• Green shoots of recovery from float emerging Anecdotal evidence suggests that bank proceeds from FX sales from clients are growing by the day, albeit coming from a very low base. CBE Governor stated FX sales proceeds stood at USD1.3bn in the first week of the float. Banks have been able to meet some of their clients’ immediate/delayed needs, as well as open new letters of credit. Portfolio equity inflows were also strong and evidence implies carry trade inflows of hundreds of USDmn. In our meeting with CBE, it stated that reserves would not be used to clear backlogs, and that the market would have to clear itself automatically.
• EGP14-15 a likely trading range; CBE’s reserves to be boosted We expect volatility to dominate the FX market in the next few weeks as the new regime settles in and a stressed FX situation eases. The EGP is, therefore, likely to remain elevated before eventually settling towards the EGP14-mark by year-end 2017, in our view, which we see as a fair value for the currency when looking at real effective exchange rate (taking into consideration this year’s inflation spike) as well as parallel market trends. Such appreciation is set to be supported by an increase in foreign reserves potentially to USD28bn (c6.0 months of merchandise import cover) by year-end as a result of expected flows of cUSD8bn (see Fig.2).
• Inflation – the key risk to the reform process We update our average inflation forecasts for FY2016/17 to 18.5% (from 14.3%) and keep our FY17/18 forecast at 12.0%, following the float and hike in fuel prices. Wage growth, social safety net and recovery in economic activity are three important cushions for the population to absorb the inflationary shock, in our view. A tight monetary policy is also key to control money supply to allow for an easing in interest rates later in 2017. We expect the easing cycle of policy rates to start in 2H17 factoring in 100bps reduction in rates, more towards year-end.
• Investment-led recovery in 2018, after adjusting to reality in 2017 While growth is set to come under pressure in 2017 as the macro adjustment sinks in, we expect early signs of a recovery in 2H17, as FX shortages ease and have, therefore, upgraded our GDP growth forecast for FY16/17 to 4.8% from our earlier 4.3%. Growth is likely to be led by a bounce in investment as the capex cycle picks up on improved FX liquidity. We expect real investment growth to double from 5.5% to 11.0% as consumption remains under pressures.

Mohamed Abu Basha