Inflation was a key word in conversations about Egypt at the International Monetary Fund/World Bank spring meetings in Washington last week. “There has to be a special focus on inflation,” IMF Managing Director Christine Lagarde said at a press conference, adding that “the inflation risk is weighing on the population.” “Bringing inflation down is a priority, not only for monetary policy management, but also for economic and social issues,” Jihad Azour, director of the World Bank's Middle East and Central Asia Department, told journalists at another press briefing. Annual inflation in Egypt came in at 30.9 per cent in March compared to 30.1 per cent in February, its highest level in 30 years. While Egyptians did not need the IMF to tell them what they have been witnessing on a day-to-day basis in terms of price hikes, the emphasis was a surprise coming from the IMF. “The IMF's recent statements come as a surprise, especially given that it is well aware of the consequences and background of the reform programme that it insisted upon in the first place,” said Allen Sandeep, head of research at Naeem, a MENA-focused investment bank. Last year's floatation of the Egyptian pound, fuel subsidy cuts and the implementation of a new value-added tax (VAT) are seen as main causes behind the spike in inflation and are part of the economic reform programme the government is implementing for which it is receiving $12 billion as an extended fund facility from the IMF. Prior to the floatation in November, Egypt's annual inflation rate stood at around 14 per cent. “To point a finger at the direct repercussions [of the programme], one of which is inflation, while the economy is in a transition stage, and at the same time still ensuring that the reform programme is on the right track seems to be self-contradictory,” Sandeep added. Egypt's minister of finance had previously said that inflation would start subsiding in April. However, the IMF also offered a solution to the problem of rising inflation. “We believe that the utilisation of the interest rate instrument is the right instrument to be used in order to manage inflation down, and this is something that we are discussing with the authorities” in Egypt, Azour told journalists in Washington. Ideally, interest rates should be higher than inflation, economist Hoda Selim, a research fellow with the Economic Research Forum, a regional think tank, said. If the Central Bank of Egypt's (CBE) nominal interest rate is lower than inflation, then real interest rates will be negative. And if they are negative, people will feel they are not getting a return on their savings. For monetary policy to work, real interest rates must be positive, which suggests that nominal interest rates must rise above 30 per cent. This would be impossible and too costly for the economy. Currently, the CBE's overnight deposit rate, overnight lending rate, and main operations rate are 14.75 per cent, 15.75 per cent, and 15.25 per cent, respectively. The discount rate stands at 15.25 per cent. Raising interest rates would do more harm than good, Selim said, as private-sector investment would suffer because of higher lending rates for investors. These are already borrowing at around 15 per cent, which is likely to impede investment, job creation and therefore growth in the medium-term. “The private sector has already been hard hit by the devaluation and the slowing economy,” she said. At these high rates, the banks would prefer to lend to the government, a risk-free and profitable investment, instead of lending to the riskier private sector. As a result, there is a risk of the government crowding out private-sector investment, Selim said. Sandeep does not expect any changes to the policy rates when the CBE's Monetary Policy Committee (MPC) meets on 18 May. He said that the floatation of the pound had been mainly to blame for the inflation, resulting in higher across-the-board costs and price increases, rather than an increase in the money supply. Lagarde The London-based economic research consultancy Capital Economics also considers it unlikely that the CBE will tighten monetary policy further. In a note issued earlier this month, it said that inflation in Egypt was “close to peaking” and that “as inflation starts to fall back later in the year the next move in interest rates is likely to be down.” Higher interest rates would also be harmful to the government. They would mean increased interest payments on government debt, which would negatively affect the country's budget deficit at a time when the government is doing everything it can to bring it down, Selim pointed out. The budget deficit stood at around 12 per cent of GDP in fiscal year 2015-16. The government is targeting a 10.5 per cent deficit in the current fiscal year. The fiscal deficit and its financing is in fact also a long-term driver of inflation, Selim pointed out. Borrowing from commercial banks does not raise enough financing, and the CBE has been printing money to finance the deficit. The banking law explicitly allows the CBE to lend to the government. The problem with all this, Selim said, is that money is being printed without any corresponding production, meaning that excess liquidity is leading to higher inflation. The CBE must stop supporting government financing, she said, adding that the government must also contain the budget deficit. Sandeep said that inflation was likely to cool when the pound strengthens, though this will only happen once the current account deficit narrows sustainably through a drop in non-oil imports, a take-off of exports and normal tourism activity. He called for a greater emphasis on local manufacturing in order to minimise external shocks. He also hoped to see international commodity prices cool off further. In the meantime, Sandeep said, “high inflation is a variable that the government should be allotting maximum weight to determine its future course of action.” The government's reform programme includes further fuel subsidy cuts with the intention of eventually eliminating subsidies by the end of the programme. This will result in further price hikes. A delegation from the IMF is expected to arrive in Cairo before the end of the month to review the government's reforms before the disbursement of the second tranche of $1.25 billion from the loan. Egypt received $2.75 billion in November. According to Lagarde, the IMF's programme with Egypt is the second-largest it now has. Since its implementation in November, the programme has been lauded as a success. “The first wave of reforms that were introduced under the programme brought very strong confidence back into the Egyptian economy, and that was translated into strong capital inflows that have stabilised the economic situation,” Azour said this week. He added that the programme was designed to take into consideration the need to alleviate pressure on lower-income layers of society. “Things are improving, and the markets are reacting positively... We need to give it more time,” Azour said, stressing that this was a three-year, and not a six-month, programme. Meanwhile, the IMF has predicted that Egypt's economy will grow at a rate of 3.5 per cent of GDP in 2017, 4.5 per cent in 2018, and six per cent by 2022.
