Cut rates may not cut it

Although the CBE's rate cuts are effective monetary tools to lift the economy, they may need the help of additional stimuli to effect a real change. Sherine Abdel-Razek sounds out the outcome
After 28 months of sticking to its 12 per cent discount rate level, the Central Bank of Egypt (CBE) reduced its key interest rate twice in the last two weeks, lowering it from 12 to 11 per cent. Government officials said the move aims at reviving the stagnating economy and giving a push to investments.
The discount rate is the one at which the CBE lends money to commercial banks. Lowering this rate reduces the cost accrued by the banks, which, in a domino-like process, will lead to a similar reduction in interbank rates and banks' credit lending rates. More liquidity would thus be pumped into the market, leading to a new growth cycle in the economy.
"It is a good step in the right direction," said Adham El-Fayyoumi, senior research analyst at ABN Amro Delta. "It was essential to pull the economy out of its current recession."
The recent move follows a similar decision taken by the US Federal Reserve, which cut its rate for the fourth time this year on 18 April. According to El-Fayyoumi, this will help keep the pressure off the Egyptian pound. Since the pound is linked to the dollar, as rates relax on the dollar, a corresponding decrease in the pound should follow. This will maintain an interest deferential, which is the difference between interest rates on both currencies, at a range of 5 to 6 per cent, which should hedge against "dollarisation" and, simultaneously, encourage local investments.
Ahmed Galal, executive director of the Egyptian Centre for Economic Studies, an independent think tank, said the move signals a new government policy of using monetary measures to revive the economy.
Galal pointed out that the CBE has utilised both the reduction in the discount rate and the amendments it introduced to ease the reserve requirements last month to increase the economy's liquidity. "This is exactly the sort of expansionary policy we need whenever the economy is witnessing a recession," Galal said.
He pointed out that such policies usually raise fears of inflation and overheating. "But since our inflation rate is currently very low, even if it increased by one per cent, it would still be under control," Galal said.
Since the main aim of lowering the interest rate is to make other kinds of investments more attractive, the cash-strapped capital market is at the top of the list of beneficiaries. The listed companies' financial results are also expected to improve after the decrease in the cost of credit.
"In addition, lowering the rate at which we discount future yields of shares, means the forecasted fair price of the shares will be higher," asserts Galal.
But are these measures sufficient to revive the market? Nomura International's Anais Faraj said they were not, according to Dow Jones news wires. Faraj said the Egyptian government needs to do much more before Egyptians can expect growth. "The latest rate action was an automatic and belated response to the US Federal Reserve's last rate cut, rather than to any concern over the domestic growth outlook," said Faraj, an emerging markets specialist in Nomura's London office.
"Monetary policy is too tight, fiscal policy is too loose and the exchange strategy is inappropriate. The central bank should cut a further 100 basis points off the discount rate at least," Faraj said.
The last discount rate reduction has not appeared to have led to a corresponding drop in the commercial bank credit rate and private inter-bank rates were minimally affected. Analysts believe this means confidence is lacking among banks and in the market as a whole towards the government's ability to maintain the exchange rate at its current level against the dollar. Banks and market players fear the CBE would not have the liquidity needed to cover their demand on credit.
Egypt is trying to stabilise the exchange rate to the dollar after it abandoned a nine-year currency peg of around 3.4 pounds last May. Although the dollar's formal rate has been standing at the CBE's set rate of LE3.85 for three months now, its shortage in banks and money dealers bureaus has pushed its black market price to LE4.25.
El-Fayyoumi and Galal both agree an economic and market revival needs other stimulating measures besides the rate cut, such as an acceleration of privatisation. Egypt's privatisation programme has slowed down due to economic stagnation and the liquidity crisis. The two-year local currency shortage is attributed in part to the CBE's efforts to meet the demand for dollars. The shortage intensified a year ago when interbank rates peaked at 17 per cent. They have since stabilised at between 10 and 12 per cent. The shortage also stems from excessive government expenditure and big business defaulting on its debts.
Most analysts do not expect another rate cut anytime soon. Faraj said one reason the CBE might not favour a further cut is the pound's peg to the dollar.
However, on a more cautious note, Galal said more time is needed to gauge the market's reaction before further steps can be taken.
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