The 25th of January 2011 marked the outbreak of the Egyptian revolution. It marked a day were Egyptians aspired to improve the social, economic and political landscape of the region. But the problem with a revolution is that from a purely economic standpoint a revolution means chaos. And investors hate chaos. Political instability took a toll on confidence, economic activity, investment, and tourism. Five years later, the Central Bank of Egypt has exhausted all of its weapons to support the Egyptian pound (EGP) and is forced to negotiate an IMF-supported economic reform program that requires the floatation of the EGP.
ECONOMIC TURMOIL OF 2011 – 2016
Several years prior to the revolution, Egypt had suffered from structural challenges including non-inclusive economic growth -economic growth that is not distributed fairly across society- and high unemployment. Since 2011 these problems have been compounded by lower GDP growth, larger fiscal deficits and lower foreign reserves. Egypt ranked 112 out of 189 in the World Bank 2015 Doing Business survey. In addition, Egypt had poor infrastructure, low human capital, inefficient labor markets and poor global competitiveness as a result of an over-valued exchange rate.
Foreign investments in government bonds dropped significantly, and led to higher government borrowing from Egyptian banks. This lead to a very negative phenomenon called crowding out the private sector. (Read here about the role of the government in market economy) Crowding out the private sector means that the credit to the government increased at the expense of the credit to the private sector. As expected, this limited the growth of the private sector and hence of the entire economy.
The position of the banking system in Egypt in 2010 was healthy as local banks granted the private sector more loans than the government. However, this changed dramatically by the beginning of 2016 where the government lending was almost 5x as much as the private sector. Fortunately, this trend has reversed after 2016 and Egypt’s Banking Sector is much healthier today.
At the same time the dealers in the parallel market were gaining ground. Around that time, the EGP reached almost 11EGP per USD which meant a premium of over 22% as investors realized that the CBE will not receive significant support from the GCC countries in the future.
Main Objectives of The CBE
According to the official website of the CBE, its main objectives are:
- Realizing price stability and ensuring the soundness of the banking system.
- Formulating and implementing the monetary, credit & banking policies.
- Issuing banknotes and determining their denominations and specifications.
- Supervising the banking sector.
- Managing the foreign currency international reserves of the country.
- Regulating the functioning of the foreign exchange market.
- Supervising the national payments’ system.
- Recording and following up on Egypt’s external debt (public and private)
As a central bank, its mandate is to ensure price stability over the medium term which means that the CBE had to use its tools to increase the value of the EGP and eliminate the black market in Egypt. So, how did the CBE support the EGP?
Phase I: INJECTING FOREIGN RESERVES
The Organisation for Economic Co-operation and Development (OECD) defines official reserves are:
“Reserve assets consist of those external assets that are readily available to, and controlled by, monetary authorities for direct financing of payments imbalances, for indirectly regulating the magnitude of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes”.
This limited definition of official reserves does not take into account the broader concept of foreign currency exposure. It is limited to the liquid foreign assets available excluding the obligations which may occur due to the accumulation of these assets.
The CBE injected foreign reserves in the market to meet the growing demand and declining resources. This phase, which lasted until early 2012, lead to the decline in reserves of more than $20 billion. It is worth noting that the change of foreign reserves and net foreign assets of the CBE has been similar and the net foreign assets of the banks are not affected (this will change in Phase II and Phase III).
Phase II: Accepting Deposits from the GCC Countries
In 2012, the CBE resorted to accepting deposits from the GCC countries. These deposits can be included in foreign reserves, and therefore increase them, but at the same time is considered a foreign liability on the CBE. This phase, which lasted more than three years, began by deposits from Qatar and Turkey, and then turned to deposits from Saudi Arabia, UAE and Kuwait. It led to the decline in net foreign assets of the CBE while stabilizing the level of foreign reserves. The net foreign assets of the banks were not affected.
Phase III: USING net foreign assets of the CBE and the banks
The CBE is allocating foreign exchange to banks and then borrow them in the form of deposits that banks can not withdraw to keep the foreign reserves stable. Thus, the banks are providing foreign exchange to their customers after the allocation by drawing on their foreign assets or increasing their foreign liabilities. These measures lead to a sharp deterioration of the position of the net foreign assets of both the CBE and the banks, and switched it to an increasing negative balance for the first time since the early nineties.
This situation threatened Egyptian banks, in particular, where it will pay off mounting obligations in foreign currency in the medium term, while the majority of its revenues realized in EGP.
On November 11, 2016, the Executive Board of the International Monetary Fund (IMF) approved a three-year extended arrangement under the Extended Fund Facility (EFF) for Egypt for an amount equivalent to SDR 8.597 billion (about US$12 billion, or 422 percent of quota) to support the authorities’ economic reform program. Markets reacted positively and the EGX 30 increased significantly after the announcement.