Defying expectations, the Central Bank of Egypt (CBE) decided to keep key interest rates unchanged during a meeting of its Monetary Policy Committee (MPC) last week, when it kept the overnight deposit and lending rates at 11.75 per cent and 12.75 per cent, respectively. Most observers expected a hike of between 0.5 and two per cent in borrowing rates in a bid to cap inflation which reached an eight-year high of 15.5 per cent in August. The CBE has raised key policy rates by a total of 2.5 per cent since the beginning of 2016. In a statement, the CBE explained the decision by saying that the inflation spike seen in August was mainly caused by “transitory cost-push factors,” including higher electricity bills and the seasonal increase in the prices of meat in Eid Al-Adha. Meanwhile, the effect of March's devaluation of the pound had been limited and thus raising rates would not have controlled inflation, the CBE said. Egypt devalued the pound by almost 14 per cent in March to about 8.78 to the dollar in a bid to deal with a thriving black market amid an acute shortage of foreign currency. The effects of the move were short-lived, however, and the pound is now again under pressure, trading on the black market at more than LE12 to the dollar, or more than 40 per cent less than the official rate. Interest rates have also not been the most effective tool to control inflation, Radwa Al-Swaify, head of research at Pharos Securities, said. Egypt was a country where only 10 per cent of the population had bank accounts and inflation continued to be largely driven by the exchange rate due to a high imports bill, she added. Fears of the negative effects of higher interest rates on weakened GDP growth had had a significant impact on the decision not to raise rates, especially given the current weakness in investment expenditure, according to Al-Swaify. The economy grew by about 4.2 per cent in the last July-June fiscal year, and government forecasts put growth this year at around five per cent. The Industrial Production Index has shown weak growth over the last three quarters, mostly due to the foreign currency shortage having taken its toll on business confidence and activity. Another reason for not increasing rates was that this could have added to the debt service burden, which currently represents 30 per cent of government spending, Pharos said. With the US central bank, the Federal Reserve, maintaining its rates unchanged last week, there was also less pressure elsewhere to raise rates. Al-Swaify said that the CBE would have needed to raise rates in order to create an attractive spread between the return on fixed income instruments in both dollars and pounds, thus attracting foreign fund inflows into the Egyptian market. The decision to hold rates at their current levels, according to Jason Tuvey, a senior economist at Capital Economics, suggested that large rate hikes were only likely once a loan deal with the IMF was in place and the pound had been devalued. Prime Research, an investment group, seconded this opinion, adding that the timing of the floatation decision would be conditioned by securing at least four months of Egypt's imports bill in the reserves. According to a Prime Research note, this would materialise after Egypt had received a $2 billion loan from China, a $2 billion loan from Saudi Arabia, $500 million as the second tranche of a $1.5 billion loan from the African Development Bank, and $2.5 to $3 billion as the first tranche of the IMF $12 billion loan, adding to the $3 billion in euro bonds which are expected to be issued shortly. The economy has been muddling through a myriad of problems stemming from the severe decline in foreign currency resources since the 25 January Revolution. Political turmoil has stripped it of tourism revenues, taking the foreign reserves to around $16.5 billion in August. Given the current level of the reserves, the expected influx of funds would push them up to around $25 billion. This level, according to Prime, would help cushion the negative consequences of floating the pound and lessen the gap between the official and the parallel exchange rates, unifying them to around LE11.5 to the dollar. “Increasing interest rates at that time will be a complementary step to attract further foreign currencies in portfolio investments,” concluded the Prime note. Were Egypt to receive all this external support within four to six weeks, Prime said an at least two per cent hike in rates could be expected at the November meeting of the MPC. Capital Economics, which predicts that the currency will be devalued by 25 per cent after the IMF deal to reach LE12 per dollar by the end of 2017, believes the CBE will take strong action and raise its overnight deposit rate by 4.5 per cent by the end of next year.
