The trade deficit is rising because exports have fallen since total production is lower these days. Tourism receipts are down significantly. Inflation, which had fallen in January and February to about 11 per cent because of lower consumption, is expected to rise significantly in the short term as consumption resumes to its normal levels coupled with lower inventories, so that money will be chasing fewer goods. Foreign currency reserves are falling at an alarming rate. These reserves, which totalled $36 billion at the beginning of the year, are now down by $3 billion in only six weeks. Some of these reserves were used to defend the Egyptian pound. And despite that the pound is falling against the dollar. What is the Central Bank waiting for to raise interest rates? Here are the problems: - Foreigners have exited the treasury bill market so that banks have had to step in, using their deposits to buy up government debt. Between corporate loans and loans to the government (in the form of buying treasury bills), liquidity is falling sharply in the banking system. Banks have to find a way of increasing their deposit base. - Real rates are negative. Except for the last two months, which were an exception, inflation was running at an average of 13 per cent while deposit rates were around nine per cent. Inflation will certainly spike again. Meanwhile, the effect of low or negative interest rates discourages savings in traditional deposits and encourages consumption. That is because deposits earning an average nine per cent depositors are getting a negative annual four per cent, which translates into an erosion of their savings of four per cent per annum. As the largest single borrower, the state is the largest beneficiary, therefore, of the financing subsidy. - The risk of dollarisation is rising. In times of uncertainty, and when it is clear that the supply of dollars is falling, savers will naturally shift to the dollar as a safe haven, thereby increasing the pressure on the pound. - The fiscal deficit is rising together with the government's need to borrow more. The time will soon come when even banks will run out of their ability to finance government debt. The Central Bank will be faced by two options. Either print money, which will raise inflation and put further pressure on the exchange rate, or raise interest rates. This will encourage savings, reduce dollarisation, and therefore pressure on the pound, and reduce inflation, since funds will go into savings rather than into consumption. In other words, it is a choice between growth with the risk of a devaluation or higher interest rates and slower growth. Let us examine the arguments. 1. Central banks are usually reluctant to raise rates because it reduces consumption — an important component of GDP (70 per cent in Egypt). True, but now we are in much greater need of savings that can eventually be routed into investments than we are in need of traditional unproductive consumption. 2. Higher interests rates are traditionally thought to discourage investment since the cost of borrowing for companies who need financing to establish businesses or expand. Investment will become costlier—that is true. But then a devaluation for even local manufacturers will be even more expensive. Their cost of debt will rise but interest expense is a much smaller component of general expenses than the price of raw materials which would rise substantially in the case of a falling exchange rate. Devaluations are good for productive, exporting economies because they discourage imports by making them more expensive and increase exports by making them cheaper. Not in Egypt, however. Studies have shown that in cases of a devaluation both imports and exports have fallen. That is because the rising price of raw materials and intermediary goods feeds into the price of the final product, rendering it in most cases more expensive and therefore less competitive. 3. Higher rates raise the cost of government debt. True, but I have said that before and will say it again. The government must seriously consider resorting to long term debt. The latest Central Bank report shows that short term local currency debt in the form of treasury bills represents around 70 per cent of total debt issued. The benefits of the government issuing long term local currency debt with maturities ranging between 10-30 years will translate into a deferment of payments. Current payments on the bonds would fall, relieving some of the pressure on the fiscal budget until growth returns and with it the consequent increase in tax revenues. 4. And finally, liquidity in banks is reaching very low levels. The deposit base must grow if they are to continue to finance the deficit, since foreign purchases of treasury bills will remain limited at least in the short term. The foreign currency reserves at the Central Bank are there to secure the country's needs for the import of strategic products—namely food. They should not be wasted on defending a currency that is structurally weak because of lack of productivity or we will find that the reserves have been spent and still the pound is losing value. Let us not go back to a time when the pound mistakenly represented Egypt's national pride.
