Another deval “not the right way forward,” says Deutsche Bank

DB offers an alternative view on the EGP: Another devaluation is not “the right way forward” for Egypt and could make it harder to attract foreign investment into the country, Deutsche Bank analysts wrote in a research note on Monday. The IMF has been pushing the view that a fully flexible exchange rate is necessary to shore up the economy and strengthen foreign reserves, making it a central requirement of our USD 3 bn loan program. However, “a fourth devaluation is unlikely to resolve Egypt’s underlying challenges, and could even prove counterproductive in attracting a return of sustainable inflows to Egypt,” the analysts wrote.

The case against another devaluation:

#1- Devaluation would do little to encourage long-term investment: “The previous devaluations have failed to attract sustainable portfolio inflows beyond very short tenors,” and a fourth deval is unlikely to be any different, according to the note. Demand for government paper has been mixed and the inflows that we have seen have gone predominantly towards short-term t-bills, shortening the government’s debt profile.

This would have implications for debt sustainability: “Egypt risks having to finance long-term debt that becomes due with more short-term financing at increasingly higher rates,” the Deutsche analysts wrote. Around USD 52 bn in longer-term debt is due in 2023 and 2024, as well as USD 64 bn of bills that will likely be rolled over.

#2- The current account deficit doesn’t warrant another deval: The current account deficit has already been narrowing following the previous devaluations and generated a surplus for the first time since 2014 in 4Q 2022. Though the bank sees the deficit continuing through 2023, there is “limited room for further contraction” thanks to rising revenues from tourism and the Suez Canal and muted import demand, it said.

#3- The currency is already undervalued: Deutsche Bank estimates that the EGP is around 10% undervalued, according to the real effective exchange rate. And that’s despite three months of exchange-rate stability that has supported the currency after the January 2023 devaluation left it 20% undervalued.

The likelihood of another devaluation has shrunk in recent weeks: Investment banks have dropped their forecasts for an imminent devaluation and are now penciling in a move towards currency flexibility later in the year. The president has also poured cold water over the idea, saying last week that a further devaluation will not be allowed if it jeopardizes the country’s national security and inflicts more pain on citizens.

Remember: Transitioning to a fully flexible exchange rate was a key condition of the IMF program. The Fund was due to carry out the first review in mid-March but has postponed it amid a lack of progress in meeting several of its key commitments, namely the currency float and raising bns of USD via sales of state-owned assets. Deutsche Bank now expects the IMF to conclude its review of the program late in 3Q, potentially alongside another currency adjustment.

The alternative route? The “focus should shift to addressing the root of the problem, namely Egypt’s local debt stock,” according to the Deutsche analysts. While the lender wants Egypt to lengthen the maturities of its debt stock, it acknowledges that a maturity transformation is unlikely to be in the cards “given the IMF’s current priorities.”

Key forecasts:

• The EGP will drop to EGP 37 against the greenback by the end of the year.
• The mid-year forecast sees the currency trading at EGP 31 against the USD — a value that “is now close to being realized.”
• The CBE will raise interest rates by another 300 bps.