The Egyptian Pound - Much Further to Fall

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Monday, October 24, 2016/ 1.20pm /BMI Research

BMI View: The Egyptian pound will depreciate by another 10% around the turn of the year as the Central Bank's willingness and ability to support the unit wanes significantly. Furthermore, the proposed IMF deal is dependent on a weaker, more competitive, currency. 

Short-Term Outlook (three-to-six months)

We expect a further 10% depreciation in the Egyptian pound by the end of the year as the Central Bank runs out of reserves to defend the currency. In addition, the proposed USD12bn IMF deal is dependent on a more competitive exchange rate.

The pound was trading at EGP8.8113/USD on August 3, and we forecast it to end 2016 at EGP9.7000/ USD. We maintain our view that inflationary pressures will continue to build, forecasting headline consumer price index inflation to reach 17% by the end of the year, from 13.2% in June.

Depreciatory pressures remain strong as illustrated by the spread between the black and official market. The black market rate for Egyptian pounds was at EGP12.5000/USD in July, suggesting the official market is far from satisfying demand for dollars – a key impediment for local businesses.

Egypt's ability to support the currency has been hit by declining reserves. Egypt's foreign currency reserves fell to USD17.3bn in June – less than the equivalent value of three months of imports.

We believe official assistance from the Gulf States has come to an end given the decline in oil prices and their concomitant worsening fiscal outlook. While the proposed IMF deal (which we expect to be concluded around the turn of the year) will prop up reserves in the long term and lead to increased investor confidence, the deal is contingent on a more completive, ie, much weaker, exchange rate.

Indeed, the real effective exchange rate has strengthen since the devaluation in March, illustrating the Egypt's worsening competitiveness with its trade partners.

Long-Term Outlook (six-to-24 months)
We expect the Central Bank of Egypt (CBE) to have a greater tolerance of a weakened pound. The strong US dollar means risks associated with a weakening currency, which Egypt has until now been trying to avoid (namely imported inflation) are lessened slightly – especially with our forecast for only limited food and energy inflation.

Overall we forecast depreciation to the tune of 21.5% by the end of 2017, with the exchange rate moving to EGP10.7000/USD. Forward currency markets highlight the worsening longer-term sentiment towards the Egyptian pound, with investors pricing in further weakness against the US dollar in the past quarter.

While non-deliverable forward (NDF) contracts for the pound have consistently overestimated the extent of potential declines in past years, the recent moves illustrate that the market has increased anticipation for further depreciation in the coming year.

In August, the six and 12-month EGP NDFs were trading at EGP10.8500/USD and EGP12.000/USD respectively, having risen sharply over the past three months.

The much weaker exchange rate will be no panacea to Egypt's economic malaise. Even with the lower rate, Egypt is still far from competitive for many businesses to invest, particularly compared with Morocco and Eastern Europe.

A new investment law is expected this year which will go some way towards improving the situation, but there has been an absence of clarity on what this will entail.

In addition, high inflation and social instability are also major risks which outweigh the positive effects of the new exchange rate.

Risks to Outlook
Risks to our forecast are mainly for greater depreciation than we currently forecast in 2016 and 2017.

Firstly, the IMF deal (which would support the currency in the long term) is not set in stone and there is a significant historical precedent for talks to break down, In addition, though not our core view, a large recovery in oil prices would worsen Egypt's current account deficit and weaken political will to enact much needed fuel subsidy reforms, thus putting more pressures on reserves.

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