Our macroeconomic analysis of Egypt in the fourth quarter of 2013 pointed at deeply-rooted fundamental problems in its economy. Against the backdrop of a political and currency crisis, one of the central questions was to determine the sustainability of the currency’s peg to the US dollar.
The thorough country analysis we conducted showed that external imbalances were growing in Egypt, resulting in an unsustainable financial situation.
In the absence of external financial assistance, Egypt would not have been able to finance its imports or defend the Egyptian pound. Only generous aid from its regional peers helped Egypt to sustain the fixed FX rate.
Moreover, we further concluded that, even in the presence of a continuous financial aid inflow, the FX reserves would fall to a critical level in the second half of 2014 due to a twin deficit and the central bank’s expenses in supporting the currency. Unless fundamental issues causing the weak financial balance were solved, we considered a devaluation of the pound as imminent.
Most external observers were positive about the aid granted by Gulf states at the end of 2013, which many thought might have allowed the central bank to continue with its protection of the currency. These expectations were reflected by a more optimistic than practical consensus forecast for the exchange rate.
However, we maintained our cautious view based on the understanding that foreign aid is only a temporary solution, making an adjustment to the pound inevitable. Our stance was substantiated in early 2015 when the exchange rate was accordingly devalued.
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