A short-term rise in interest rates may be useful after all, writes Niveen Wahish Interest rates, and where they are heading, have been the topic of serious debate for years. When rates move in one direction, there will always be an expert calling for them to move in the other. In fact, while some believe that high interest rates are a deterrent to investments and a burden on public debt, others think that high rates are needed to encourage individuals to keep their savings in Egyptian pounds, thus fortifying the local currency's exchange rate and avoiding increased dollarisation. The debate has heated up once again following the recent interest rate hikes (to 12 per cent and more) on deposit certificates, a move initiated by two public sector banks, and quickly copied by other banks which wanted to avoid losing their clients. Ahmed Galal, executive director of the Egyptian Centre for Economic Studies (ECES), said that the choice to increase or decrease interest rates should depend on specific needs at a certain point in time. He argues, nonetheless, that short-term interest rate hikes could actually do more good than harm. Presenting his findings at a seminar for economic journalists earlier this week, Galal said experience had shown that raising interest rates concurrently with a flotation of the local currency helps avoid an excessive drop in the local currency's value. Brazil, Turkey and Mexico -- three developing countries with economic conditions similar to Egypt's -- were all dead set on protecting their local currency, but had to abandon that approach because they could no longer sustain it. Using these three countries as examples, Galal showed that with slight variations, and during an adjustment period of six to nine months, interest rates were raised to slowdown the "overshooting" (or excessive drop in the value) of their local currency. That excessive drop was gradually contained, and the value of the currency eventually stabilised. The dollarisation rate also dropped after reaching its peak at the time of flotation. Although hard currency reserves also drop (since they are used to support the local currency), they gradually build up again, Galal said. He also indicated that concurrent with these events, growth was only affected temporarily. "Following the adjustment period it picked up again." Galal also argued that interest rates are not the only factor taken into account when making an investment decision, at least not the short-term interest rate, which is controlled by the Central Bank of Egypt (CBE). An investment, he said, is a long-term decision that has an element of risk, and can not be easily revoked. With this in mind, Galal argued that Egypt has not benefited from the experiences of other countries that have liberalised their exchange rates. Because of what he called "fear of floating", Egypt extended the adjustment period, and "two years after the flotation in January 2003, it has not done enough". According to Galal, one of the steps that have not been taken involves completely letting go of the pound, and allowing the market to determine its price. The existence of both an official and a black market, the gap between which only recently narrowed (and has yet to be completely eliminated), makes that clear. Galal said interest rates were not raised at the appropriate time; had they been, the drop in the value of the pound might have been better contained. The currency exchange market, in the meantime, was not allowed enough freedom and flexibility, with most banks offering similar prices. At the same time, the role of foreign exchange bureaus was downsized, and the absence of a dollar interbank market made things worse. Galal suggested that, in any case, the low interest rates did not lead to increased investments, which were being held back by the recession, low demand, and a complicated investment environment. "What is needed now is to do what we should have done two years ago," Galal said. He pointed out that in terms of monetary policies the exchange rate should be allowed to move freely, and the number of entities trading currencies should be increased. He also said there was "a need to raise interest rates [because] it will be temporarily beneficial". In the meantime, Galal also recommended that the CBE be strengthened as an institution in order to enable it to manoeuvre all these changes.
