We’re not ready for a devaluation, Goldman Sachs says: Under current conditions, it is unlikely that a managed devaluation would the Madbouly government’s policy objectives, according to a Goldman Sachs report seen by Enterprise.

What is cabinet aiming to do? Unify the parallel and official exchange rates, ensure medium-term FX stability EGP, and do it all with as little devaluation as possible. That’s unlikely to happen without further policy tightening and a bigger war chest of FX ahead of a devaluation, the bank said in the report.

The conditions we’re missing: Demand for FX in Egypt must be in line with anticipated supply inflows following a devaluation — and the system will need enough cash on hand to ensure FX needs can be met by allowing the official FX rate to adjust.

Goldman Sachs believes that demand for foreign currency remains “high and inconsistent with an official FX clearing rate,” making it difficult for the central bank to choke out the black market without deeper devaluation (or a full float) of the EGP. On top of this, GS thinks the banking sector lacks the FX liquidity it needs to close the gap amid a high FX backlog and much of the country’s FX inflows going through unofficial channels.

Goldman doesn’t see a full float taking place: The bank sees policymakers continuing to manage the official exchange rate, but possibly with more flexibility than has been the case in recent years. The report’s author, Goldman MENA economist Farouk Soussa, attributes the conservative approach to the state’s concerns about the exchange rate overshooting and the possibility of an even more volatile exchange rate than the parallel market in the event of a full float.

What do we need to do next? Act now to “to curb FX demand and build liquidity buffers ahead of any prospective attempt to clear the market through a devaluation of the official FX rate.” Specifically:

  • Continuing to raise policy rates to address high inflation levels by reducing demand, which in turn will help clamp down speculative hedging of FX;
  • Fiscal tightening to reduce the amount we spend financing the deficit and to slow the increase of debt monetization, which the bank partly blames for helping push FX demand and inflation;
  • Less off-budget spending on projects reduce both FX demand and overall aggregate demand;
  • Borrowing from external lending partners to build up FX liquidity and ease FX supply constraints;
  • Continued asset sales to help rebuild long-term FX buffers.

BACKGROUND- The CBE recently hiked interest rates by 200 bps, with many analysts expecting further hikes paired with the anticipated devaluation. Ministers approved a decision two weeks ago slashing allocations for investment in fiscal year 2023-2024, extending a series of cutbacks to government spending that initially targeted non-essential projects and spending that placed demand on foreign currency.

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