By Dahlia Kholaif

CAIRO -- Egypt's central bank floated its tightly controlled currency Thursday, in a surprise step that aims to draw foreign capital back to the country but risks pushing the price of goods out of reach for ordinary Egyptians.

The Central Bank of Egypt, which also raised interest rates by 3 percentage points, said the decision to "liberate exchange rates" was intended to return foreign-currency trading to the formal banking sector and away from a black market that has capitalized on months of acute dollar shortages.

The move led to a sharp devaluation of the Egyptian pound.

The National Bank of Egypt, the country's biggest lender, and other state-owned lenders said on their websites that the dollar could be bought for 13 Egyptian pounds and sold for 13.50, down considerably from around 8.88 Egyptian pounds to the dollar. The Commercial International Bank, the country's largest publicly traded lender, offered greenback for 14.30 Egyptian pounds and purchased it for 14.00.

A more flexible exchange rate is one of several requirements Egypt must meet to get final approval for a $12-billion loan from the International Monetary Fund -- a would-be lifeline for the battered North African economy. The three-year loan, which was approved in principle in August, hinges on Egypt's ability to secure up to $6 billion from bilateral financing, cutting subsidies and adopting a flexible exchange rate. Egyptian Prime Minister Sherif Ismail said last month that 60% of the bilateral financing has been secured.

Years of political turbulence and an increase in terrorism have hurt Egypt's main sources of hard foreign currency -- tourism and foreign direct investment. With foreign reserves falling, the country was forced to ration dollars to pay for essentials such as wheat and medicines. This pushed local businesses to the black market to fulfill urgent needs for foreign currency.

In recent months, inflation has reached double digits and stood at 14.1% in Sept. Price hikes have hit Egyptian households hard and displays of anger have surfaced in a country where the government keeps a tight lid on dissent.

When formula-milk supplies ran dry, dozens of mother staged a protest. Talk shows have allowed listeners to call in and complain about high prices and shortages of sugar and medicines.

In response, Egypt's armed forces said last week it has prepared 8 million containers of basic goods that would be available to consumers at reduced prices.

Now, Egyptians are watching the pound's devaluation with anxiety.

"What matters to me is how much will this affect my expenses, because it has been stretched to the maximum," said Ahmed Fathi, a 32-year-old cabdriver and father of two. "They keep saying they're working on bringing prices down, but they're not."

Timothy Kaldas, a nonresident fellow at the Tahrir Institute for Middle East policy, said the government was walking a tightrope between the need to keep a lid on inflation while also allowing investors to move money in and out of the country.

"If the government takes the right steps and acts transparently, these changes can have a clear positive impact on Egypt's economy in the medium term," he said. "That said, the immediate period will be quite difficult for the average Egyptian."

Central bank Governor Tarek Amer said the government was committed to keeping inflation in check.

"Inflation rates already soared; this is history and we're working on limitingthis," he told the media.

The central bank's move bucked expectations. Analysts had expected it to opt for a managed float of the currency or announce a sharp devaluation.

The country's reserves have hovered around $16 billion since the end of 2015, at half of the pre-2011 levels. But recent loans from the World Bank and Saudi Arabia helped replenish those reserves, which amounted to $19.6 billion at the end of September, compared with around $16 billion the month before, according to central bank figures.

"This is a very positive, courageous step on many levels, firstly, the extent of the move and secondly the fact that it is effective immediately," Mohamed Abu Basha, Cairo-based economist with the EFG-Hermes, said.

"We are looking at what is very likely the end of the foreign exchange crisis."

In a statement, the IMF welcomed the currency liberalization.

"The flexible exchange rate regime, where the exchangerate is determined by market forces, will improve Egypt's external competitiveness, support exports and tourism and attract foreign investment," it said.

"All of this will help foster growth, job creation and a stronger external position for the country."

The interest-rate rise is aimed at guarding against the rise in prices a currency devaluation may bring. Egypt's central bank raised the overnight interest rate, overnight lending rate and the rate of the central bank's operation to 14.75%, 15.75% and 15.25%, respectively. The discount rate was also raised by 3 percentage points to 15.25%.

Following the central bank's announcement, Egypt's benchmark stock index soared to its highest level in at least six months. The EGX30 climbed 8.2%, before leveling off later in the day and closing with a 3.35% increase at 8810 points.

(END) Dow Jones Newswires

November 03, 2016 14:33 ET (18:33 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.