The new Minister of Investment Mahmoud has ignited a fierce debate over the direction of interest rates and monetary policy in Egypt, Wael Gamal reports Mahmoud , minister of investment and head of the Economic Committee of the ruling National Democratic Party, told Reuters that he "hoped that higher interest rates would contain inflation and help make the Egyptian pound more convertible, which is an incentive to foreign investment." The announcement was unexpected from a minister whose sole concern should be investment and not a preoccupation with monetary policy that lies outside his authority. It was received with mixed reactions that ranged from outright rejection to conditional approval. However, nobody denied that 's proposed higher interest rates could be beneficial. The logic of the 's hypothesis is that a short-term interest rate rise is needed to unify the exchange rate and to attack high inflation, which inhibits investment. Also, many consider it necessary to raise interest rates in order to fight the dangerous dollarisation levels in the economy, by making savings in Egyptian pounds more profitable. Dollarisation levels have increased twenty per cent from last year. Nevertheless, raising interest rates would be a hindrance to investment, especially since the economy is in recession. "When you raise interest rates you make general investment less favorable because it is safer to put your money in the bank. It creates more competing alternatives to investment," said Khaled Abu Heif, general manager of the Commercial International Brokerage Company (CIBC). "From the macroeconomic perspective, the prevailing situation cannot be sustained and such a move could be justified," said Abu Heif. "But being partial to one of the extremes will be fatal. There has to be a compromise that is gradually implemented because the market cannot take any shocks at the moment," he said. Most businessmen are against raising the interest rate because it will squeeze their profit margins by raising the cost of borrowing. "This will negatively effect businesses. The economic cycle will be slower and the recession could deepen," said Gamal El-Nazer, head of the Egyptian Businessmen Association. Businessmen see priorities differently. "Taxes, customs and corruption are more severe problems that should be dealt with first. The technical principle is right but the timing is not good," El-Nazer added. Another controversial subject is the skyrocketing public debt. In the third quarter of the 2003-2004 fiscal year it reached LE284 billion or 62.1 per cent of GNP and it continues to rise at an ever increasing rate. Every one per cent rise in interest rates will mean a rise of LE2.1 billion in debt service. "Increasing the debt service costs will complicate the problem," said Abdel-Fatah El-Gibali, advisor to the minister of finance . "What we need is a balanced interest rate that includes the reconsolidation of the exchange rate system and the recycling of the Egyptian economy." But he warned that such a policy has to be guided by a quantitative model which calculates the appropriate level. said that there is such mechanism and that the interest rate is applied gradually by the central bank. Interest rates have been rising for the past nine months. They were seven per cent on three months treasury bills in October 2003 and are now around 12 per cent. But the banks have not raised the interest on deposits because they think the new level is too high to maintain. This gradual upward trend underlines the limits of monetary policy in the Egyptian economy. There have not been any setbacks in the stock market, which has been rising moderately. In the three days after 's announcement, the stock market produced no noticeable reaction. In more developed economies, such an announcement would have had significant repercussions. In fact, a recent study by Mohamed Hassan, professor of Economics at Cairo University, concluded that the nominal interest rate does not have a significant impact on real domestic credit going to the private sector. The study, therefore, points to the limitations of an active and efficient monetary policy in Egypt. The study prescribed measures to invigorate monetary policy. These include "firstly, taking the required steps that will allow the banking system to develop new instruments to hedge against the exchange rate volatility. Secondly, gradually restoring fiscal discipline. Thirdly and more importantly, granting the central bank independence in terms of instruments and the numerical representation of targets." The orientation outlined by the new Investment minister has a tough road ahead, therefore. It has to face the problems of recession, a burdensome public debt and inflation, within the confines of a crippled monetary policy. The challenges will be especially difficult if the relationship between the government and the central bank is not redefined.
