Until the early 1960s, Egypt had no central bank. The National Bank of Egypt(NBE), which started to issue Egyptian banknotes in 1899, acted as the country's de facto central bank. It was only in 1960 that the law provided for the establishment of the Central Bank of Egypt(CBE), giving it the right to issue all Egyptian banknotes. The bank claimed the old headquarters of the NBE built in 1948 at Down town Cairo. Witnessing the changes in Egypt's economic paradigms, from the Nasserrist social regimes to the open door policies of the seventies and the current neo-liberal policies, the CBE has always been responsible for formulating and implementing monetary policy, with price stability as the primary and overriding objective. An easy task? Definitely not, especially since the 25 January Revolution when foreign currency resources took a battering and now, amid mounting concerns that financial support from the Gulf might not be as generous as it has been before. Under such circumstances, devaluation of the Egyptian pound, with all its accompanying inflationary pressures, has become virtually inescapable. The country's foreign currency reserves tumbled from $36 billion in 2011 to $16.423 billion in November 2015. Meanwhile, the pound has declined by 33 per cent of its value to reach LE7.93 to the dollar in banks. Low reserves, less generous financing from the Gulf countries and an expected drop in tourism revenues and foreign direct investment due to security concerns mean that Egypt would appear to be in a dangerous economic position. According to Capital Economics, a London-based macroeconomics research firm, Egypt needs $17 billion in foreign currency to cover its current account balance and maturing external debt over the next 12 months, meaning that it will have to withdraw from its reserves and leave the pound to lose still more ground against the dollar. Hisham Ramez, the Central Bank governor for 33 months ending in October this year, tried to contain the problem by managing limited devaluations of the pound three times in 2015. Ramez believed that the currency was not overvalued and that a significant devaluation was not necessary. Instead, he has argued that the country's forex problems are caused by “speculators” and the private sector's importation of “unnecessary” goods. Accordingly, his policies were based on fighting the black market by rationing demand for the dollar through restrictions on dollar deposits and prioritising essential imports. But the result of the policy may not have had the intended results. “Measures introduced to shore up the pound and clamp down on the black market for dollars have backfired. Foreign exchange reserves have remained low,” said Jason Tuvey, a senior economist at Capital Economics. He added that the increasingly draconian restrictions on access to foreign currency, setting daily limits on deposits of $10,000 with a monthly ceiling of $50,000, have meant that firms have struggled to import goods, causing growth to slow sharply. Egypt's largest car assembler and distributor, GB Autos, was forced to halt production for 20 days in September and October, for example, as it was unable to secure the necessary parts from abroad. Against this backdrop, it has been little surprise that GDP growth has weakened this year. Ramez's policies triggered criticism both from the business sector and from different ministers in the government, with Minister of Investment Ashraf Salman saying that it would be better to leave the pound to fall further than to deplete the reserves. It was known to people close to the cabinet that Ramez was also at loggerheads with Minister of Finance Hani Kadri over policies to support the pound. In the end, tensions over foreign policy saw the CBE governor quit at the end of October. Then came Tarek Amer, previous chairman of the National Bank of Egypt. “The fact that Amer's appointment was made by President Abdel-Fattah Al-Sisi , and presumably backed by the government, suggests that he is likely to be more inclined to share the government's views on exchange rate policy,” commented Tuvey soon after the appointment. Another important development was the decision to appoint ex-Central Bank governor Farouk Al-Okda to the CBE's coordination council, responsible for setting monetary policy goals in liaison with the government. While the CBE is an independent authority, the economic problems the country is currently facing have made more coordination between the CBE and the government inevitable. Al-Okda was the main engineer of the pound's flotation in 2003, which succeeded in ending the black market for currency trading which was followed by a stabilisation in the pound's value. Amer was Al-Okda's deputy at the bank during that period. The council also includes Prime Minister Sherif Ismail, the finance minister, and other government ministers, as well as Mohamed Al-Erian, the former CEO of Pimco, one of the world's largest bond investors. The structure of the committee strengthens expectations