Sunday, 31 July 2016

What does an IMF programme mean for the Egyptian pound?

After many false dawns, Egypt is set to agree a deal with the IMF which could stabilise its battered currency.

Egypt’s currency crisis has been an important theme since the revolution of 2011. The crisis has intensified in recent months, with the price of the US dollar in the black market deviating by as much as 30-40% from the official price. But news surfaced last week about a possible loan package from the International Monetary Fund (IMF) and other lenders totalling $21 billion over three years, increasing hopes that this could stop the freefall of the Egyptian pound. The latest developments raise two questions: Will Egypt conclude an agreement with the IMF before the end of the year? And will the agreement prevent the official price of the US dollar from sharply increasing again this year, say to above 10 pounds, by the end of 2016?

Will Egypt conclude a deal with the IMF before the end of this year?

Despite some scepticism, a deal is likely to be agreed. The scepticism stems from previous false dawns (in June 2011 and November 2012), in which Egypt seemed to be on the verge of an agreement with the IMF only to pull out in the last minute.

But the potential for reaching an agreement this time is more credible for three reasons. First, there has been official statements from the minister of finance, the prime minister and even the president admitting negotiations have been taking place for three months and suggesting a deal is likely to be in the offing. Second, Egypt is in a rather desperate position now given the large deviation between the official and market exchange rates, the low level of reserves and the reduced support from the Gulf. Third, there has been progress on the implementation of some of the policies required by the IMF, including the recent approval of the civil service law (which controls spending on public sector employees) and the value-added tax (VAT), which is expected to be approved by parliament in September.

All in all, the likelihood of a deal is high, probably around 80%.

Will the official price of the dollar increase above 10 pounds by end-2016 if an agreement is reached?

Historical experience suggests not. Egypt had three programmes with the IMF in the 1990s, and none of them resulted in a devaluation of the official rate by more than 3% four months after the start of the programme. This is quite far from the 14% devaluation required to push the official exchange rate (currently at 8.88) above 10.

Furthermore, for every argument favouring sharp devaluation, there is a counterargument against it:
  • Yes, the IMF would favour a flexible exchange rate regime, which is likely to result in a depreciation of the pound closer to the market value. But inflation is high (14%) and should rise with the likely implementation of the VAT. This may convince the negotiating parties to delay the depreciation until inflation has moderated.
  • Yes, the projected $7bn of loans per year fall short of Egypt’s financing needs, forecast at $8bn in 2016 ($12bn current account deficit minus $4bn foreign direct investment). But the gap is small and could be filled with support from the Gulf, higher foreign investments or other financial flows.
  • Yes, the Egyptian authorities may devalue the currency ahead of the deal as a sign of goodwill towards the IMF. Indeed, a large devaluation had preceded the programme of 1991-93. But any devaluation should be delayed until sufficient reserves have been built up to ensure its stability. Otherwise, the official price may end up chasing its tail.

Overall, the likelihood of a sharp devaluation of the official exchange rate is low; maybe as low as 25%.

Conclusion. Egypt is likely to agree on a loan deal with the IMF. The IMF team has started a visit to Cairo on 30 July and a staff-level agreement may be concluded at the end of the two-week trip. The agreement could get formal approval from the IMF Executive Board by September/October. It is unlikely to lead to a large devaluation in Egypt’s official exchange rate before the end of the year. 

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