The Central Bank of Egypt's decision to cut the discount rate last week was hailed as a good step, but plenty still remains to be done to boost the economy. Yasser Sobhi investigates In a step aimed at reviving the economy, the Central Bank of Egypt (CBE) reduced its lending and discount rate by one percentage point last week from 11 per cent to 10 per cent. Some banks immediately responded to the decision by a subsequent reduction of 0.5 per cent in their interest rates on loans and deposits. "We have been demanding an interest rate reduction for a long time," said Hussein Choucri, president of HC securities group. "It's a decision in the right direction. They are these kinds of decisions that could restore confidence in the government's commitment to help the economy recover." In the last few years, investors and economists have complained that interest rates were too high, which affected the cost of financing and the competitiveness of firms at a time of recession. The banks lend at nominal interest rates of around 14 per cent, while inflation rates hover at around three per cent, which means the real interest rate stands at nearly 11 per cent, one of the highest around the world. The CBE maintained the high interest rates mainly for fear of increased dollarisation. Also, because a large segment of the Egyptian population depend on the monthly income generated by the interest rate on their deposits, it was feared that a reduction in this income will affect the Egyptian family's spending power and negatively impact demand in the economy. During the past year, the CBE carried out a number of measures to enhance liquidity in the market and to encourage credit extension. Among these, the monetary authorities introduced a new deposit system that allows banks to deposit in the CBE for shorter periods. The CBE also helped the banks by reducing the obligatory reserves banks have to keep with the CBE from 15 per cent to 14 per cent of their total deposits. The improved liquidity has resulted in a drop of average Interbank overnight rates from 10.52 per cent in July to 4.39 per cent in October, a decrease of more than a half. Banks now have a surplus in liquidity. "Lending activities are slow because of a lack of demand from firms, due to the recession in the market," said Pacinthe Fahmy, general manager of Misr International Bank (MIBank). "If this situation continues, banks will have to continue reducing their interest rates until they become attractive to investors." She explains that banks' response to the lending and discount rate reduction will depend on each bank's liquidity situation. The more liquid the bank is, the more rapid and aggressive it will be in the reduction race. On the other hand, banks with less liquidity will keep their rates high to attract more deposits. Although they welcomed the decision, the business community is still not fully satisfied. "It's too little too late," said Ali Moussa, president of United Group for paints and chemicals. In his opinion, the cost of funds is still very high in comparison with other countries. He thinks that there are other important impediments besides the high financing costs that affect the expansion of economic activities. On the list is the uncertainty that surrounds the business community, after the arrest of some businessmen, the criminal trials of others and the corruption cases. "We need clearer lending criteria based more on the feasibility of the project rather than on physical collateral, which has brought the market to the situation it is in at present," he said. In addition, more progress has to be made to return to a single exchange rate. He also called for a reduction in tax rates and a reform of the tax administration that would increase the state's income. Furthermore, the inclusion of the informal sector into the economy will add more discipline to the market, which will help bring about a real recovery. "We need more dynamic and courageous decisions, so markets can respond significantly," Moussa said. The government has tried to boost market activity in the past two years by focusing on fiscal policy tools. An increase in government spending aimed at creating more opportunities, but resulted in an increase in public debt and in a budget deficit that exceeded seven per cent of GDP. "You can't apply an expansionary fiscal policy anymore, but there is room for using monetary policy while applying prudent fiscal policy," said Ahmad Galal, executive director of the Egyptian Centre for Economic Studies (ECES). "You can't reduce interest rates and do nothing to the exchange rate and foreign monetary reserves," Galal said. He explained that reducing interest rates will be accompanied with dollarisation if there was no flexibility to the exchange rate and no use of reserves to defend the local currency. What markets need most is to regain the confidence between the government, the business community, the financial sector and consumers, he said. Intelligent and practical decisions could play a role. But, without regaining the trust, no decision would be efficient.
