Egypt’s decision to make the exchange rate more flexible will return the central bank to the managed float in use before the 2011 uprising sent foreign investors and tourists packing, economists and bankers said.
Egypt devalued the pound by 13% on Monday and said it would move to a more flexible exchange rate system, without giving details.
Amid concern that the devaluation would fuel inflation, the central bank said it would do everything in its power to maintain price stability. Tellingly, it promised to maintain order, not stability, in the exchange rate.
Economists and bankers expect the central bank to return to a managed float, allowing the pound to fluctuate daily within a limited range depending on market conditions.
Though it supplied $1.5bn to banks on Wednesday at a stronger rate of E£8.78 to clear a backlog of credit, they said the central bank would let the pound move in a weaker trajectory overall towards 9-9.50 per dollar.
“It is very likely that they will go back to a system they know, a system that prevailed prior to 2011,” said Mohsin Khan, former Middle East and Central Asia director at the IMF and senior fellow at Atlantic Council.
“I have always said (that system) was more managed than floating and I would say you (should) change the weighting and go more floating and less managed.”
Egypt’s pound was mostly pegged to the dollar until January 2003, when a free float was announced.
The central bank created an interbank foreign exchange market, intervening heavily through two market-maker banks to keep the currency within comfortable parameters. Forex markets cleared daily, however, allowing flexibility that kept the market closer to balance.
But as foreign reserves tumbled after the 2011 uprising that ended Hosni Mubarak’s 30-year-rule, Egypt’s currency came under pressure.
The central bank allowed incremental devaluations, then began to ration dollars at formal auctions that it used to set the exchange rate. As imbalances grew, so did the black market.
In 2015, it imposed caps on the deposit and withdrawal of forex, while letting the pound gradually weaken some 10%.
But the caps exacerbated the forex shortage, undermined the confidence of foreign investors who could no longer repatriate their earnings and made it harder to clear imports at ports.
When Tarek Amer became central bank governor in November, he set about gradually easing the caps and moving to narrow the trade deficit.
But economists said Monday’s devaluation was not enough to win back investors’ trust and called for the central bank to end its forex auctions and return to the interbank system.
“It is critical that the new regime re-establish confidence in the convertibility of the Egyptian pound. There has to be a market where prices adjust to a point where the pound can be bought and sold on demand,” said Simon Williams, central and eastern Europe, Middle East and Africa chief economist at HSBC.
“The central bank may intervene to limit volatility, but the market has to be allowed to set the market clearing rate.”
For many bankers and economists, the question is whether the central bank can stay the course without a major forex injection.