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How can futures eliminate parallel market of foreign currency in Egypt?

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The economies of the whole world are suffering from the repercussions of the Russian-Ukrainian war which led to the rise in inflation indicators around the world, which in turn affected the emerging economies.

This prompted Egypt to take strategic measures to preserve its economy, especially the Egyptian pound’s price, as it witnessed a 26% decline against the US dollar during the last nine months, reaching EGP 19.66 compared to EGP 15.60 in March 2022.

The Central Bank of Egypt decided on 21 March to devalue the local currency against the dollar by about 15% at that time through a managed float regime (a method of currency devaluation in which the Central Bank intervenes to reduce the currency value only by a certain percentage, not a complete float).

With all these changes, Egypt witnessed a crisis in the dollar liquidity, which prompted a proactive action to stop documentary credits for recreational goods (a document issued by the bank that guarantees the provision of dollars for companies to carry out import operations from abroad) in order to preserve the available foreign exchange liquidity.

As the crisis worsens globally and locally, the Central Bank of Egypt is working to launch the index of futures contracts for the local currency.

A futures contract is a legal agreement to buy or sell a particular commodity asset, security, or currency at a predetermined price at a specified time in the future.

It helps in hedging any drop in the currency price, as well as obligating the selling party to provide the required currency on the date of fulfillment of the contract, and obligating the buying party to provide the consideration as well.

For example, any company engaged in an agreement with a bank to buy foreign exchange at a price of about EGP 23 on a contract that has a one-year term, and it is currently trading at EGP 19.60.

The goal here is to provide the currency in time, and that this company believes that the price of the dollar can rise during the year, so it hedges against the decline of the pound, as well as ensuring the provision of cash that it needs “ liquidity insurance”, which enables it to build future plans for its company.

On the other hand, how will the bank provide the currency in light of a dollar liquidity crisis? With the emergence of this type of contracts, it will lead the dollar holders to agree with banks on a futures contract at a price higher than the current price, for example, EGP 23 for one year, as a hedge against any decline in the currency .

Here comes the important question, how would the price of the pound against the dollar be calculated? It is a very complex process that includes many economic indicators, and it is calculated through a dedicated system. The Central Bank is expected to purchase it from abroad from one of the exchanges that deals in currency futures. But the simplest way is to calculate the difference between the Egyptian pound and dollar interests.

What is required to launch it? The Central Bank will be required to launch a complete system on which these contracts are traded (the same mechanism of trading in the stock exchange for example), and train bank employees, create a futures clearing and settlement company (which will settle contracts between sellers and buyers).

The most important thing is the need to create liquidity on the contracts through trading them, as those found in the stock exchange, which is the most important indicator of the success of the mechanism.

Why does the Central Bank want to use this indicator now? The Central Bank wants to eliminate the parallel market of foreign currency, secure enough dollar liquidity, and protect the Egyptian pound from further decline against the dollar.

Moreover, traders can use the futures contract as a documentary credit to import goods with the guarantee of the contract, and establish a secondary contract called the derivative contract between the exporting party and the bank, provided that the bank pays directly to the exporter when the contract is due.

How will the goal be achieved? A new index of the Egyptian pound is the answer. “We will make an index for the Egyptian pound through a group of other currencies in addition to gold in order to change the culture that we are linked to the dollar,” Hassan Abdalla, the central bank’s acting governor, said Sunday at the Egyptian Economic Conference in Cairo. He noted that the Egyptian pound rose against the Turkish lira by about 100%, and it also rose against other currencies such as the euro and sterling.

Does this have anything to do with free floatation? An informed source told Daily News Egypt, that the move does not prevent free float in the event that the Central Bank makes its decision to do so, but will protect the currency from violent decline if the decision to float is made, likely to complete the trading system in currency futures within four months.

The free float is one of the conditions required by the International Monetary Fund in order to grant Egypt the expected loan. Egypt needs the loan to bridge the financing gap, as the price of the dollar against the pound is the most prominent point that is addressed by the representatives of the Fund in the circulating news.

The first week of November is scheduled to witness a visit by the IMF delegation to Egypt to follow up on the government’s efforts to fulfill the loan requirements, according to a source familiar with the negotiations.