In its meeting last Thursday, the Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) decided to raise the overnight deposit rate, overnight lending rate and the rate of the CBE's main operations by one percentage point each to 9.25 per cent, 10.25 per cent and 9.75 per cent, respectively. The “preemptive rate hike is warranted to anchor inflation expectations and hence limit a generalised price increase, which would be detrimental to the economy over the medium-term,” a CBE press release said. The discount rate was also raised by one per cent to 9.75 per cent. This was the first time the MPC had moved the rates since the beginning of 2014. During the second half of 2013 it had made several cuts to interest rates. The decisions took the market by surprise, as analysts had been expecting the CBE to cut interest rates or at worst to keep them unchanged. But the CBE went in the opposite direction and increased the rates by 100 basis points, equivalent to one per cent, in one go. The trend in previous meetings had been to increase or decrease by no more than a quarter or half a per cent. Eman Negm, an economist at Prime Holding, said that the decision was “totally surprising”. She explained that the CBE had been expected to continue easing monetary policy and cutting interest rates to spur growth. The Egyptian economy grew at 2.5 per cent in the third quarter of 2013/14, compared to the 1.04 and 1.44 per cent recorded in the previous two quarters, respectively. This brings annual growth for the first nine months of 2013/2014 to 1.65 per cent, compared to the growth rate of 2.31 per cent during the same period in 2012/2013. Even after the government's decision to reform the fuel subsidy system it was expected that the CBE would hold rates steady. A couple of weeks ago the government announced several measures aimed at limiting expenditure and increasing revenues. These measures included the partial lifting of subsidies on fuel and electricity, as well as several new taxes including higher taxes on cigarettes and alcohol in addition to a tax on stock market gains. The measures “will improve fiscal sustainability over the medium-term,” the CBE said in the press release, adding that “a relative price increase is, however, inevitable.” According to the press release, the CBE believes that the direct first round effect of these price adjustments will be reflected in inflation figures for July, while “the indirect and second round effects could be reflected in both the headline and core inflation rates during the quarter ending in September 2014 at varying degrees, which poses an upside risk to the inflation outlook.” Banker Pacinthe Fahmy failed to understand the rationale behind the decision and saw myriad disadvantages to the move. She said the CBE's move would have been understandable had inflation been driven by increased demand, but instead it was due to the government's move to restructure fuel subsidies. “The move beats what the government is trying to achieve in the first place,” she said, explaining that while the subsidy reform was being carried out to help narrow the budget deficit and subsequently cut government domestic debt to cover the deficit, the additional one per cent rate would make it more expensive for the government to borrow, hence leading to a bigger domestic debt. It not only placed the government in a tight spot, she said, but also impacted on borrowers, whether individuals or investors. “People are already going through tough times and are having difficulty repaying their debts. This will make it even harder for them,” she said. According to Fahmy, the additional percentage point was also detrimental to investors in the stock market. While the stock market was not faring well, this would make things worse since a higher yield on bank deposits as a result of the interest rate hike would mean that investors would be more attracted to placing their savings in deposits rather than risk them on the stock market. Negm tried to put herself in the CBE's shoes, saying that the price hikes that had come on the back of the partial lifting of fuel subsidies could have been higher than expected, which for the CBE was worrisome. Targeting price stability was at the heart of CBE monetary policy, she said, and the CBE could have worried that the Egyptian pound would depreciate further as a result of inflation and the black market for foreign currency. It had therefore decided on an interest rate rise to defend the pound, she said. As for investment, she said the CBE believed that serious investors were not deterred by interest rates and one per cent would not make a big difference to their decisions, especially since investments continued to be low. Regarding public debt, Negm estimated that there would only be an additional LE5 billion needed to service the debt in the 2014/15 budget, which the government had put at LE199 billion. “This is relatively small compared to the around LE45 billion in savings from the fuel subsidy reform,” she said. However, it would mean that the budget deficit would go from a targeted 10.5 per cent to 11 per cent of GDP as a result of the additional cost, she pointed out. Although Negm understands what drives the CBE, she is not optimistic that the move will curb inflation. She explained that the inflation Egypt is witnessing is not driven by demand but rather by increased production costs because of energy price adjustments. As a result, increasing interest rates might not bring it down, she said. Hani Genena, head of research at Pharos Securities Brokerage, described this inflation as “structural adjustment in the level of prices.” In a written commentary, he questioned how an interest rate hike could help in that regard. “Will consumers save more? Consumers have already lost part of their income to spend on more expensive food and gasoline.” To him, the decision would not affect investment because “most companies have not yet launched expansion plans and many of them may defer such plans until they assess the impact of recent fiscal measures on their feasibility studies.” He said that only if the interest rate hike triggered an appreciation of the pound would this decision make sense, because “a stronger currency will be the most effective instrument used to counterbalance the inflationary effects of recent fiscal measures.” That appreciation could come on the back of higher yields on pound deposits, encouraging depositors to hold onto their pounds rather than seek to exchange them for hard currency. In that same sense depositors might be the one group to benefit from this move. As Negm put it, “the interest rate hike may help those who hold deposits to face the price increases rather than curb inflation as such.” However, Negm did not see this as a long-term issue. She estimated that prices would settle down within three to six months during which time the MPC would keep rates unchanged and could “start cutting rates by the beginning of next year.”
