In a classic scenario of hot money outflows, capital rapidly exits developed economies as investors seek higher returns or safer havens elsewhere. This phenomenon often emerges when interest rates in advanced economies are reduced, weakening the currency and diminishing returns on investments.
The sudden shift in capital flows can destabilize financial markets. As developed nations face reduced liquidity and weakened currencies, emerging markets may experience surges in capital inflows, often leading to increased volatility and speculative bubbles in local assets. As a result, each time the central bank of a developed economy cuts interest rates, a surge in capital inflows to emerging economies is anticipated.
Recently, the Federal Reserve lowered interest rates by 50 basis points for the first time in over four years, bringing them to a range of 4.75% to 5%, marking the beginning of what is expected to be a consistent easing of monetary policy.
In their latest statement, the Fed’s policy makers expressed growing confidence that inflation is moving sustainably toward the 2% target, with risks to employment and inflation objectives appearing nearly balanced. Policymakers expect the Federal Reserve’s benchmark interest rate to drop by another half percentage point by the end of this year, a full percentage point in 2025, and an additional half point in 2026, settling between 2.75% and 3.00%.
This raises an important question: Is Egypt ready to attract capital outflows from the U.S. economy?
Elijah Oliveros-Rosen, chief emerging markets economist at S&P Global Ratings, told Business Today Egypt that lower U.S. interest rates could encourage greater capital flows to emerging markets, as interest rate spreads with the U.S. become more attractive. However, interest rate spreads are just one of many drivers of capital flows.
Other important factors that influence capital flows are inflation, exchange rates, fiscal and external account dynamics, economic growth, and political stability, among others.
“Egypt has made progress in some of these factors, most recently in liberalizing its exchange rate in early March of this year, which over time should help improve external account dynamics, and could attract capital flows. However, the country still faces key structural economic growth constraints, which include the large informal sector (which hampers fiscal revenue), relatively weak (albeit improving) governance and transparency of state-owned enterprises, and barriers to competition that restrict private sector activity,” Oliveros-Rosen stated.
On March 6, the Central Bank of Egypt (CBE) raised the overnight deposit rate, the overnight lending rate, and the rate of the main operation by 600 basis points to reach 27.25%, 28.25%, and 27.75%, respectively. Additionally, the discount rate was raised by 600 basis points to 27.75%.
The CBE allowed the exchange rate to be determined by market mechanisms, stating that unifying the exchange rate is a crucial step to contribute to eliminating the accumulation of demand for foreign currency, following the closure of the gap between the official market exchange rate and the parallel market rate. It also added that in preparation for implementing the reform program measures, the necessary funding has been provided to support foreign currency liquidity.
On March 1, the Cabinet announced that Egypt received $5 billion as the final installment of the first tranche of the deal aimed at developing Ras El-Hekma with the United Arab Emirates. This development serves as a significant boost to Egypt’s economic reforms and underscores the appeal of the country’s investment environment. Prime Minister Mostafa Madbouly disclosed plans to convert $5 billion from the UAE deposit into Egyptian pounds (EGP).
Economic analyst Haytham El-Gendy remarked that the Federal Reserve’s September rate cut marks the start of a monetary easing cycle that is likely to alleviate financing pressures on emerging and developing economies. Still, the extent of relief depends on the Fed’s pace of rate cuts and its forecasts for borrowing costs.
El-Gendy told Business Today Egypt that the more the Fed loosens global financial conditions, the more portfolio flows (hot money) Egypt could receive. To make the North African country more appealing, he suggested leveling the playing field for the private sector and maintaining exchange rate flexibility, with a focus on attracting foreign direct investments (FDIs) rather than just volatile carry trade funds.
On another note, El-Gendy anticipated that the Bank of England (BoE) would keep rates unchanged after its first rate cut in early August. He noted that the divergence between the Fed and other major central banks benefits developing markets by anchoring the U.S. dollar, easing imported inflationary pressures, and supporting local currencies.
When asked if Egypt is ready to attract hot money, economic consultant Ali Hamoudi said that attracting such capital requires careful consideration and strategic action. While Egypt has potential, it faces several challenges that need to be addressed for the country to become a more appealing destination for foreign investors.
Hamoudi clarified that these challenges include significant currency fluctuations that make it risky for investors to preserve the value of their investments; persistent inflation further erodes returns, which requires effective inflation control to build investor confidence. Additionally, bureaucratic hurdles complicate the investment process, which highlights the need for streamlined procedures, reduced red tape, and greater transparency to attract and retain foreign capital.
“Consistent economic reforms, a stable political environment, and clear legal frameworks are crucial to instill confidence,” he stated. Hamoudi told Business Today Egypt that attracting hot money to Egypt requires a comprehensive strategy that focuses on macroeconomic stability, improving the investment climate, promoting sector-specific growth, and strengthening financial markets.
“This approach is not just about offering short-term incentives but about creating a sustainable environment for long-term investment. While the journey calls for concerted efforts, these steps can position Egypt as a more attractive destination for foreign capital,” he noted.
For Egypt to attract hot money, Hamoudi recommends several strategic steps. Most important of these is focusing on strengthening macroeconomic stability by implementing robust monetary and fiscal policies to control inflation. This entails maintaining a stable exchange rate through effective management of monetary policy and foreign exchange reserves. Ensuring fiscal discipline is also crucial and involves managing government spending and controlling debt levels to avoid further economic strain.
Improving the investment climate is another key area. Egypt needs to streamline regulations by simplifying investment processes, reducing bureaucratic obstacles, and enhancing regulatory transparency. Protecting property and corporate rights through strong legal firewalls is essential to safeguard investor interests, and to invest in critical infrastructure, particularly in energy, transportation, and logistics in an effort to create a more attractive environment for investment.
Another key step is underlining the promotion of sectoral growth, which involves identifying and prioritizing key sectors with high growth potential, such as tourism, industry, and renewable energy, and offering targeted incentives and tax breaks to attract investment in these sectors. Developing human capital is also important, with a focus on investing in education and skills training to build a skilled workforce for emerging industries.
Finally, strengthening financial markets is central to developing deeper and more liquid capital markets to attract long-term investments and encourage the growth of a robust bond market that can provide alternative investment opportunities for foreign investors.