that a devaluation of the pound will soon take place. “The reactivation of the coordination council and the appointment of key figures like Al-Erian and Al-Okda to the council, which includes the heads of the economy-related ministries, suggest that coordination between monetary, fiscal and investment policies will improve materially,” said Hany Genena, a senior economist at Pharos Holdings, a leading local investment bank. Soon after Ramez's resignation, the CBE surprised markets when it acted to strengthen the pound on 11 November by 20 piastres, bringing it to LE7.7301 to the dollar and widening the gap further between the official and black market rates, which hover at around LE8.53. Tuvey reads the move as “a sign that policy-makers are trying to engineer more volatility in the exchange rate. This should curb speculation that the pound is a one-way bet ahead of a shift to a more flexible exchange rate regime,” he said. Moreover, the CBE plans to pump liquidity into the market in December in addition to holding an exceptional foreign exchange auction, according to the presidency. The announcement came after a meeting between Al-Sisi and Amer in the first week of December. Amer has been the bank's de facto governor since Ramez said he would resign, and he has been holding meetings with bankers and businessmen to find out the real dimensions of the problem. According to Reuters, last month the CBE supplied $1 billion to the banks to cover 25 per cent of the dollar overdrafts opened for companies during the current crisis, and just after the state banks had supplied $1.8 billion to clear a backlog of imports. The CBE also repaid foreign portfolio investors $547.2 million, clearing the entire backlog. The problem of the repatriation of profits stripped the Egyptian stock market of important investments during 2015, a fact that was reflected in thin volumes of trading and an always-heading-south trend. The market reacted to Amer's move by gaining seven per cent in three sessions in the first week of December. The CBE also outlined new criteria for allocating dollars to the banks at its regular foreign exchange sales, based on assessing the banks' ability to extend credit facilities in foreign currency to cover clients' needs and stressing that the priority should be to cover the importation of essential goods. So far the government hasn't revealed the source of these dollars. However, Egypt is expected to receive $3 billion in loans from the World Bank over three years, the first $1 billion of which is expected to be disbursed in the coming weeks. The upshot is that policy-makers have bought themselves time to get to grips with the country's external problems. However, the government has major repayment commitments that will eat up the reserves and will be further reflected in the value of the pound. These payments include $700 million due to the Paris Club of creditors in January 2016, the scheduled $3.1 billion of pending backlogs to oil companies before June 2016 (with a large tranche to be paid before the end of the year), and the pending cover of a $1 billion loan from Qatar. The main concern now is the inflationary pressures that will result from the expected devaluation. Inflation picked up from 9.2 per cent year-on-year in September to reach 9.7 per cent year-on-year in October, largely driven by a rise in the cost of food. Non-food inflation was broadly unchanged last month. A government plan to make essential commodities available at reasonable prices is expected to cap food costs, especially since global food prices remain subdued, limiting inflation on imports. Weak local economic growth and uncertainty surrounding the global economy could pose downside risks to domestic GDP, and these factors mean that underlying inflation pressures should remain contained. All this supports the belief that the CBE will keep its overnight interest rates at their current level of 8.75 per cent for deposits and the lending rate at 9.75 per cent. Meanwhile, Pharos Holding stated that raising interest rates would be the logic step to take. According to a recent note by the investment bank, as banks have been enjoying record high net interest margins-difference between interest rates paid on deposits and those imposed on loans-of almost 5 per cent or higher, the CBE will persuade them to raise deposit rates to support the de-dollarization initiative, while maintaining lending rates unchanged. While so far there has been no official statement that the CBE will pursue devaluation, the fact that it is less concerned about conserving its foreign currency reserves means the devaluation is more likely than ever. “This will enable the Central Bank to eventually formally scale back foreign currency restrictions and, crucially, attract foreign investors back to the country, both of which would support growth,” Tuvey said. He expects the pound to fall to LE8.50 to the dollar by the end of next year, “although there's a clear risk that it could overshoot this.”
