• USD7-8bn liquidity shield could be ready for September - October float Egypt is still a few weeks away from a much-anticipated EGP adjustment: we believe authorities will be able to build USD7-8bn in reserves by late September or early October, providing a decent buffer to begin the float. We see the USD-EGP potentially settling closer to average parallel market trading in the past three months, which would be lower than current trading levels of EGP12.50/60. Our calculations are based on parallel market trends, as well as real effective exchange rate calculations – a 25% move would bring the REER back to its 15-year average.
• Egypt’s key competitive advantage lies in high interest rates We expect the current account (CA) deficit to remain at historical highs of 4-5% of GDP even after the initial EGP move, given limited room for further depression in imports and low elasticity of other key drivers of the CA. In this context, Egypt’s ability to attract capital inflows – particularly the revival of the carry trade – is the key factor in stabilising external balances. High interest rates – which are likely to be even higher post adjustment (we see the potential for further rate rise of 100bps in 2016, after 250bps YTD) – are likely to lure foreign investors, provided the EGP adjustment process is a successful one. 12m T-bills currently yield 16%.
• Revenue-side measure to lead 5.5% sought fiscal consolidation Fiscal revenues, at 18% of GDP, are running at historical lows – partially because of lower income from the national oil company – and are, therefore, likely to bear the biggest share of attaining the transition to a primarily surplus sought by the IMF programme. This would be likely led by the value-added tax (VAT), activating previously-approved tax reforms (property and mining taxes) and improved administration of the tax authority/legislation to enhance tax collection. Revenues are of particular importance, given the IMF programme’s focus on channelling part of any savings towards social programmes to ease the pain of the adjustment.
• Combined adjustment will weigh on domestic demand in short term Domestic demand is set to come under intense pressure over the coming 6-12 months as monetary and fiscal adjustments happen simultaneously. The adjustment is already underway, thanks to the dominance of the parallel market – inflation is running at a seven-year high of 14% - but there are still further pressures ahead, given recent EGP weakness, as well as prospective fiscal measures, led by VAT. We forecast domestic demand growth to decelerate to 3.3% in FY2016/17, representing the slowest pace in four years. Risks to growth are tilted to the downside, while risks to inflation – we expect an average of 14.3% in 2016/17 – are to the upside.

Mohamed Abu Basha