The Central Bank of Egypt (CBE) liberalized the exchange rate on Thursday, giving banks operating in Egypt the right to flexibly set their rates, a move that has been long anticipated by observers and economists.
The exchange rate rocketed on the black market in the last few days, hitting LE18 to the dollar for the first time, before dropping slightly on Wednesday.
The CBE announced a number of measures in light of the devaluation, in a statement on Thursday. We explain what these decisions will mean.
What is the interbank?
The CBE permitted banks the freedom to set exchange rates through the interbank — an internal network that banks use daily to determine the exchange rate, explains Ramy Oraby, an economist at Pharous Holding Company.
Each bank will review the situation regarding the liquidity available, and will establish the exchange rate based on their evaluations, Oraby says. Banks will share their rates between each other daily through this network, excluding the highest and lowest rates, and then will communicate their final decisions with media outlets. This system was utilized in Egypt previously, but hasn’t been active recently, Oraby adds.
How will the price of the pound be determined?
Setting the exchange rate is subject to a number of different mechanisms. In the case of free floating, the price of the local currency is set according to supply and demand. However, there is a margin for governmental intervention in the selling and buying of foreign currency through the CBE, in order to control the unstable exchange rate in the short term, as the level of intervention differs from one country to another.
At what point will the exchange rate be stabilized?
It is difficult to predict the amount at which the exchange rate will stabilize, Oraby says, explaining that it will depend on a number of factors, including the way in which the CBE handles the devaluation and the amount of foreign currency.
As for the price-setting mechanism of the CBE, which is LE13 to the dollar, Oraby says banks and financial institutions are following the Non-Deliverable Forwards for the pound, and indications of the market value of the dollar. The average of these NDFs stabilized on Wednesday at LE12.95 to the dollar, which is why the CBE set the rate at LE13 on Thursday.
It is expected that the exchange rate will increase in the short term, after the devaluation, before it decreases again, Oraby says.
Why are interest rates being raised?
The CBE decided to raise the interest rate overnight by 3 percent, to reach 14.75 percent for deposits and 15.75 for lending. Generally, the CBE sets the interest rate for the pound, directing the market and banks to follow suit in setting their own interest rates.
Why will banks operate until 9 pm and during weekends?
This is a move that is intended to absorb liquidity from the black market, Oraby says, adding that he doesn’t imagine all banks will be able to facilitate this directive, depending on their size and the number of branches.
What’s the status of withdrawal limits?
The CBE announced limits on withdrawals and deposits would continue for companies importing unnecessary goods and services, putting the monthly deposit limit at US$50,000, and $30,000 for daily withdrawals.
The limits are intended to keep foreign reserves within the official banking sector. The CBE, according to Oraby, is working on attracting clients away from the black market and encouraging them to exchange their dollars with the banks. He explained the optimal moment to do this was after the exchange rate dropped on the black market on Wednesday.
Why was the devaluation step taken?
The CBE’s statement explained that the decision to float the pound is part of a “larger program for financial and structural reform announced by the Egyptian government, which is going to be implemented firmly to decrease budget deficit and public debt.” The Egyptian government is working on securing a US$12 billion loan from the IMF to ease escalating economic pressure.
Christine Lagarde, executive director of the IMF, said in earlier press remarks that Egypt needs to take some steps before the loan comes into effect, including the floating of the pound. Another move to reduce energy subsidies is expected to follow.
In a previous interview with Mada Masr, Oraby said the decision to devalue the pound would lead to a severe increase in inflation short term, adding that, “inflation might continue to escalate for months before citizens are able to adjust their spending habits.”