Unfavourable market conditions are wreaking havoc on government attempts to engineer an economic recovery. Yasser Sobhi reports The Central Bank of Egypt (CBE) has increased interest rates to control inflation, but other banks' deposit rates are not following the trend. Two main questions remain for the market: why are banks not responding to the CBE's monetary measures? And more importantly, why are authorities not applying a restrictive monetary policy when the long awaited recovery of the economy and higher growth levels have not yet been achieved? Interest rates on deposits accepted by the CBE from local banks, the main mechanism used by the monetary authority to influence other interest rates in the market, have increased significantly on six-month deposits during the last three months, from 7.7 per cent last February to 10.03 per cent in April and 11.73 per cent on 31 May. Treasury bills and inter-bank rates followed the race skyward. Three- and six-month treasury bill rates also increased to almost 11 per cent at the end of May. Inter-bank rates increased from 6.5 per cent in February to around nine per cent in May for overnight lending, and to 9.94 per cent for lending over a month. However, private banks were reluctant to increase their rates, preferring instead to stick with their individual business decisions. With the volume of deposits increasing and corporate lending decreasing, most banks are in a position of excess liquidity. Whether this is a consequence of bad loans or the economic slowdown, banks are being forced to invest in bonds and treasury bills rather than new lending projects. The deposit to asset ratio in banks has decreased from around 80 per cent in 1996/97 to nearly 50 per cent last year. Subsequently, most banks were not actively seeking new deposits. Interest rates on three-month deposits slightly declined from 7.83 per cent in February to 7.68 per cent in May. Banks also maintained the wide spread between the deposit rates they pay and the credit rates they earn from lending money, the latter kept stable at around 13.3 per cent for loans of one year or less. "There is a shortage in the demand for credit because of the slowdown in the economy and the weakness of individuals' income," says Pacinthe Fahmi, general manager at the Misr International Bank, "but banks also are reluctant to provide loans as a fear of the legislation system that led many bankers to jail, accused of corruption, when projects fell. Credit officers prefer not to take the risk of taking a lending decision that would make them accountable in case of an economic failure of the project." Nevertheless, banks cannot resist forever. Weak growth in lending is negatively affecting bank profits. Additionally, the demand for credit is expected to increase, further tempting banks to take on lending ventures. "The real cost of borrowing is actually negative when compared with the high inflation in the market. This should attract entrepreneurs to increase their demand for credit even though they are still in a waiting position because of uncertainty in policies," says Mohamed Hassan, assistant professor of international finance at Cairo University. "The applied restrictive monetary policy will actually lead to a shortage of liquidity in the market. Hence, banks will raise their rates to attract more deposits," he added. But, the authorities prefer to apply a restrictive monetary policy that would affect economic growth rates after almost five years of modest growth. High interest rates affect credit demand, stock market performance, corporate competitiveness in international markets and the implementation of the new mortgage system, a possible stimulus for the real estate market, which is an important catalyst for economic growth. "It's a choice to be made. Is it better to sacrifice long-term growth for a short-term purpose, or to prepare the stage for sustainable growth in the medium and long term?" asks Hassan. He explains that applying an expansionary monetary policy would significantly increase inflation, therefore negatively affecting growth in the medium term. But a slowdown for another year and then a stable growth for the next five or 10 years would be a wiser path. Hassan believes such a policy would only be effective if implemented within a package of policies and reforms that are in accord with the investment climate. In fact, the new banking law has set "targeting price stability" as the main objective of the CBE's monetary policy. The new CBE administration, led by Governor Farouk El-Oqda, is trying to define a new monetary policy that would regain the credibility of the market. Even though the policy is not yet clear to many people, including bankers, the increasing stability in the exchange rate market and the decrease of the dollar price in the black market ($1 is traded around LE6.3, while the official rate in banks is around LE6.2), are considered signs of market confidence in monetary policy. "There are clear inflation pressures in the economy that have to be addressed. Raising interest rates helps to absorb liquidity from the market and achieve price stability, which is the primary objective of the central bank according to the new law," Hassan said. Nevertheless, experts think that other measures are yet more important. "Measures taken (within the monetary policy) were late and not enough. They could be necessary temporarily, but should be accompanied with solutions to the real problems," says Ahmed Galal, executive director of the Egyptian Centre for Economic studies. Galal explained that raising interest rates, and using other monetary tools like international reserves, should have accompanied the currency flotation decision in January 2003. "We would have been talking now about reducing interest rates. It's better to do it late than never. But, those measures would not be effective without real reforms," he added. The reforms, he mentioned, include making the CBE more institutional, enhancing its capabilities, introducing more monetary and fiscal tools and banking reforms.
