In Egypt, the pound has hit a record low, passing 56 to the dollar, down about 15% this year, even with foreign reserves at a record $57 billion. Exchange data show foreign investors sold well over $1 billion of Treasury bills in just two sessions this week, and today the central bank decides on rates. So is this the flexible system doing its job or a warning for investors? Joining me right now is Dr. Ayman Ghoneim, economic and legal expert. Doctor Ayman, welcome back to the show.
Thank you, sir.
In July you told us the March outflows showed Egypt’s system had matured. Then the pound moved from about 47 to 50 and reserves rose. Right now it is above 56. Is this the same test or a harder one?
Actually, it is the same test but with different conditions. In March, due to the geopolitical crisis in the Middle East, we had portfolio outflows of 5 to 8 billion USD, mainly foreign investors in treasury bills and bonds denominated in Egyptian pounds. The IMF documented that foreign holdings of EGP-denominated treasury bills and bonds declined from 39 billion USD to 22 billion USD at that time. But here we have to see what did not happen, and this is very important. Official reserves did not decline. They increased and reached a historic record high of 57 billion USD. The net foreign assets in the banking sector did not decline. They increased to a historic figure of around 31 billion USD. The credit rating of the country did not decline. It improved. Moody’s improved the credit rating from Caa1 to B3. All these data show that the flexible exchange rate system was able to absorb part of the shock. Of course it was a shock and it happened abruptly. The pound fell from 47 to more than 50 per US dollar, and it happened quickly. But all these figures show that we were able to pass that test.
I think you have said that a few times already. This is a natural result of a flexible market. But the pound has lost about 15% this year. At what point does flexibility stop absorbing the shock and become the shock itself?
There is no scientific answer to at which level flexibility becomes instability. What we should look at is whether the depreciation has become a self-fulfilling prophecy. Whether households are buying US dollars in anticipation of an increase in the value of the dollar versus the pound. Whether other speculators are doing the same. Whether importers are front-running and buying dollars early. And also very important, we have to see whether there is foreign currency availability in the market or not. With all these factors, we cannot say that we have an unstable exchange rate system. We have a flexible exchange rate system that has gone through a shock, and whose reaction to that shock was much better than the previous shocks, whether of 2011 or 2022.
At the moment one-year Treasury bills pay nearly 26% and analysts say that is still an attractive real return. Yet foreign investors keep selling. What do you think they are seeing that the yield does not show?
I have heard this question from many commentators. Being a market risk specialist, I will tell you that we have to differentiate between the yield to maturity and the return on investment. They are two different concepts, although they are interrelated. You have the yield to maturity, which is 26%. Then you apply the tax rate, which is 15% for foreigners, to get an after-tax yield of around 22%. From this 22% you have to deduct the local currency depreciation, which is around 10 to 15%. Then you have the return that has to cover the risk premium, or that you can use to hedge by buying a hedging instrument. With this calculation the return is still attractive, because you still have around 4 to 5% after tax and risk adjusted. But we have to remember that many foreign investors price the so-called tail risk, meaning low probability and high severity risk. Presently in the Middle East we have that problem, a geopolitical problem, and sometimes foreign investors look at the worst side. With sentiment going that way, a 4 to 5% risk-adjusted return after tax may not be that good or very attractive.
Today the central bank decides on rates. Most analysts expect a hold at 19%, but some say a hike is back on the table. Would a hike actually defend the pound or just raise borrowing costs for everyone else?
I would not encourage using monetary policy, especially the interest rate, to defend the currency. Interest rates should be used to anchor inflation. Our headline inflation improved from 14.5% in August to 13.9% in September. The central bank deposit rate is 19% and the lending rate is 20%, so the main operation rate is 19.5%. We have a positive real interest rate. The nominal interest rate is much higher than the inflation rate, so we can consider that our interest rates are still restrictive. Yes, of course, interest rates if used can support the Egyptian pound. But if the central bank increased the interest rate by 100 or 200 basis points, I do not think the portfolio investors who exited the market would be attracted by 100 or 150 basis points to come back, especially with the high risk in the short run. This high risk has not materialised. We are talking here about low probability and high severity risk.
It is very valuable getting your insights on what is happening at the moment with the Egyptian pound. As usual, we look forward to having you on Fintech TV once again. Thank you.
