The Central Bank of Egypt (CBE) held its overnight deposit rate at 11.25% yesterday, against the median expectation of 11.75% among the 11 analysts surveyed by Bloomberg (with five projecting a 100bps hike, two projecting a 50bps hike and four projecting no change). However, the CBE also decided to increase the required reserve ratio by 400bps to 18%, which the monetary policy committee (MPC) statement says will “complement the tightening stance that the CBE is maintaining” after raising rates by 300bps since March, which it says “is still transmitting through the economy".
Markets were anticipating some additional commentary on the CBE’s currency management strategy amid growing speculation that EGP will be devalued, with forward markets pricing in 20% depreciation over the next 12 months, but, in the event, it was not mentioned. However, we hesitate to read too much into its omission, with the CBE possibly opting to wait until its strategy is fully hashed out before telegraphing a move. EGP flexibility is likely a prior action of Egypt’s pending IMF programme, which Finance Minister Maait said earlier this week he is hopeful will materialise in the next 1-2 months.
The relaxation of import controls earlier this month could be a sign that the CBE is preparing for more flexible exchange rate management, and may have been another policy prerequisite for the IMF. That said, with inflation running at 14.6% yoy in August and core CPI at an even more elevated 16.7%, a policy hike today could have pre-emptively reduced currency pressure ahead of a potential devaluation and signalled the CBE’s intent for an orderly adjustment (although the required reserve hike will help reduce US$ demand, albeit with less of a symbolic impact than if it was coupled with a policy rate hike).
The CBE sees inflation as driven primarily by temporary supply-side factors and emphasises that future policy decisions will be made based on forward-looking inflation expectations rather than the prevailing rate. But, with robust domestic growth, core inflation running even hotter than headline CPI, the real policy rate at -3.3% and rate hikes gathering pace around the globe (including the Bank of England by 50bps, Fed by 75bps and Riksbank by 100bps this week in developed markets and the Bank of Indonesia by 50bps and South African Reserve Bank by 75bps in emerging markets, among others), the CBE is at risk of falling behind the curve.
We think further policy tightening will be required by the CBE in the months ahead, with the next MPC meeting scheduled for 3 November. Until then, we will continue to monitor progress toward Egypt’s IMF programme, which is necessary to meet Egypt’s large gross external financing requirements. In the meantime, Egypt will have to find alternative sources of funding, with Finance Minister Maait outlining plans to seek affordable bilateral loans from China and Japan and to issue a US$500m panda bond, US$500m green bond and US$2bn Sukuk this fiscal year if market conditions are favourable.
However, Egypt can only paper over the cracks for so long. In the year through March, a period in which official reserves fell by over US$4bn, reserves were supported by a near US$13bn influx of short-term deposits (including US$5bn from the UAE, US$5bn from Saudi Arabia, US$3bn from Qatar and a US$2.8bn Chinese currency swap), taking the total to US$16bn. Moving forward, Egypt will need to find a more sustainable funding model to avoid the continuation of external boom and bust cycles, with EGP devaluation and attracting FDI as key components of that shift.
A rate hike at yesterday’s MPC meeting would have been an encouraging signal of the CBE's willingness to rein in import demand and tighten liquidity ahead of a potential devaluation, although the required reserve hike means the opportunity wasn’t entirely wasted. Moving forward, securing an IMF programme will be essential for Egypt to avoid a balance of payments crisis, which will almost certainly entail greater FX flexibility and may, in tandem, require a tighter policy stance to rein in external and price pressures and move Egypt’s real rate towards a sufficiently positive level to attract future portfolio inflows.
In the meantime, we maintain our Sell recommendation on EGP and EGP-denominated government debt.
Egypt: Downgrade local debt to sell amid devaluation concerns, August 2022
Egypt: Priced for distress: Too harsh but don’t expect the army to drive reform, July 2022 (Malik)
Egypt reaches critical point amid rising risk of debt distress, May 2022
Egypt: Currency devalued to combat rising external risks, March 2022
Egypt: Upgrade to Buy after selloff, October 2021
Fixed income strategy: Top picks for Q4 2021, September 2021
Egypt makes progress on reforms by external vulnerability is rising, April 2021
Fixed income strategy: Our top picks for 2021, December 2020
Discussion with Egypt’s IMF Mission Chief, October 2020
Egypt: Carry trade alive and well once again, July 2020