Flexible exchange rate is key to getting out of our bottleneck, IIF says

Egypt financial situation “precarious” -IIF: A slowdown in imports during the last fiscal year might have eased some of the external pressures we face, but Egypt’s finances remain in a “precarious” position amid uncertainty over the future of its loan program with the IMF. That’s according to analysts at the Institute of International Finance (IIF), who wrote in a note this week that adopting a flexible exchange rate will be key to resolving the imbalances and rebuilding reserves.

What’s the IIF, again? It styles itself as the global industry association for the finance industry and counts commercial and investment banks, asset managers, sovereign wealth funds, hedgies and central banks (among others) as members.

Multiple pressures: The postponement of the IMF program, high external debt levels, twin fiscal and current account deficits, a deteriorating net foreign asset position, and portfolio outflows are all putting pressure on the country’s finances.

Remember: The USD 3 bn IMF assistance program has been on hiatus since mid-March when the Fund postponed the first review due to the government’s lack of progress floating the currency and selling state-owned assets.

Import slowdown eases pressure: Import restrictions in place through most of 2022 together with the series of currency devaluations caused a “large contraction” in the volume of goods being brought into the country, easing pressure on the country’s balance of payments. This helped the country generate its first current account surplus in almost nine years in 2Q FY2022-2023 and the IIF expects the deficit to have narrowed to 1.1% of GDP over the course of the fiscal year, from 3.5% in FY 2021-2022.

FDI rebound: The IIF expects a “large increase” in foreign direct investment in FY 2023-2024 which will be key to financing the deficit in the absence of portfolio inflows.

But vulnerabilities remain:“Egypt remains extremely vulnerable to external factors as well as to domestic structural bottlenecks,” the analysts wrote. Expectations for slower global growth this year could dent revenues from exports, tourism, and the Suez Canal, while a recovery of imports would cause the trade balance to “quickly deteriorate.” The IIF expects these factors could cause the current account deficit to widen to around 1.7% of GDP this year.

A flexible currency is key: Adopting a fully flexible exchange rate and eliminating the parallel market is one of the adjustments policymakers will need to make to rebuild reserves, according to the report. “An additional devaluation could lower the trade deficit, constraining imports while boosting non-hydrocarbon exports, while also allowing remittances to recover to FY22 levels as the parallel and official rates converge, lowering financing needs,” the analysts wrote.