The Pound Float: One Year On



Sat, 04 Nov 2017 - 04:11 GMT


Sat, 04 Nov 2017 - 04:11 GMT

The International Monetary Fund logo is seen during the IMF/World Bank spring meetings in Washington, U.S., April 21, 2017 - Reuters/Yuri Gripas

The International Monetary Fund logo is seen during the IMF/World Bank spring meetings in Washington, U.S., April 21, 2017 - Reuters/Yuri Gripas

CAIRO - 4 November 2017: A year after Egypt launched its ambitious economic reform program, the country is reaping some fruits of the austerity measures that left half of the population already near or below poverty line struggling to make ends meet as inflation levels soared to the highest in decades.

Backed by a $12 billion three-year loan agreement with the International Monetary Fund (IMF), the state had implemented a set of reforms that include the pound’s flotation last November, VAT introduction and subsidy cuts.

Among the positive signs which reflect that the program is on the right path was the recovery of foreign currency inflows and foreign reserves. Ex-ports also boomed as the industrial sectors have witnessed notable development in that regard, with GDP figures growing steadily over the year.

Foreign currency resources recovered in a year
Foreign reserve has increased since the government sealed the IMF loan deal in November, to reach $36.535 billion by the end of September—com- pared to $19.041 in the month before the float— marking the highest foreign reserve level since the January 25 uprising, according to the Central Bank of Egypt (CBE).

The CBE has helped Egypt mitigate its foreign currency shortages by stabilizing exchange rates and eliminating the parallel dollar market, the IMF had said in its review.The government has already secured its $2 billion financing gap for fiscal year 2017/18 through mul- tilateral and bilateral financing, according to the IMF.

The gap was funded through $1 billion fromthe World Bank, $350 million from the African Development Bank (AfDB) and $600 million from G7 countries, the IMF said.

In addition to this, the banking sector has collected $47 billion since the flotation from foreign trade transactions, CBE’s sub-governor Tarek Fayed said in September. Egypt also issued $7 billion in Eurobonds in January and May on the global bond market, which were both oversubscribed, ac- cording to the Ministry of Finance.

Foreign remittances have also increased by 11.1% ($930 million), to hit $9.3 billion over the six-month period follow- ing the float (from November 2016 to April 2017), up from
$8.3 billion in the same period last year, CBE said last June. For the entire fiscal year 2016/17, remittances registered $17.4 billion, inching up 2% year-on-year.

Tourism revenues also played a role in recovering influx of foreign currency as it jumped 170% in the first seven months of 2017, reaching $3.5 billion, according to government of- ficials.

The Suez Canal as well had its revenues rising in the first half of 2017 to reach $2.938 billion, up from $2.919 billion, according to chairman of the Suez Canal Authority Mohab Mamesh. Mamesh attributed the increase to the fact that more than 9,900 ships crossed the canal during that period, compared to 9,745 ships in the first half of 2016.

GDP to keep growing
Growth in the telecommunication, construction and trade sectors drove Egypt’s GDP to 5% in the fourth quarter of fis- cal year 2016/17, up from 4.5% in the same period last year,according to Minister of Planning Hala el-Saeed.

As for the entire fiscal year of 2016/2017, the GDP ended at 4.2%, up from 4% in the previous fiscal year. More improvements are expected as the IMF and the World Bank Group (WBG) expect the real GDP growth for fiscal year 2017/18 to reach 4.5%.

While the government expects a GDP growth of 4.2% in 2017, Moody’s Investors Service expects a further acceleration to 5% in 2019, supported by the government’s structural reforms.

A credit upgrade would stem from faster-than-expected progress on the govern- ment’s reform program and more rapid fiscal consolidation and improvements in debt metrics, the rating agency said. Meanwhile WBG expects the GDP to reach 5.3% by 2019.

WBG warned, however, from the impact of the current in- flation rate, saying that “if the current rate continues, Egypt might need to tighten its fiscal policy, which will affect the economic growth.” Egypt is expected to rank among the world’s 21 most powerful economies in 2030 thanks to its GDP, according to a report from Price water house Coopers (PwC) published earlier this year.

