Egypt Floats Currency, And It Sinks. Then Rises.

Short-term pain may yield long-term gains, however.

The Central Bank of Egypt floated the pound last month, and the currency quickly lost nearly half of its value before rebounding on news of a $12 billion loan agreement with the International Monetary Fund.

“The liberalization of the exchange rate regime and the devaluation of the Egyptian pound were critical steps toward restoring confidence in the economy and eliminating foreign exchange shortages,” said IMF managing director Christine Lagarde.

The IMF’s seal of approval to Egypt’s structural reform program could unlock a significant influx of foreign investment. “By floating the pound, the central bank will eventually be able to fully dismantle foreign exchange restrictions, reducing disruptions to activity,” says Jason Tuvey, Middle East economist at Capital Economics. “A weaker currency also boosts external competitiveness and could encourage foreign investors back to the country.”

The return of FDI, Tuvey says, would help place Egypt’s deteriorating currency account on a more sustainable footing and—if backed up by further reforms—should ultimately support stronger economic growth.

There will be near-term pain, however, in the form of rising inflation, which is expected to peak near 20% in the middle of next year. This will erode real incomes and weigh on consumer spending, economists warn. To limit the inflationary impact of the devaluation, the central bank simultaneously raised interest rates by 300 basis points.