SECTION TWO WAR'S LEVERAGE ON EGYPT 1: THE MACROECONOMIC FOOTPRINT

The Russia-Ukraine war hit the Egyptian economy, creating a remarkable inflationary wave, which resulted in an increase in the prices of fuel, food, and other strategic commodities. Also, the war triggered capital outflows and reduced the central bank of Egypt’s (CBE) foreign reserves and banks’ net foreign assets and caused several other economic imbalances. However, the applied economic reforms in Egypt offset this huge impact. In response to these adverse global developments, Egypt also undertook exchange rate, monetary and fiscal measures. This is in addition to adopting new IMF-backed economic reform that contributes to supporting Egypt's financial discipline.

A. Economic Growth

Economic growth seemed to recover from the reduction resulting from the COVID-19 pandemic at the end of FY 2020/21 until it achieved growth of 7.7% in Q4 2020/21. Then, it continued to increase in Q1 2021/22, yet the economic activities witnessed a declining trend over Q2, Q3, and Q4 for the same year. These activities have been impacted by multiple global shocks, notably the rising cost of domestic and imported inputs, global price dynamics, and exchange rate depreciation, as well as, domestic supply bottlenecks, according to the World Bank. The economic growth increased to reach 4.4% during Q1 2022/23 as continuing to pursue reforms and promoting the participation of the private sector in higher value-added and export activities for jobcreation and better living standards explained by the World Bank. However, the growth slightly declined in Q2 2022/23 to reach 3.9%.

B. Inflation Rate Vs. Interest Rates

Egypt's annual headline inflation rate skyrocketed in April 2023 to 33.9%. These inflationary pressures were triggered by the coronavirus pandemic and Russia's war in Ukraine. At the local level, there is a combined effect of several factors that impacts inflation, including the disruptions in the domestic supply chain, the depreciation of the Egyptian pound, demand side pressures raised because of the excess of real economic activity development compared to the maximum production capacity, and high broad money growth outturns, according to the CBE.

As part of the Egyptian government’s measures to deal with the repercussions of the war, the CBE has proactively raised key interest rates by 1000 basis points (bps) over 2022 and until March 2023. The Monetary Policy Committee (MPC) clarified that the main target of the CBE’s proactive policy is to counter inflationary pressures on the demand side.

The MPC clarified in its last meeting on March 30 that the CBE’s upcoming inflation targets 7% (±2%) on average by Q4 2024 and 5% (±2%) on average by Q4 2026, according to the CBE.

C. US Dollar Exchange Rate

Since Russia's invasion of Ukraine, the Egyptian pound slumped to a very low level against the US dollar, a sign that the Egyptian authorities are pressing ahead with a shift to a more flexible currency regime. The US dollar value against the Egypt pound (EGP) appreciated from EGP 15.76 in February 2022 to EGP 30.94 in April 2023, gaining around 96% over this period.

The CBE has sharply devalued the Egyptian pound three times since the war, exposing vulnerabilities in Egypt's finances. The first correction was on March 21, 2022, the CBE stressed the importance of the exchange rate flexibility to act as a shock absorber to preserve Egypt’s competitiveness, pushing the exchange rate of the pound against the dollar to reach EGP 18.27 for sale instead of EGP 15.76. The second one was decided in CBE's meeting on October 27, 2022, through moving to a durably flexible exchange rate regime, leaving the forces of supply and demand to determine the value of the EGP against other foreign currencies, making the US dollar exchange rate to jump to EGP 22.96 for sale instead of EGP 19.75. Egypt’s third and latest correction so far, caused the pound value to depreciate to about EGP 32 per dollar on January 11, 2023, according to the CBE.

It is also worth noting that the CBE decisions to raise interest rates also pushed the price of the US dollar in the local market to its highest levels since starting to implement the IMF economic reform program in 2016.

E. Balance of Payments (BoP) Deficit

Egypt’s balance of payments (BoP) registered a current account deficit of $5.8 billion in Q3 of FY 2021/22, before it witnessed an improvement in Q4 of FY 2021/22, as the current account deficit fell by around 49% quarter-on-quarter (QoQ). This drop was due to a significant decline in petroleum imports by about 50% and non-petroleum imports by nearly 19%, according to the CBE. The reason behind this decline in imports may be the critical shortage of foreign currency since Russia invaded Ukraine, which happened because of the exit of dollars from the Egyptian markets and the drop in Russian and Ukrainian tourists coming into Egypt, according to the CBE.

In H1 of FY 2022/23, the current account deficit again dropped by about 77% to record $1.8 billion compared to $7.8 billion in H1 of FY 2021/22. This remarkable correction in the current account was primarily driven by the improvement in non-petroleum trade balance by around $6.5 billion, and the surplus in petroleum trade balance of $1.8 billion. This is in addition to the recovery in tourism revenues, and transportation receipts by 25.7%, and 45.1% respectively, according to the CBE.