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Pressure on EGP exchange rate set to rise, says IIF: The local currency is currently overvalued by some 10% in comparison with its “real effective exchange rate” — its relative strength compared to a basket of 13 of our major trading partners — the Institute of International Finance (IIF) said in a note on Wednesday. Analysts at the institute blamed record inflation here at home, diminishing inflation amongst trading partners, and the fixed exchange rate for the overvaluation, which they say could widen to 20% by the end of 2024.
Remember: The EGP-USD exchange rate has remained pegged at EGP 30.96 since March after a series of devaluations that saw the local currency lose almost half of its value against the greenback. The parallel market rate, meanwhile, currently stands around 30% above the official rate, according to the IIF.
The solution? A full float of the EGP, says the IIF: The data “strengthen[s] the argument in favor of a floating exchange rate, a policy shift that would, if accompanied by tighter policies, help bring Egypt one step closer towards macroeconomic stability,” the analysts wrote. The IIF had previously called on policymakers to adopt a fully flexible exchange rate and eliminate the parallel market to help rebuild depleted FX reserves.
The IMF concurs: Many market-watchers are expecting a further devaluation of the EGP in tandem with the IMF’s anticipated review of our USD 3 bn loan, under which the government agreed to shift to a fully flexible exchange rate.
Devaluations help — but they don’t go far enough: One-off devaluations of the exchange rate starting in 2016 have helped alleviate pressure on the EGP in the short term, bringing the official rate in line with the real rate, the IIF says. However, “bottlenecks in the economy, poor monetary policy transmission, subsidized lending, and expansionary fiscal policies” soon reintroduce pressure that drives up the real rate, leading to the need for another devaluation and “starting the cycle all over,” the report says.
A float isn’t a silver bullet — but it goes “a long way”: Even in the absence of other policy reforms, a move to a full float “would allow the real exchange rate to fall closer to its fair value level, benefitting the export sector, reducing the current deficit, helping bring in capital, and taking Egypt one step closer towards macroeconomic stability,” the analysts wrote.
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.
