Basma Mahmoud is a young, newly graduated physician. Late last month as the weather suddenly got colder she decided to buy a pair of winter shoes and a new handbag. She headed to one of Cairo's medium-priced shops, a place where an item might average around LE200. However, she found that the prices had doubled. For the LE500 she had with her she could barely buy one item, and she felt that the item she wanted was not worth that amount. Though LE200 is now not worth much in terms of purchasing power, to Mahmoud it is still a substantial sum given that her income has not increased. What Mahmoud and all Egyptians have been experiencing was translated into the November urban inflation rates, which surged to 19.4 per cent up from 13.6 per cent the month before. This is their highest level since 2008, when they reached around 18 per cent, according to World Bank figures, on the back of global commodity price hikes. They also reached similar levels back in 1991.
The floating of the pound and the cuts in fuel subsidies were the reasons for the surge, according to the Central Agency for Public Mobilisation and Statistics (CAPMAS), which releases inflation rates on a monthly basis.
Egypt floated its currency early in November, and since then the pound has depreciated by around 100 per cent compared to its official rate prior to the float. The government also announced cuts in fuel subsidies by 30 to 80 per cent. Core inflation, computed by the Central Bank of Egypt (CBE), surged to 20.73 per cent in November, excluding volatile items such as fruit and vegetables and government-regulated prices. The CBE considers core inflation to be a more telling measurement of current and future inflation because it excludes short-run fluctuations. The depreciation in the value of the pound and the subsidies elimination though temporary in nature are nonetheless problematic because the initial level of inflation was already high, said economist Hoda Selim. If inflation had been at around three to four per cent before the floatation, she said, it would have climbed to a much lower level than 20 per cent. According to Selim, safe inflation levels range between four to five per cent. The surge in the inflation rate will have negative ramifications not only on the individual level but also on the growth of the economy as a whole. “Purchasing power is being eroded, and the poor and middle class are losing out. Those on fixed incomes are suffering, and bank savings are losing their purchasing power,” Selim pointed out.
The provision of savings certificates at 16 and 20 per cent was a good move to attract savings in the banking sector, she said. However, with inflation at around 20 per cent, the certificates still mean that savers can barely maintain the value of their savings, Selim added. If inflation goes above 20 per cent, people might turn to alternative instruments outside the banking sector, she warned, being more likely to put their savings into either dollars, or real estate or gold. Following the floatation of the pound, Egypt's three state-owned banks offered three-year and 18-month savings certificates at 16 and 20 per cent interest rates to increase the attractiveness of the local currency.
For the economy as a whole, the higher inflation rates will likely dampen consumer spending triggering a sharp slowdown, said Dubai-based research house Capital Economics. Consumption has been credited for much of the growth throughout the past six years since the 25 January Revolution, and Capital Economics estimates a GDP growth rate of just 1.0 per cent this year. The International Monetary Fund (IMF) forecast a GDP growth rate of 3.8 per cent for 2016 in its October World Economic Outlook.
But things may not stop there. Capital Economics expects inflation to rise further on the back of recent decisions to increase import tariffs. “This will further add to price pressures, and we think the headline rate will peak at around 22 per cent in the middle of next year,” it said. So, what needs to be done? Capital Economics expects an additional interest rate hike of 150 basis points by the Central Bank of Egypt (CBE), possibly during the monetary policy committee meeting on 29 December. The CBE had already raised interest rates by three per cent when it announced the decision to float the pound, in order to maintain the attractiveness of the currency. Broader monetary and fiscal policy reform is what Selim believes is needed. The fiscal deficit is a long-term driver of inflation, she pointed out. Egypt's deficit came in at around 12 per cent in fiscal year 2015-16, while a safe budget deficit level is around three per cent of GDP.
The problem with such high deficits is that they are financed by borrowing from the commercial banks and printing money, Selim said. Printing money without any corresponding increases in production inevitably leads to higher inflation, she explained, recommending that the independence of the CBE be increased by prohibiting its financing of the deficit. Furthermore, Selim said there should be a transparent nominal anchor to serve as a target for monetary policy. Ever since the official exchange rate target was abandoned in 2003, the CBE has had no official target, she pointed out. It continually says that it is targeting price stability. But it needs to clearly state what its target is and how it will achieve it. Other complementary reforms such as the introduction of an effective communications strategy should help build credibility, Selim added. “The publication of an inflation forecast will help in making the CBE's objectives known to the public. It will ensure that markets are better informed and market expectations better managed,” she said. She worries about further hikes in interest rates due to their effect on increasing the cost of servicing government debt. “If policy rates are raised, all the other interest rates are raised too, including the treasury bills rate at which the government borrows money from the banks,” she said. She is concerned that this will mean higher borrowing rates for investors, “which is too costly and is likely to impede investment, job creation and therefore growth in the medium-term.”
Selim fears that with the high interest rates the banks will prefer to lend to the government than to the private sector, therefore crowding out private-sector investment.
She hopes that the recently enacted policies will help improve macroeconomic conditions and promote growth, in turn helping to ensure fiscal sustainability and reduce the deficit as a share of GDP.
