Over the last couple of years, Egypt’s economic landscape has faced significant turbulence. At the heart of this storm is the Central Bank of Egypt (CBE), grappling with a depreciating currency and rampant inflation. The freefall of the pound has become the talk of the town, from the wealthy safeguarding their savings to the less fortunate trying to make ends meet.

The tide began to turn with the unexpected mega deal of Ras El-Hekma and the new International Monetary Fund (IMF) deal. Both deals shored up the depleted CBE reserves. This stability paved the way for a controlled devaluation of the pound, with enough reserves to avoid shooting up of the exchange rate, where the US dollar exchange rate went down from around 65 pounds in the parallel market to less than 50 pounds post devaluation, achieving a single, unified exchange rate across the market.

CBE’s success in unifying the exchange rate has helped curb the dollarization wave, encouraging a return to the pound, especially with the high interest rates on bank deposits. Additionally, remittances from Egyptians abroad began to recover as the appeal of exchanging US dollars in the parallel market diminished.

The combination of the high interest rate, a unified exchange rate and increasing CBE reserves attracted large inflows of hot money, substantial short-term foreign investments, notably in government treasury bills. Such large inflows, which reached close to $35 BN, shifted the banking system’s net foreign assets balance from negative to positive, for the first time in 2 years.

While these developments are promising and offer a positive short-term economic outlook, the real turning point was the influx of foreign currency from recent mega deals. CBE has effectively utilized these resources to address longstanding issues, but the focus now shifts to tackling inflation and managing the influx of hot money.

Traditionally, CBE has relied on higher interest rates to curb inflation, a strategy effective primarily against demand-driven inflation. However, the current inflation is supply-driven, resulting from supply shocks and exchange rate increases, where the impact of interest rate hikes is limited.

The positive development this time is the realization of CBE that supply driven inflation shouldn’t be tackled by interest rate hikes only and the focus of CBE on directly absorbing liquidity from the banking system in the last few months. Recognizing this, CBE has recently focused on directly absorbing liquidity from the banking system, resulting in a slowdown in money supply growth.

Liquidity absorption, a crucial tool for addressing supply-driven inflation, has led to a decline in inflation rate for the fourth month in a row. Although inflation rate remains high and is expected to persist due rising energy prices and other upcoming reforms, CBE’s diversified approach offers hope for more effective management.

Despite maintaining high interest rates, which strain the government budget and private sector, there is optimism that as global interest rates decline and local inflation stabilizes, CBE may begin to lower rates by year-end.

The elephant in the room is hot money. With $35 BN invested in local government debt in the recent few months, CBE’s strategy appears to involve leaving the interbank market to manage entry and exit of hot money with no guarantees. Still, CBE would be wise to pre-emptively mitigate the impact of hot money on the exchange rate to avoid previous challenges. 

In conclusion, CBE has navigated substantial challenges over the last couple of years, managing currency pressures and rampant inflation. The latest mega deals have given the economy a lifeline, enabling CBE to stabilize the Egyptian economy in the short-term. The key positive development is CBE’s diversified approach to curb supply driven inflation. However, effectively managing the influx of hot money remains a critical task to ensure long-term stability.

Omar El-Shenety,

Managing partner at Zilla Capital and adjunct faculty at AUC School of Business