Experts are waiting to see which way the Central Bank of Egypt will direct its overnight lending and deposit rates. Niveen Wahish reports Next Thursday the Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) will be meeting for the third time since its formation last month. The MPC's nine members include the governor of the CBE, two deputy governors and six members of the board of directors. Its primary function is to make monetary policy decisions that are implemented through a set of policy instruments and procedures. One of the committee's first decisions was to put in place a new policy instrument dubbed the "corridor", which sets a ceiling for overnight lending rates and overnight deposit rates. These ceilings are decided by the committee when it meets on the first Thursday of each month. According to the CBE, this mechanism enables the bank to meet its inflation objectives by "steering short-term interest rates, while keeping in view the development in credit and money supply as well as a host of other factors which may influence the underlying rate of inflation." Essentially, this system helps control inflation by withdrawing excess liquidity from the market. Such policies are used according to the CBE as a transitional phase until a formal inflation targeting framework can be put in place to anchor monetary policy. A formal framework is expected to enhance the predictability and transparency of the monetary policy in Egypt. While the MPC has kept the rates unchanged since it first set the overnight deposit rate and the overnight lending rate at 9.5 per cent and 12.5 per cent respectively, it is not clear what it may do on its next meeting. The CBE kept the rate unchanged earlier this month "because it saw that there has been no significant change in the balance of risks to price stability." As a CBE press release put it, "price stability is the primary and overriding objective of the CBE's monetary policy." Price stability is often best achieved through low rates of inflation. While some experts believe that the rates will remain stable, if not decrease slightly, others believe the CBE might temporarily increase the rate. Bassant Fahmi, senior advisor for finance, engineering and restructuring of banks at the Arab Academy in Jordan, believes that various factors may drive the CBE to raise rates despite the fact that these rates, when first set, came down with the previous rates. She pointed out two factors in particular, the US Federal Reserve starting to increase the interest rate of the dollar and second, the possible effects that the Sharm El-Sheikh bombings may have on the value of the pound. "There is no doubt that as a result of the hit to the tourism sector, the flow of hard currency will drop, at least temporarily," Fahmi said. As a result, she added, these rates will be increased to support the pound. Investing their liquidity at a high interest rate will prevent banks from using that liquidity to buy dollars. The idea of raising interest rates is often used by the CBE to boost the attractiveness of the Egyptian pound verses the dollar. Just last year it was able to encourage individuals with dollar savings to exchange their money for Egyptian pounds and buy long-term savings certificates set above a 12 per cent interest rate. That move was one of the primary factors that contributed to the stability and appreciation in the value of the pound from around LE6.20 a year ago to LE5.8 today. This system is not only useful in support of the pound, but has other merits as well. Amr Bahaa, senior general manager of the treasury and money markets department of the Egyptian Commercial Bank (ECB), points out that this system has prevented the fluctuations which previously plagued overnight lending and deposit rates. Ali Fayez, director of the Federation of Egyptian Banks, also adds that it has empowered banks to make full use of their funds, thus enabling them to make available savings schemes which offer daily returns on deposits, something previously not available. And it has allowed banks suffering short-term liquidity shortages to meet their needs through borrowing at a clearly defined rate. These rates have no direct bearing on the lending and deposit rates set by banks for their clients. Nabil Hashad, chairman of the Arab Centre for Financial and Banking Studies and Consulting, explains that deposit rates are determined by the cost each bank is bearing on its deposits as well as on the liquidity available within the bank and the status of that liquidity. The status of liquidity may provide an indicator of where interest rates may be heading. While interest rates are determined by each bank independently, they may be affected indirectly by actions taken by the CBE. For example, changes in the discount rate, open market operations or any changes in the amount of reserves against deposits that banks are required to keep with the CBE could affect the interest rates of individual banks. Lower interest rates on lending have often been called for as a means to encourage investment. However, as Bassant stressed, the decision to invest is based on the return on investment. The interest rate is simply one of the costs. If the return will cover the costs, then the investment may be worthwhile even if the interest rate is high. Currently, average lending rates stand at between 14-15 per cent. The overnight lending and deposit mechanism is one of the efforts of the CBE to strengthen its monetary policy and reform the financial sector. These efforts, according to Hashad, will lead to the creation of a stronger financial system. He praised the insistence by the CBE that banks meet capital increase requirements on time. The deadline for banks to increase their capital expired and was not renewed by the CBE in mid-July. This, decision, according to Hashad, has highlighted the credibility of the CBE and will eventually lead to the creation of stronger banking entities.