The ranking comes based on the country’s expected GDP by purchasing power parity (PPP). The report placed Egypt in 19th place, with a projected GDP of $2.049 trillion.

Exports rebound, trade deficit trimmed
The flotation of the Egyptian pound has come in favor of Egyptian exports as the industrial sectors have witnessed notable development in that regard.

The Egyptian industries were the first beneficiary from the economic reform program, as it contributed to increasing the dependence on the local products instead of the imported ones, Minister of Industry and Foreign Trade Tarek Kabil said in June.

“Consequently, local productivity rose, more job opportunities were offered and the pressure on the monetary reserves were re- duced,” he added.

In fact, the deficit in the trade balance fell by $12.23 billion (37%) in the first eight months of 2017, to stand at $20.1 bil- lion, compared to $32.4 billion in the same period in 2016.

Data released by the Ministry of Trade in October showed that non-petroleum imports declined by 23% to reach $35.1 billion, down from $45.5 billion in the same period last year.

Meanwhile, non-petroleum exports in that period increased in the period between January and August by 11% to register LE 15 billion, compared to LE 13.5 billion in the same pe- riod last year.

“Exports do not increase at the same rate that imports’ drop because a big part of what we produce is directed to meet local needs,” Kabil explained. Divided by sectors, exports of eight sectors have increased.

The list was topped by chemicals and fertilizers at a 44.3% increase, ready-made garments (10.6%), building materials (8%), textile (6%), engineering industries (5.8%), food industries (5.4%), agriculture crops (3.8%) and upholstery (1.6%).

On the importing side, a number of sectors have registered declines, such as the ready-made garments at 55%, books at 49% and leather products at 39%.

Part of this occurred because the number of exporting companies increased, especially the small and medium enterprises, “the rise of exports has been not powered by the mega companies, but the small ones,” Kabil had said in a previous interview with Business Today.

Egypt’s exports advanced $2 billion last year and have a possibility to raise additional $2 to $3 billion in 2017 year- on-year.

“We’re aiming to cover 50% of the trade balance deficit by 2020, with more focus on raising the exports,” the minister had said. In its review, the IMF agreed on the impact of economic re- form measures on trade balance.

“Improved competitiveness from depreciation and productivity gains from the reforms are expected to support exports and contain imports,” the report said.

In attempt to rationalize spending of international foreign reserves, the government has taken measures over the past two years to lessen its imports bill.

Toward that goal, the Ministry of Industry and Foreign Trade started working on decreasing the deficit in the trade balance. Among the steps attained was eliminating low-quality imports, achieving the target from the exports’ development plan, preserving the hard currency and depending on the local products.

People walk in front of the Central Bank of Egypt's headquarters at downtown Cairo, Egypt- Reuters
Reforms to push FDI above target
A year after launching the economic reform program, a pickup in foreign direct investment (FDI) was seen as a sign of being on the right track toward restoring confidence in the Egyptian economy, bolstering job creation and sustain- able growth.

Egypt’s net FDI increased to $13.3 billion in the last fiscal year, ending in June 2017, compared to $12.5 billion in the previous fiscal year, with a 6.5% increase, the CBE said in its annual bulletin.

“Within the last four months (ending in May), we already achieved $6.8 billion, and based on that I am projecting that we go beyond the initial target,” Minister of Investment Sahar Nasr told Reuters in August.

The FDI is one of the main sources of filling the govern- ment’s financing gap, which is estimated to range between $10 to $12 billion this fiscal year.

“The government is target- ing $10 billion in FDIs for the current fiscal year. Larger inflows of foreign investments are needed for the country to achieve a sustainable high trajectory of economic growth since most such forms can act as long-term sources of capital,” Nasr told Business Today.

In a step to attract the badly needed FDI and cutting red tape, President Abdel Fattah al-Sisi ratified in June the long- delayed Investment Law, which provides a set of incentives for investors. After being reviewed by the State Council, the executive regulations are pending the investment minister’s notes before being approved by the Cabinet.

