Egypt currency is expected to appreciate gradually against the US dollar and to eliminate the overshooting by the first quarter (Q1) of 2018, HC Securities said in a research note.
“EGP/USD overshooting continues 8 months into EGP floatation despite some USD8.4bn of portfolio inflows: [w]e calculate the fair value of the EGP based on the mean reversion of the real effective exchange rate (REER) index, which suggests a c27% discount to the current spot EGP/USD rate of 18.12,” the report said.
“While the overshooting could have initially been explained by the short-term supply/demand dynamics, sizable portfolio inflows in recent months should have taken the EGP closer to its fair value. In our view, the Central Bank of Egypt (CBE) is favoring an undervalued, yet stable currency over a volatile exchange rate, as evident by an increase in non-reserve foreign currency deposits to USD5.86bn by the end of May,” it added.
The report also noted that resilient inflation can no longer be fully explained by cost-push factors, based on the percentage of imports to other GDP constituents, namely final consumption, gross capital formation, and exports.
“We estimate that only c12% of the c24% cumulative increase in the consumer price index (CPI) since October can be explained by currency movement. While total domestic credit growth has been largely flat since November,” the report explained.
The report noted that any efforts to contain prices at the current stage should be played through the exchange rate.
Meanwhile, the report said that expanding governmental foreign debt could have a similar impact on inflation, with the single largest borrower in the market showing almost no elasticity to interest rate movements.
Private businesses and household credit expansions have only been modest at c5% and c3% respectively, suggesting that any further interest rate hikes would significantly risk growth.
At the long term, the report considers that the government’s fiscal consolidation efforts as having a positive impact on inflation, which they expect to average 24.0% in FY 2017/18, as they see the budget-deficit-to-GDP dropping to 10% from 11.5% in FY 2016/17.
“Going into FY18/19e, we see inflation averaging 12.0% and the budget deficit further dropping to 8.3%.,” the report added.
“Persistently high inflation would keep private consumption growth depressed as well as erode the EGP’s competitiveness, negatively impacting the country’s external position. Our estimates point to an average EGP/USD rate of 15.72 in FY17/18e and 15.38 in FY18/19e.”