Could Egypt depend less on 'hot money' as source to bolster its FX reserves in the short term?

Doaa A.Moneim , Friday 3 Feb 2023

Could Egypt lower its dependency in the short term on "hot money" as a source of securing liquidity in foreign exchange amid the government's plan to focus on attracting more direct investments in a longer term strategy for strengthening the economy? Ahram Online asked various analysts.

 US dollar
Two pairs of US hundred dollar and Egyptian hundred pound notes are held before a window showing the skyline of Egypt s capital Cairo and the Nile river on January 16, 2023. AFP

Egypt's prime minister and finance minister asserted on more than one occasion during 2022 the government's intention to focus on attracting more direct investments to avoid shocks caused by any sudden hot money exodus.

Since March 2022, amid the global inflationary pressures triggered by the Russia-Ukraine war, a total of $25 billion of indirect investments in the local debt instruments (hot money) exited the Egyptian market toward higher return on the US dollar after the US Federal Reserve raised interest rates to control inflation at home.

Moreover, Egypt's Net International Reserves (NIRs) have fallen considerably from $40.9 billion in February 2022 – recorded just one month before the onset of the war in Ukraine – but stabilised at $34 billion in December 2022.

Speaking to Ahram Online, banking expert Ahmed Shawky stressed that Egypt cannot do without local debt instrument investments as a supplementary source of foreign exchange and investment along with direct investments.

“The exit of the $25 billion in hot money in 2022 sent shocks in the local market pushing the government to announce that it will aim to lower dependence on this kind of investment as a key source of foreign exchange and liquidity for the Egyptian economy," Shawky said.

"This kind of investment is supposed to be supplementary as a source of foreign exchange - it supplements other actions taken by the government such as the issuing of 'golden licenses' for foreign investors, releasing stranded imports in ports, and depreciating the Egyptian pound against the US dollar," Shawky said.

"We can also add to these actions the efforts made to list the Egyptian pound to be among the currency baskets of other central banks just as the Russian central bank did when it listed the Egyptian pound in its currencies basket," Shawky explained.

These T-bills are offered at higher interest rates than the rates applied before after key interest rates have already been hiked, he added.

 "Monetary policy," he stressed, "is a tool that gives quick results over a short term."

The calm after the storm

The Central Bank of Egypt (CBE) announced in mid-January increases in the country's reserves of hard currency as a result of securing $925 million in indirect investments in local debt instruments in less than five days.

Since 11 January, the Egyptian pound continued a three-month-old process of steep depreciation, trading at over EGP 30 to the US dollar at the end of this week, down from EGP 19 in October of last year amid the adoption of a flexible exchange rate regime as part of the new  IMF deal.

The pound depreciation has led to greater interest in indirect investment in local debt instruments.

Outstanding local T-bills and bonds has increased to EGP 4.3 trillion in December 2022, according to recent report by the Ministry of Finance.

The value of the outstanding T-bills posted EGP 1.7 trillion: EGP 755.3 billion in 364-day type; EGP 137.3 billion in 273-day type; EGP 377.8 billion in 182-day type; and EGP 456.6 billion in 91-day type, according to the report.

The maturity for these T-bills extends from 3 January 2023 to 26 December 2023, the report showed.

Moreover, the report indicated that the outstanding balances of treasury bonds registered close to EGP 2.6 trillion by end of September, with maturities extending from 1 January 2023 to 18 January 2037.

The 25-percent-annual-interest CDs, which were issued in early January by state-owned banks to lower money supply in the market in order to rein in inflation, pulled in over EGP 460 billion in 20 days.

Chairman of the Federation of Egyptian Banks Mohamed El-Etreby said that an enormous number of clients have already exchanged the US dollars in their possession to buy these CDs because of its unprecedented yield rates.

On Thursday, the CBE) announced that the country's Balance of Payments (BOP) witnessed an improvement in the first quarter of FY2022/2023 (July-September) with the current account deficit narrowing by 20.2 percent to post $3.2 billion compared to $4 billion in the same period of the preceding fiscal year.

CDs and T-bills

Heba Mounir, a financial analyst and economist at HC Securities and Investment, told Ahram Online that “we expect the EGP 1-Year T-bills to average around 20.6 percent in 2023 (accounting for a 15 percent tax rate for US and European investors), after factoring in a 200 bps rise in the corridor that we expect to materialise over the rest of the year."

"This takes into consideration fluctuations in Egypt’s 1-year certificates of deposits (CDs), which currently records 504.7, down from its peak at 1,774 on 27 July 2022, yet still high compared to its record low of 181 on 17 September 2021," Mounir explained.

"The EGP depreciated by 17 percent against the US dollar in December, registering EGP 29.9 to the USD, due to the accumulated pressures on Egypt's Balance of Payment (BoP) and high foreign debt obligations," she noted.

"This came despite a number of improvements such as the slight improvement in Egypt’s Net International Reserves (NIRs) that edged up by 1.4 percent on a monthly basis for the first time since December 2020, compared to a 16.9 percent decline to $34 billion in December 2022 Y-oY," Mounir said.

 “The latest 12M T-bills auction yield of 18.57 percent (accounting for a 15 percent tax rate for US and European investors) offers a real yield of positive 0.57 percent given our expectation for inflation to drop to 18.0 percent in January 2024 thus solidifying our view of a needed increase in policy rates until the end of the year," she added.

Moving forward: Direct investments & private sector 

Economic expert Medhat Nafea told Ahram Online that working on increasing exports at the expense of imports as well as supporting local investors are crucial for the country to enhance its investment scene and restore its foreign exchange liquidity.

Nafea added that Egypt’s new policy of replenishing its foreign exchange liquidity centres more on attracting direct investments rather than indirect ones, pointing out that indirect investments entail considerable risk to the economy as it is easy to exit the market at any time.

In December 2022, the government adopted the State Ownership Policy which ushers in a new era of relying on the private sector as a key engine of the country’s growth with the aim of raising the private sector's share in the economy to 65 percent, up from the current 30 percent, over the forthcoming three years.

Monetary policy in the short term

To rein in soaring inflation, which had climbed over 21 percent from 8.8 percent posted in February 2022, the CBE's Monetary Policy Committee (MPC) raised the interest rate by a total of eight percent (800 bps) in 2022, 

However, in its first meeting in 2023 on Thursday, the MPC kept its rates unchanged (16.25 percent for the overnight deposit rate, 17.25 percent for the lending rate, and 16.75 for the main operation) despite modest hikes in interest rates by the US Federal Reserve and the Central Bank of England in the last two days.

Some analysts suggest that this CBE decision might reflect a desire to allow the market to absorb the impact of recent hikes fully and also to relieve some of the depreciationary pressures on the pound.

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