Appreciation To Prove Temporary

BMI View: We expect the appreciation of the Egyptian pound following the foreign exchange auction to prove temporary and anticipate deprecation to resume in the coming months. Whilst current levels may be sustained for the time being, owing to greater foreign reserves , our expectation for inflation to remain elevated and for inflows to stay subdued will see the EGP7 . 0000 /US$ barrier broken in the coming weeks, before reaching EGP7.3 000/US$ by the end of 2013 .

The recent appreciation of the Egyptian pound against the US dollar will prove temporary and does not signal a reversal in the currency's fortunes. On September 4 the government launched an exceptional sale of US$1.3bn to finance strategic imports such as wheat, oil and essential industrial equipment with a cut- off price of EGP6. 8 9 52 /US$ . The currency has since strengthened to EGP6.90 5 5 /US$ on September 9 from EGP6. 9984 /US$ before the auction. We expect to see the EGP7.0000/US$ barrier broken in the coming weeks, before reaching EGP7.3000/US$ by the end of 2013.

The government is clearly optimistic about the prospects for the economy, and expect the new level to prove sustainable. This follows the decision by Egypt's Monetary Policy Committee to unexpectedly lower interest rates by 50 basis points in August to 10.25%, the first drop since 2009. However, we would caution against becoming optimistic at this stage, as in our view, the latest government move simply highlights the extent to which economic stability is now dependent on foreign aid inflows.

Temporary Drop
Egypt - Exchange Rate, EGP/US$

BMI View: We expect the appreciation of the Egyptian pound following the foreign exchange auction to prove temporary and anticipate deprecation to resume in the coming months. Whilst current levels may be sustained for the time being, owing to greater foreign reserves , our expectation for inflation to remain elevated and for inflows to stay subdued will see the EGP7 . 0000 /US$ barrier broken in the coming weeks, before reaching EGP7.3 000/US$ by the end of 2013 .

The recent appreciation of the Egyptian pound against the US dollar will prove temporary and does not signal a reversal in the currency's fortunes. On September 4 the government launched an exceptional sale of US$1.3bn to finance strategic imports such as wheat, oil and essential industrial equipment with a cut- off price of EGP6. 8 9 52 /US$ . The currency has since strengthened to EGP6.90 5 5 /US$ on September 9 from EGP6. 9984 /US$ before the auction. We expect to see the EGP7.0000/US$ barrier broken in the coming weeks, before reaching EGP7.3000/US$ by the end of 2013.

The government is clearly optimistic about the prospects for the economy, and expect the new level to prove sustainable. This follows the decision by Egypt's Monetary Policy Committee to unexpectedly lower interest rates by 50 basis points in August to 10.25%, the first drop since 2009. However, we would caution against becoming optimistic at this stage, as in our view, the latest government move simply highlights the extent to which economic stability is now dependent on foreign aid inflows.

Temporary Drop
Egypt - Exchange Rate, EGP/US$

Egypt's ability to prop up its currency has been substantially boosted by aid flows from the Gulf. Net foreign reserves reached US$18.1bn in August and are set to head above US$23.0bn as the remainder of the US$12.0bn pledged by the Gulf States is deposited in the Central Bank of Egypt. Whilst we now rule out a balance of payments crisis occurring in 2013, there has yet to be a fundamental improvement in the current account of FDI dynamics which would cause us to change our bearish stance on the currency.

Propping Up The Currency
Egypt - Net Foreign Reserves & % chg (RHS)

Long-term Outlook Is Bleak

Whilst the government is anticipating a significant uptick in investment into Egypt and demand for pounds, we are considerably less sanguine. Export growth will remain slow in the short term, given our view that the eurozone (where around 30.0% of Egypt's exports are directed) will contract 0.5% in real terms in 2013, before posting growth of 0.9% in 2014. The key issue that would need to be resolved before we see an improvement in the country's trade deficit (which came in at 13.7% in FY2013) is subsidies. Food and fuel account for almost half of Egypt's imports by value, with demand for both artificially elevated due to subsidies. We do not expect subsidies to be reduced until after a new government is elected (which we expect to occur in Q214). If, or when, reforms to the subsidy system are undertaken, we will likely see a reduction in import demand, thus placing less strain on foreign reserves.

Looking Weak
Egypt - FDI Flows (US$mn)

Other key source s of foreign exchange earnings, w hich would support the currency over the long term are FDI, tourism and revenues from the Suez Canal. Given our expectation for the fractured political situation to continue, income from these sources are set to stay muted. While Net FDI inflows came in at US$1.0bn in Q113 , the highest level for three quarters, this was primarily due to a one-off decline in FDI out flows from US$2.2bn to US$1.1bn. Indeed FDI inflows declined by US$300mn.

Furthermore, the recent slow but steady recovery in the tourism sector is set to grind to halt, and tourist arrivals will remain far below levels enjoyed before the overthrow of former President Hosni Mubarak in 2011 for some time due to a deteriorating security situation in the major cities . In addition, greater revenues from the Suez Canal look unlikely. O ur Shipping team expect a slowdown in shipments on the Asia to Europe route and thus we could see declines in revenues in future , after several recent quarters of stagnation. This is practically likely given reports of attacks by militants in the Suez Canal over the past week . As well as reduced inflows into the country, we expect inflation to add to pressure for further depreciation in the currency. Headline CPI is currently at 9.8% and we expect it to remain near double digit levels given our expectation for continued elevation in food and fuel prices.

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Sector: Country Risk
Geography: Egypt
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