“As for FDI, it brings along the best global practices of technology and management, and can therefore boost value creation and productivity as key components in our economic growth model,” Nasr told Business Today.

She added that this requires attracting quality-type FDIs that can integrate domestic firms into worldwide supply chain networks, and accordingly enhance their efficiency, and widen their market accessibility and access to finance.By the fiscal year 2021/22, Egypt is expected to attract $13 billion, up from the $9.4 billion anticipated during this fiscal year, the IMF said in its report.

As gas production will expand in 2017 with the start of production of British Petroleum’s (BP) West Nile Delta project and Eni’s Zohr gas field, the IMF said the “recent gas discoveries are enhancing FDI and reducing energy imports, and suggesting that Egypt will soon be a major supplier of natural gas, beyond domestic consumption needs.”

“Our reform program and measures to improve the invest- ment environment should contribute to reducing systemic and investment risk, and accordingly will induce higher for- eign inflows into the Egyptian economy,” Nasr told Business Today.

Inflation starts to ease after peaking
While the launch of Egypt’s reform program was a reversal from past policies, which had led to a buildup of large external and fiscal imbalances, the sharp depreciation of the pound spiked inflation, pressuring the budget and the majority of the country’s middle and low-income people.

Since the reforms launch last November, Egypt’s inflation had steadily went up since last November following the pound flotation, energy subsidy cut and the VAT introduction.

Inflation declined for the first month after flotation, registering 31.9% in August after reaching a record high in July as Egypt implemented a second round of reforms which included raising fuel prices by up to 50% and electricity prices by up to 42% to slash its budget deficit.

In September, the annual urban consumer price inflation eased further to 31.6%, the official statistics agency, CAPMAS, reported.

However, economic experts and analysts expect Egypt’s inflation to dip further in the coming months, allowing the CBE to consider cutting interest rates after raising them by 700 basis points (7%) since the float.

“We think the first rate cut is likely to come as soon as the Monetary Policy Commit- tee’s meeting on December 28 with a penciled in 100-basis point cut, taking the overnight deposit rate to 17.75%,” London-based think tank Capital Economics said in a re- search note.

Capital Economics said that inflation has now shrunk for two consecutive months for the first time since early 2016, expecting inflation to fall more sharply in the final months of 2017, as the effect of the flotation of the Egyptian pound will start fading.

“In addition, the effects of subsidy cuts and tax hikes will also start to fall out of the annual comparison. We expect headline inflation to fall to around 23% year-on- year by December.”

In line with the previous forecast, Pharos Holding ex- pected the annual inflation rate to decelerate from 32.2% in the first quarter of the fiscal year 2017/18 to 26.5% YoY in the second quarter of 2017/18, and 13.6% YoY in the second quarter of the next fiscal year.

In the review, the IMF said that “the authorities’ immediate priority is to reduce inflation, which poses a risk to macroeconomic stability and hurts the poor.”

It further noted that the CBE has taken significant steps to reduce inflation by raising policy interest rates and absorbing excess liquidity.

Local currency stabilizing after float shock
While the CBE’s long-awaited move to free-float the pound led to a unified exchange rate and curbed the dollar parallel market, the depreciation was strikingly sharp as the pound sank to LE 19 per dollar, more than double com- pared to LE 9.8 per dollar before the float in November.

The depreciation was stronger than expected, and both the authorities and the IMF admitted that its overshoot was beyond their estimates.

To tame the soaring inflation which was mainly fueled by the pound depreciation, the CBE raised its key interest rates by 700 basis points since November.

As the markets restored confidence in the local currency and foreign investors’ appetite for Egypt domestic debt, the exchange rate started to stabilize around LE 18 per dollar since mid-March.

In its staff review, the IMF praised the authorities’ commitment to make timely progress in the re- form agenda, but warned against the risks that the sharp depreciation of the pound could pose to the reform program.

“All quantitative performance criteria for December 2016 were met, but a large depreciation of the pound is posing policy challenges,” the IMF said.



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