The Central Bank of Egypt (CBE) opted to raise overnight interest rates on interbank deposits and lending by two per cent this week, citing the need to contain runaway inflation. The move, taken during the CBE's Monetary Policy Committee (MPC) meeting on Sunday, is the second of its kind since the CBE devalued the pound and abandoned currency controls in November. The total hike in interest rates since then amounts to five per cent. On Sunday, the overnight deposit rate was upped to 16.75 per cent, while the lending rate was raised to 17.75 per cent. Economists, bankers and businessmen expressed worries about the effect of the move on growth rates that are already as low as 3.5 per cent. Justifying the move, the MPC said that while the decision to raise borrowing costs in November had helped contain underlying inflation, the balance of risks related to the inflation outlook had tilted more strongly to the upside, with recent economic and monetary data releases pointing to strengthening demand-side pressure. The annual inflation rate came in at 32 per cent in April, its highest level since 1986. However, the monthly increase was slower at 1.7 per cent, the slowest since October. The government is worried about social unrest being fed by the record high inflation rates. President Abdel-Fattah Al-Sisi recently pledged to embark on “protective measures” to help the poor, including increasing the value of subsidised food on ration cards and upping the ceiling of tax exemptions for the low and middle-income classes. However, the CBE decision was still unexpected by observers polled by Bloomberg and Reuters this week. Only two out of the 21 analysts surveyed by the two agencies had forecast a change in rates. “More than anything, we think pressure from the IMF was the key driver behind the decision to raise interest rates,” noted Jason Tuvey, Middle East economist at London-based firm Capital Economics. He explained that while earlier in 2017 the sharp rise in inflation had increased expectations of interest rate hikes, the MPC had held rates steady at its meetings in the first few months of the year, apparently indicating that policy-makers would resist further hikes. This view was reinforced by the release of the CBE's Monetary Policy Report in late March, which attributed the “temporary” increase in inflation to the decline in the value of the pound as well as the government's decision to raise fuel prices and introduce a new value-added tax (VAT). This ruled out any need to curb inflation through interest -rate changes, the report said. Last month, the IMF said curbing inflation should be Egypt's top priority and said it was confident that the CBE had the right tools to do so. Egypt finalised an agreement with the IMF in November in order to acquire a $12 billion loan over three years. The second instalment of the loan was approved two weeks ago. “Reading between the lines, IMF staff appear to have pressured the CBE into tightening monetary policy,” wrote Tuvey in a research note. Not all kinds of inflation are curbed by increasing interest rates, said Hani Tawfik, chairman of Acumen-Beltone Asset Management. He explained that the current inflationary pressures had resulted from the increase in the dollar exchange rate and not from an increase in demand and thus could not be dealt with through hiking rates. This opinion was in line with what Mark Mobius, chairman of the Templeton Emerging Market Group that manages billions of dollars in emerging markets, told Bloomberg following the hike. He said that the IMF's one-size-fits-all programmes to stabilise economies do not work for Egypt. When the IMF goes into a country, it says “look, first of all you've got to solve inflation. You've got to raise interest rates and increase taxes,” he said. “This is all well and good when the environment is healthy. But in an environment like in Egypt now, it is not a healthy situation.” Looking at the move from a different angle, Hani Geneina, former head of research at Beltone Financial, pointed out that the move aimed at controlling the liquidity of the local currency with the aim of strengthening the pound. Geneina said that local liquidity with the banks had increased by LE130 billion since the floatation. Meanwhile, foreign currency inflows are less than they should have been and have been mainly in the form of investments in treasuries, with the banking sector not receiving sufficient funds. “Had the CBE not taken this step, the dollar rate versus the pound would have increased significantly,” Geneina said. The pound has lost almost 50 per cent of its value versus the dollar since the devaluation, with the dollar currently officially trading at LE18 to the pound compared to LE8.8 before the floatation. Now, Geneina added, the CBE would be able to drain liquidity from the local banks through the latter investing in high-yielding treasuries, thus giving a boost to the pound.
WINNERS AND LOSERS: The rate hike will add a further LE30 to LE35 billion in additional interest payments to government expenditures, according to Pharos Holding, a local investment bank. This will push up the budget deficit, which is already among the highest in the world. In order to maintain the 2017/2018 budget deficit within the pre-announced target of 9.1 per cent, Pharos analyst Rami Orabi expected the government to undertake further fiscal consolidation measures, mainly cutting fuel subsidies. Analysts expect the government to slash fuel subsidies by a further 20 per cent by the second quarter of the 2017/2018 fiscal year. Another price that the economy could pay after the move will be a slower growth rate. “A surge of two per cent in interest rates means we are adopting a contraction policy in a time when we should be going for an expansionary policy to increase growth and employment rates,” Tawfik said. Investment bank Arqaam Capital has cut its GDP growth estimates for Egypt from 4.9 per cent in fiscal year 2017/2018 and 5.7 per cent in 2018/2019 to 4.5 per cent and 5.5 per cent, respectively, “given the pressure this hike will have on consumption and investment growth over the coming six to nine months.” The effect on private-sector profits and expansionary plans was underscored by a statement issued by the Federation of Egyptian Industries (FEI). “The timing of the unexpected move is totally wrong as it will add to the woes of local industry,” Mohamed Al-Sewidi, head of the FEI, was quoted as saying. He asked the CBE to allocate funds to different industries at lower rates, so that the hike in rates would not slow down growth and exports. However, Orabi said that given the fact that private-sector credit represents 20 per cent of GDP, such a low level of debt minimises the negative effect of high nominal interest rates on the broader economy. In a related note, Orabi said that cash-rich corporations would be key beneficiaries of the interest rate hike, while highly leveraged corporations and those with high debt figures would continue to bear the brunt. The Egyptian stock market fell on Monday, the day following the move, with the EGX30 index losing 2.5 per cent of its value. Stock market yields are now much less than those on treasuries and deposits. On the other hand, Arqaam Capital expected that the hike would serve to increase portfolio investment flows to Egypt, which jumped from $111 million in October 2016 to $6.4 billion in May 2017. The government estimates that portfolio investments could reach $10 billion in 2017. Another beneficiary from the move, according to Arqaam Capital, is the household sector, which will now get higher returns on deposits and certificates of deposits. Arqaam expects the public banks to offer new certificates at higher rates, or at least to revise their rates on timed deposits upwards to lure liquidity. The CBE offered certificates at 16 per cent and 20 per cent for three years and 1.5 years, respectively, in November 2016 in order to fight dollarisation and absorb excess liquidity in the economy. The offerings were snatched up by investors. “However, this time round individuals' responses might not be as aggressive, given the small differential between existing certificates and possibly higher return certificates,” Arqaam noted. More importantly, with the challenging economic environment for households, fewer people may be willing to part with the cash they have in anticipation of the rise in prices from the upcoming fuel price hike in the summer, it added.
