Interest rates are a tool used by governments worldwide to control prices and spur growth in the economy. When interest rates, the amount of money paid by a borrower to a lender, increase, consumers tend to have less money to spend, the economy slows, and inflation decreases. Conversely, when interest rates decrease, businesses are able to borrow more money causing the economy to grow and inflation to increase.
Following an expansionary economic policy and giving better access to credit seems to be a main priority of the newly appointed government, and this was reflected in the Central Bank of Egypt's (CBE) decision to lower interest rates on loans and deposits by 50 bps to 10.25 per cent and 9.25 per cent, respectively, during the meeting of its monetary policy committee (MPC) earlier this month.
Before the meeting most experts expected the CBE to keep the rates unchanged, abandoning its two-year policy of defending the pound by keeping rates high while increasing the dollar supply through withdrawing from its reserves.
The fact that the pound gained some ground recently thanks to an aid package from the Gulf countries boosted international reserves and stabilised the forex market, supporting these expectations.
The CBE's desire to protect the pound since the 25 January Revolution had meant the loss of almost $20 billion from the country's reserves, while still failing to halt the depreciation of the pound against the dollar. The pound has lost some 13 per cent of its value against the US currency since January 2011.
Pharos Securities, a leading local investment bank, noted on the eve of the MPC meeting that the black market in dollar trades in Egypt was experiencing a three per cent spread over the official rate, contrasting with an average spread of 10 per cent since the beginning of the year, meaning that the CBE was no longer under such pressure to maintain its two-year hawkish policy.
Most experts had ruled out a hike in interest rates, but none had expected a rate decrease, especially with the inflation rate following an upward trend since the beginning of 2013.
“The MPC's rate cut could be more reflective of the current mindset of the MPC committee members than of the current market and economic conditions,” commented Moheb Malak of Prime Securities in a research note.
Malak said that the rate cut was an indication of a commitment to the stimulus plan announced by the government, as well as of more coordination between the country's monetary and fiscal policies.
“Given that the downside risks to the Gross Domestic Product (GDP) outlook outweigh the upside risks to the inflation outlook, the MPC decided to cut the key CBE rates,” the MPC said in a statement accompanying the decision.
The statement also said that heightened uncertainly and the weak growth of credit to the private sector since early 2011 had kept investment low.
Egypt's GDP grew by 2.3 per cent in the nine months to the end of March this year, after 1.8 per cent growth in the same period a year earlier, well below the six per cent pace thought necessary to absorb new entrants to the country's labour force. Egypt's unemployment rate now stands at 13.2 per cent, almost four per cent higher than its level immediately before the 25 January Revolution. However, while the MPC move should help to stimulate growth, it may also run the risk of accelerating inflation, as was mentioned by the MPC itself in its press release. Urban consumer inflation rose to an annual 10.28 per cent in July, compared to 9.75 per cent in June and marking its highest rate since July 2011and its fastest increase in two years. Food price inflation hit 13.9 per cent year on year in July, up from 12.6 per cent year on year a month earlier. Soothing fears of increased inflation, the investment bank EFG-Hermes said in a note that it expected inflationary pressures to ease in the next five months as the Gulf aid poured into Egypt. The bank forecast an average annual consumer inflation rate of 9.4 per cent in the fiscal year to June 2014. Prime Securities also expected a slowdown in inflation during the third quarter of 2013, “as the phenomena of imported inflation disappears on the back of a stable exchange rate, while domestic demand remains subdued by the political tension and violence, despite the rate cut.” Another risk that might emerge from the decision to cut interest rates, it said, was that of “further pound depreciation in the case of elevated political confrontations and violence leading to capital flight and tourism sector setbacks.” However, it underlined the fact that the confidence signalled by the members of the MPC in the economy and the stimulus effect this would have in increasing demand for the pound would offset the reduced demand for the local currency on the back of lower interest rates, helping to keep exchange rates stable.
