The Central Bank of Egypt under pressure by new facts of life

As Bank's Monetary Policy Committee meets today to discuss rates, no changes are expected. Inflation remains in check but some criticize that corporate lending remains low

The Central Bank of Egypt's (CBE) Monetary Policy Committee (MPC) meets today to decide on key overnight interest rates. For the past nine meetings, the MPC had kept its overnight lending rate at 9.75 per cent and its deposit rate at 8.25 per cent. It had also left the discount rate unchanged at 8.5 per cent.
Similarly, no changes are expected to be announced after tonight's meeting, either.
Urban inflation fell from 11 per cent in October to 10.2 per cent in November, its lowest level since August 2009.
Although core inflation, on which the CBE bases its decision, surged to 8.58 per cent in November, up from 7.75 per cent in October, it remains within CBE's comfort zone, which experts say is between six to eight per cent. Core inflation does not take into account the volatile fruits and vegetables process, or goods with regulated prices like fuel.
But Magda Kandil, executive director of the Egyptian Center for Economic Studies, believes that wheat and vegetable price shocks are becoming permanent and should be factored in the monetary policy. Kandil discussed the matter during a recent seminar titled "Monetary Policy in Egypt; Recent Challenges and Policy Implications."
According to Kandil, global factors such as droughts and increased demand for oilseeds and grains for biofuel production lead to an increase in prices.Moreover, increased food manufacturing and vegetable exports are causing local prices to rise.
Consequently, she explained, the increased prices of wheat and vegetables are becoming a fact of life.
To achieve a realistic inflation target, she said, these permanent shocks need to be factored into the monetary policy. And, hand in hand with the monetary policy,
Kandil added, measures must be taken to deal with structural distortions affecting distribution of goods, and monitoring schemes and market regulations must be enforced so as to ensure a more competitive market.
Price shocks are not the only challenge facing Egypt's monetary policy.
Large inflows of portfolio investments further complicate monetary policy because they may leave as quickly as they come, creating uncertainty. This then causes fluctuations in the exchange rate, further distracting policy makers.
Salwa El-Antary, former head of research at the National Bank of Egypt, showed fluctuation in the portfolio investments as it went from a negative $9.2 billion in 2008/2009 to a positive $8.9 billion in 2009/2010.
Furthermore, in the period of July-September 2010, portfolio investments reached $5.9 billion, 80 per cent of which went into treasury bills. Kandil suggested "some countries have put regulations to control these inflows on a temporary basis."
El-Antari pointed out that the CBE has tried to neutralize the effect of portfolio investments by buying dollars from banks and then absorbing the excess liquidity through auctions.
She showed that in the period of July-September, the CBE pulled liquidity off the market at the sum of LE23.1 billion, a staggering number compared with the LE18.6 billion pulled off the market during the entire previous year.
But while dealing with these exogenous factors, the Central Bank is faced by local challenges.
Kandil said, monetary policy has not avheived the desired effect in Egypt because of the intermediation process whereby liquidity available to banks is not lent to new investments.
In fact, El-Antari shows, banks preferred risk-free investments such as government lending. According to her, the government's share of total domestic credit increased from 30.5 per cent in June 2008 to 43.1 per cent in September 2010.
Cheap available liquidity is not used to set up projects which would create jobs and spur growth.This, Kandil complains, hinders Monetary Policy (MPC) from delivering on its objectives.