As expected by many economists, the Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) decided in its sitting last week to keep key interest rates unchanged, nearly two weeks after the bank raised them with a surprising 300 basis points (bps) amid other measures, including liberalising the forex system and floating the local currency. The bank said risks to GDP growth and inflation are balanced and judged that interest rates are appropriate. It added that the interest rate is based on the targeted reserve money and inflation outlook. Tightening monetary conditions was warranted, it added, and that despite the increase in inflation, the effect on the forex system was moderate. I believe the statement of the CBE is appropriate to current conditions that will most likely change sooner or later. Time is a very important factor and a further move by the bank is dependent on forces that are taking shape now. For example, the CBE expected inflationary pressures to continue due to the reform measures, gradually dropping afterwards. But when and how? There is much need now to evaluate the prospects of inflation, production capacities and recovery of foreign-income-generating sources. Theoretically, liberalising the forex system as well as fiscal and monetary reform measures ultimately increase the country's production capacity, but again, how and when could that be the case in an ailing economy? Recalling what has been happening for a few weeks will enable us to see clearer. On 3 November, the CBE decided to liberalise the exchange rate, leaving the rate to be set by supply and demand forces, a move seen as essential to boost the economy. The local currency was devalued by 48 per cent to the US dollar (now LE15.75 from LE8.78 previously). The bank introduced several tightening monetary tools that worked to raise interest rates on saving certificates in some local banks to 20 per cent. These moves were seen as a response to wide and persistent twin deficits and strong external pressures. They were basically an important step in implementing economic reforms that included imposing new taxes such as VAT, cutting energy subsidies and raising fuel costs. It was also meant to unlock a $12 billion loan the government signed with the IMF in August. Early this month, the fund's board approved the loan and said a tranche of $2.75 billion was transferred immediately to the CBE. The rest of the story will have to be explored in time. One of the major fiscal tools that will have to be monitored closely is interest rates. The CBE, which has hiked rates by a cumulative 550bps this year alone, will not risk further hikes in the current unsettled market, with inflation high but not beyond control, in my view. The annual urban consumer price index (CPI) eased for the second consecutive month in October, despite an increase in core inflation. Still, the CBE needs time to evaluate the performance of the market based on the government's austerity measures. It is obvious that the monetary tightening policy the CBE is undertaking now aims at preserving the value of the pound by absorbing excess liquidity to avoid an overvalued exchange rate and to contain imported inflation. But it seems the CBE believes time is yet on its side to fulfil this goal. I believe that the bank's need for more time to evaluate the market is based on the high volatility of exchange rates with relative uncertainty about investor trends. The value of the currency is still affected by uncertainty of retail profit operations and transfers to banks. Some firms require more clarity on both exchange market and monetary policies. “I think the Central Bank will most likely hold the short term interest rate,” says Khaled Abdou, associate professor of financial services and accounting at Pennsylvania State University, Berks College. He explained that the main reason would be a “wait and see” attitude. It will all depend on the flow of foreign direct investment (FDI) and exports, on the one side, and expenditure controls on the other. How long to wait? The government's success in implementing reforms with wide social acceptance of their necessity is the core answer. Several factors will decide in the coming weeks whether the MPC makes any further moves. Inflation, stability of the exchange rate system, levels of FDI inflows, GDP growth, continuity of receiving loan tranches from international institutions and the success of economic reform programme in absorbing social discontent will all play into the decision making process. A move to raise interest rates in the near future could be trigged by strong price pressures amid a weaker currency, especially if the government fails to control the markets and the import bill on basic commodities goes above target. Price pressures will be elevated by energy subsidy cuts, VAT and other reform measures needed to satisfy five IMF revisions to acquire further tranches of the $12 billion loan. But if such challenges are successfully met there will be no need for any interest rate increases. Omar Radwan, head of asset management at HC Securities and Investment, supports this view. “No more hikes are needed to avoid any further negative pressure on the business environment,” he said. The Central Bank needs to keep interest rates at current high levels for a while to fight inflationary pressures, fight dollarisation, attract repatriation and defend against any possible dollar hike, Radwan explained, pointing out that the Egyptian pound should be lucrative for foreign investors in the carry trade where investors are encouraged to borrow dollars at low rates, convert them to Egyptian pounds, invest in Egyptian T-bills at high yields for short maturities, and then convert this back to dollars, benefitting from a stabilising currency and interest rate differential. But is cutting interest rates still an option? Actually yes. A move to cut interest rates in the short term will depend on the success of the government in monitoring the market, creating a milder inflation outlook despite pressing challenges, as well as the inability of the government to afford higher borrowing costs meant to fill the widening budget gap. Meanwhile, macro-economic indicators are yet on a long path to consolidate, and fiscal imbalances will not be corrected automatically following liberalising the exchange system, especially with political uncertainty and question marks about the prospects of the tourism industry, the Suez Canal development area, and other large-scale national projects. Over the medium and long term, though, there could be a cut in interest rates as the growth outlook recovers and inflationary pressures ease. The start of gas flows from Eni's massive Zohr field in the Mediterranean somewhere in 2017 will also stimulate growth, facilitating a decision to cut interest rates in the medium-to-long term. Finally, I believe a hold on interest rates could prove successful over the short term as long as the tools the government uses to boost investor confidence and revive the troubled-economy gain momentum. The writer is a political researcher based in Jeddah, Saudi Arabia.
