Chances and challenges facing Egyptian economy

Recently, after prolonged bargaining and negotiations with the International Monetary Fund (IMF), the Central Bank of Egypt announced the allowance of the exchange rate to freely float and hiked the key interest rate by 600 basis points to 27.25%.

Following this announcement, the Egyptian pound plummeted against the US dollar, sliding from the stable rate of 31:1 maintained for almost a year to as low as 50:1, marking a nearly 40% drop and hitting a historic low. This significant devaluation, the fourth in two years with previous ones being 14%, 19%, and 17% respectively, shattered records for the speed of currency devaluation worldwide.

Accompanying the sharp fluctuations in the exchange rate, Egypt has been grappling with high inflation rates this year, with prices soaring for essential goods including food, particularly noticeable increases in the prices of meat, poultry, grains, and bread. For two-thirds of Egypt's population living below the poverty line, this new year isn't promising.

The sudden relaxation of exchange rate controls and the "aggressive interest rate hike" in Egypt appear as radical and abrupt measures, but they are laden with inevitability and necessity. Firstly, extreme forex scarcity is a major ailment of the Egyptian economy. As a populous African nation and a significant developing country, Egypt has a high demand for foreign exchange but severely inadequate earning capacity. Its trade balance has long been in deficit, the once thriving tourism sector is yet to recover from the blow of the COVID-19 pandemic, and the revenue from the Suez Canal has been cut off by the "Red Sea crisis," leading to a complete imbalance in forex inflows and outflows. Meanwhile, the Federal Reserve repeatedly postponed interest rate cuts and maintained high rates, causing a continuous outflow of international capital from developing countries. Approximately $20 billion of hot money has fled the Egyptian market, according to incomplete statistics.

Secondly, relinquishing exchange rate controls is the "price" Egypt pays for international loans. When the IMF reached a $3 billion loan agreement with Egypt in 2022, the Central Bank of Egypt was required to allow the exchange rate to float freely. Since then, Egypt has devalued the official exchange rate several times, but due to inflationary pressures, it did not further devalue the pound. Therefore, Egypt failed to pass the IMF's subsequent reviews for full disbursement of loans. In order to obtain more loans to alleviate debt pressure, Egypt can only compromise and loosen exchange rate controls. According to Egyptian media reports, a few hours after the Central Bank of Egypt lifted exchange rate controls, the IMF agreed to disburse $8 billion in loans to Egypt (increasing from the initial $3 billion by an additional $5 billion), and the IMF also provided an additional $1.2 billion in environmental sustainability loans to Egypt, bringing the total amount of loans to Egypt to over $9 billion.

Thirdly, the parallel forex market (black market) thrives in Egypt. Although the official exchange rate had been pegged at around 1 US dollar to 31 Egyptian pounds, the rate on the black market had a stark difference from the official rate for the past year, reaching over 70 Egyptian pounds per dollar in January this year. Observers noted that the black market exchange rate offers significant advantages over the official rate, leading people to naturally prefer exchanging currency through the black market, resulting in a drain on the Central Bank of Egypt's dollar reserves. Therefore, some argue that the actual impact of the pound devaluation is not as exaggerated as the numbers suggest, as the black market exchange rate has to some extent already become a barometer of the Egyptian economy, and the government's action this time merely aligns the official exchange rate with the black market rate.

Despite the risks of rampant inflation, the devaluation of the pound and the international aid resulting from other economic reform measures are still a relief for Egypt, allowing it to temporarily catch its breath. At the same time, Egypt is also exploring various ways to raise more relief funds to increase forex liquidity.

Regarding Egypt's current situation, some experts are optimistic, stating that the Egyptian government's current focus has shifted from solving the forex shortage problem to how to fully utilize forex to achieve economic control objectives and promote sustainable economic development. As the effects of exchange rate liberalization are gradually absorbed, the pound's exchange rate against the dollar is expected to stabilize between 45:1 and 50:1, and the convergence of the official and black market exchange rates will attract more foreign direct investment, remittances, and portfolio investments in a virtuous cycle.

However, there are also cautious voices. They believe that whether these additional funds can change the weak state of the pound is still unknown. The US dollar investments Egypt can obtain in the short term, combined with various loans, can only cover the $29.23 billion in principal and interest payments due this year. If the government lacks other forex income to increase imports of basic commodities to curb domestic prices, the problem of rampant inflation will continue to drag down the pound's value and may even pose a more serious risk of capital outflows.

Contributed by Chen Tianzhe, correspondent of Guangming Daily in Cairo