypt and caused bond investors to flee the country.

More recently, it’s suffered from the Israel-Hamas war in Gaza, which borders Egypt. That caused a slump in tourism late last year. In addition, shipping attacks by Houthi militants in the Red Sea have seen traffic through the Suez Canal — a critical source of income for Egypt, amounting to billions of dollars a year — dive.

“It might take a few days or weeks for the exchange rate to stabilize around its new equilibrium,” said Gergely Urmossy, an emerging markets strategist at Societe Generale SA. If the central bank “transitions away from the hard peg, Egypt’s outlook will improve.”