Egypt floats its currency and agrees with the IMF to increase a bailout loan to $8 billion

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This is a locator map for Egypt with its capital, Cairo. (AP Photo)

CAIRO (AP) — Egypt on Wednesday floated its currency and announced a deal with the International Monetary Fund to increase its bailout loan from $3 billion to $8 billion, moving to shore up an economy hit by a staggering shortage of foreign currency and soaring inflation.

The flotation of the Egyptian pound, combined with a sharp raise of the main interest rate, is meant to combat inflationary waves and attract foreign investment. The measures, announced by the Central Bank of Egypt early Wednesday, were among the key demands of the IMF to increase its $3 billion bailout loan that both parties agreed to in 2022. The central bank, known as CBE, increased the key interest rate by 600 basis points to 27.75%.

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Following the announcement, the pound began floating and within hours lost more than 60% of its value against the dollar. By the end of the day, commercial banks were trading the U.S. currency at more than 50 pounds for $1, up from about 31 pounds.

The value of a floating currency is determined each day by traders in global markets, rather than by government policies. In that way, a floating currency imposes discipline: Investors tend to buy the currency of a nation with prudent economic policies, driving up its value.

Conversely, the market typically shuns the currencies of poorly managed economies, keeping their value low. It often punishes countries that run up huge deficits or that recklessly print money and stoke inflation. Black markets emerge when a government fixes the value of its currency above what the market thinks it's worth, which is what happened in Egypt.

The Egyptian economy has been hit hard by years of government austerity, the coronavirus pandemic, the fallout from Russia's full-scale invasion of Ukraine, and most recently, the Israel-Hamas war in Gaza. The Houthi attacks on shipping routes in the Red Sea have slashed Suez Canal revenues, which is a major source for foreign currency. The attacks forced traffic away from the canal and around the tip of Africa.

The war in Ukraine, which rattled the global economy, hit cash-strapped Egypt where it is financially vulnerable — the most populous Arab country is the world’s biggest importer of wheat and needs to buy a majority of its food from other countries to help feed its population of more than 104 million people.

The CBE said that its measures Wednesday would help end the black market in currencies and slow inflation, which reached unprecedented levels in recent months. The annual inflation rate was more than 31% in January, according to official figures.

“The CBE will continue to target inflation as its nominal anchor, allowing the exchange rate to be determined by market forces,” the central bank said.

The authorities also said the CBE has managed to “secure funds” for market needs — an indication they expected the exchange rate to stabilize.

“We have sufficient foreign currency to cover our obligations, particularly after the unification of the exchange rate,” central bank Gov. Hassan Abdalla told a news conference. He said the CBE will focus on slowing down two-digit inflation.

"We will not hesitate to take any measures to fight inflation," he said.

Analysts believe the source of the funds was a multibillion dollar deal last week with an Emirati consortium to jointly develop the Mediterranean city of Ras el-Hekma, 350 kilometers (about 220 miles) northwest of Cairo. Egypt will get $35 billion from that deal.

The rising cost of basic goods has deepened the hardships faced by middle-class and poor Egyptians. They have suffered from price hikes since the government embarked on an ambitious reform program in 2016 to overhaul the battered economy. Nearly 30% of Egyptians live in poverty, according to official figures.

The new devaluation and interest rate hike will inflict further pain on Egyptians already struggling with soaring prices, said Hamish Kinnear, senior analyst at risk intelligence company Verisk Maplecroft.

The central bank measures paved the way for an agreement with the IMF to increase a bailout loan to $8 billion, up from $3 billion after marathon negotiations. The agreement, announced late Wednesday afternoon, still needs the approval of the IMF executive board, which is expected to meet this month.

“The authorities are showing strong commitment to act promptly on all critical aspects of their economic reform program," said Ivanna Vladkova Hollar, IMF mission chief for Egypt, adding that the main reforms include a free-floating exchange rate and a slowdown in infrastructure spending to reduce inflation.

Egyptian Prime Minister Moustafa Madbouly said the new deal would enable the government to receive loans from other financial institutions, including the World Bank.

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AP Economics Writer Paul Wiseman in Washington contributed to this report.

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