Interest rates -- here and there

By Niveen Wahish
The interest rate plays a crucial role in the navigation of an economy. And when this is changed in the world's biggest economy, investors and bankers around the world must take a close look at the domestic implications of such a decision. US Federal Reserve Chairman Alan Greenspan's recent 0.5 per cent cut in interest rates aims at easing the US economy into a period of lower growth. Although Greenspan made his decisions miles away in Washington, Egyptian banks could not avoid doing the same on US dollar deposits.
While one might predict that such a move would encourage individuals to resume making their deposits in Egyptian pounds, which boast an interest rate ranging between 9.5 and 10.5 per cent, experts are not expecting this to happen. The instability of the dollar exchange rate, they say, will encourage depositors to hang on to their dollars.
The decision to make a deposit depends on three factors: the interest rate, the currency exchange rate and confidence in the banking system, explained one banker who preferred to remain anonymous.
While confidence in the banking system is not the main factor in this particular case, clarified the source, the other two factors are more decisive. "If the exchange rate is guaranteed to continue at its current level, without the risk that it might lead to a further decline in the pound, an individual might then convert their US dollar deposits into Egyptian pound deposits."
"What is lacking in Egypt is confidence in the continuity of the current exchange rate." This situation has prevailed since the pound began to decline in value over a year ago. "The fact that the interest rate on the pound is higher is no incentive," the banker said. Nonetheless she believes that the situation could change provided that interest rates on the Egyptian pound are raised, which would mitigate the risk of fluctuations in the exchange rate.
The ability to acquire hard currency is an issue that "could drive an individual to overlook the interest rate factor just to hold on to his dollars," the banker said, again referring to the dollar crunch which reached its peak last summer. With interest rates on dollar deposits reduced slightly, she said that ideally, new depositors would choose to make their deposits in Egyptian pounds, especially given predictions that interest rates on the dollar will be reduced further.
But the interest rate is a double-edged sword. The banker believes that although its reduction would support the value of the pound, it might put a brake on investments, leading investors to put their money into short-term treasury bills.
She stressed that investors and individuals are waiting for the government to announce a coherent plan to deal with the economy's woes -- especially the exchange rate regime.
Early this week, Prime Minister Atef Ebeid said that the government does not plan to either float or rigidly fix the value of the Egyptian pound, but explained, somewhat paradoxically, that its value will be left to market forces. "A programme should be announced because that is what investors base their expectations and plans on. Guessing only leads to speculation," said the banker.
Munir Hindi, professor of finance at Alexandria University, reiterated a similar point of view. In his opinion, those who make dollar deposits are not looking to interest rates, but have made their decision on the basis of their belief that the value of the dollar will increase against that of the pound. "The interest rate would play a role if the exchange rate were stable," he said.
Hindi expects the pound to decline further and demand for the dollar to increase, especially with the pilgrimage season coming up.
He strongly opposes any increase in interest rates. "We need to cut interest rates on the pound, just as Greenspan did with the dollar because that is the only way to revive the economy."
He believes that raising interest rates will cause an economic setback because this will increase the cost of investments and raise the price of exports, taking away their competitive edge.
Raising interest rates on the pound would also take its toll on the stock market as well. "With an already slow stock market, raising interest rates would bring it to a halt. If you want people to invest in the stock exchange, the interest rates have got to go down."
He pointed out that some banks have raised the interest rate because they are short on liquidity. Now that the Central Bank of Egypt is finding that banks are in a tight spot, it is reviewing the possibility of decreasing the obligatory reserve it requires banks to place with it as a precautionary measure. Currently the CBE requires banks to contribute 15 per cent of the value of their deposits.
Amr Mohamed, another banker, believes that individuals can make capital gains by holding on to their dollar deposits. The value of the US dollar against the Egyptian pound has risen by around 17 per cent. Thus a higher interest rate on pound deposits would still yield lower returns than US dollar deposits, he pointed out. "As long as the public has the impression that the value of the dollar will rise, people will not relinquish their hard currency."
Mohamed advocates raising interest rates on the Egyptian pound to 12 to 12.5 per cent. He sees no danger in increasing interest rates because "investment decisions do not hinge on the interest rate alone," suggesting that an investor can bear to pay an interest rate of up to 20 per cent if the investment environment is promising. "Raising interest rates is necessary to encourage savings," he added.
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