The Central Bank of Egypt is sending strong signals to the market that the way for interest rates to go is down. Niveen Wahish reports Interest rates are one variable which the market is constantly observing. Depositors want to know what returns they will be getting on their bank savings while those wishing to take out loans want to know the costs they will incur. Interest rates have lately been on a slow but sure descending slope. Only two weeks ago the Central Bank of Egypt (CBE) decided to reduce its overnight deposit rate by 25 basis points to eight per cent per annum down from 8.25 per cent, and the overnight lending rate to 10 per cent per annum down from 10.25 per cent. This is the fourth cut the CBE's Monetary Policy Committee (MPC) has undertaken to overnight deposit and lending rates within less than a year. When MPC was first established in June 2005 overnight deposit and lending rates stood at 9.5 per cent and 12.5 per cent respectively. In September 2005, these rates were dropped to nine per cent and 11.5 per cent respectively. In December 2005 the CBE again reduced its overnight deposit rate to 8.75 per cent and overnight lending rate to 10.75 per cent. Two months ago, the MPC cut overnight deposit and lending rates by 50 basis points to 8.25 and 10.25 per cent respectively. It cut its discount rate for the first time in more than three years to nine per cent from 10 per cent. The CBE last cut the rate in November 2002 from its 11 per cent level. The CBE embarked on this latest cut after stating that inflation rates have been holding up at moderate levels. Inflation in the Consumer Price Index (CPI) was 3.4 per cent in January, compared to 3.1 per cent for the period of October-December 2005. The CBE is using short-term interest rates to keep inflation low. With reduced inflation prices stabilise and interest rates drop. When MPC was created, the CBE announced that it intends to establish a formal inflation targeting framework so as to anchor monetary policy, once the fundamental prerequisites are met. Inflation targeting means that the CBE openly adopts a target for inflation, and maintains it. This is seen as essential for reducing uncertainty and sustaining high rates of investment and economic growth. Doha Abdelhamid, professor of finance at the American University in Cairo says that the advantage of an inflation targeting regime is that it will "enable investors to make their calculations based on a clear signal of where inflation is heading." Abdelhamid says that an inflation targeting mechanism is based on two pillars, "the first is that the CBE must publicly announce three-month and annual inflation forecasts in advance. The second is that the minutes of the MPC must be made public." This has not happened so far. The CBE's continued cuts to the interest rate show a downward trend for both interest rates and inflation. Abdelhamid says that the direction in which interest rates are heading is considered an "investment boost". This should mean credit being made available at a lower cost. In the meantime lower interest rates would push depositors to invest their savings in higher-return ventures. Abdelhamid believes there is "no limit" to the extent to which interest rates may be lowered. She refers to Japan, "where interest rates were at one point nil." But she also acknowledges the fact that a lower interest rate might cause small depositors to cry over their savings. She advises that they start investing in financial market instruments. But she warns that it is at the same time "very important" to increase public awareness of alternative venues of investment in order to avoid the recurrence of panic as happened in the recent Black Tuesday, when panic-stricken small investors dumped their shares, suffering huge losses and causing a market crash. Abdelhamid advises that the public should invest in bonds and mutual funds, which are "a prudent investment and offer a higher rate of return than banks. And, they would not be losing their seed money." But Ismail Siam, another banking expert is against cutting interest rates altogether. He suggests that interest rates should remain high in order to support the pound. "Egypt is a net importer of foodstuffs, capital goods and production inputs," says Siam. He fears that cutting interest rates will once again lead to dollarisation, a process by which investors exchange their pounds for dollars. Siam says that the current interest rate cut primarily serves the government, since it reduces the burden of interest that it must pay on its public debt. He argues that interest rates are "not the real burden" on investors. The CBE had previously maintained higher interest rates in order to support the Egyptian pound. Safaa Safwan, a banking expert, explains that by maintaining the interest rates on pound deposits, the CBE was hoping to divert depositors from converting their pounds into dollars which are considered "a value retainer". She adds that "this is no longer a fear." According to Safwan, the pound's exchange rate against the dollar has been stable especially now that people have "greater confidence" in the economy's positive performance. She says that the CBE also no longer fears dollarisation, "since the interest rate on dollar deposits remains below that on Egyptian pound deposits." Interest rates on three-month and one-year deposits range between six and eight per cent. Safwan predicts that they "will not be dropping overnight but will take a couple of months before the banks adjust to them". Lower interest rates should also reflect themselves in better lending rates, but Safwan adds that lending rates are set, not based only on interest rates, but also on the costs borne by banks. "And those remain high."
