Faced with sluggish growth yet rising prices, Egyptian monetary policymakers are caught between a rock and a hard place, writes Niveen Wahish For the past two years the Central Bank of Egypt (CBE) monetary policy committee (MPC) has kept the overnight deposit and lending rates unchanged at 8.25 per cent and 9.75 per cent respectively. The discount rate was also kept at 8.5 per cent. The CBE would move these rates should it sense any threat to medium-term price stability. In theory this should mean that if inflation increases, so will interest rates; while a decrease in inflation would have the opposite effect. And yet, while the rate of increase is still below those reached in 2008 and 2010, inflation has indeed been rising. In September the headline consumer price index (CPI) increased by 1.43 per cent month-on-month, following a 1.1 per cent increase in August. The annual rate declined slightly to 8.21 per cent in September from 8.49 per cent in August, supported by last year's favourable base effects. Rates in 2008 and 2010 and 2008, stood at around 23 and 14 per cent respectively. What could be a greater cause for concern is the upward curve in the core CPI, the measure preferred by the CBE, over the past few months. Core CPI excludes the price of volatile items such as vegetables and fruits, as well as items with regulated prices like gasoline. Core CPI increased by 1.13 per cent in September, following a 1.18 per cent increase in August, leading the annual rate to increase from 6.98 per cent to 7.95 per cent. The last time the CBE had moved its lending and deposit rates downward was when inflationary pressures were cool in September 2009, when core inflation stood at around five per cent while headline inflation stood at around nine per cent. This may indicate that the CBE will soon push its rates up. But there are other factors, such as growth, which will affect the decision over whether to raise or lower interest rates. If interest rates are high, that could slow down an already sluggish growth. As the MPC press release shows, real GDP grew by only 0.4 per cent in the fourth quarter of 2010/2011 following the significant contraction of 4.3 per cent recorded the previous quarter. This led annual GDP growth for the whole year 2010/2011 to fall to 1.8 per cent from 5.1 per cent recorded in 2009/2010. The press release highlights that, "while a marked decline in economic activity was expected, the magnitude is larger than anticipated at the outset of the revolution." It adds: "Looking ahead, the current political transformation may continue to have ramifications on both consumption as well as investment decisions, adversely weighing on key sectors within the economy." It also points out "concerns related to global recovery". The bottom line is that the CBE has to face the challenge of balancing the trade-off between propelling growth and containing inflation. According to economics professor at Cairo University Hanaa Kheir Eddin, that is no small challenge, since inflation is the byproduct of other factors beyond the CBE's control. For one, the growing government budget deficit has been found to augment inflation. That has been found to be the case especially in developing countries, where the central bank is not totally independent from the government. A second factor is that of monopolistic market practices. In fact, Sarah El-Nashar, economist at the Egyptian Centre for Economic Studies, says the market structure is a major problem in Egypt and uncompetitive practices have long gone unregulated. "Organising the market and interfering to reduce prices and prevent them from rising according to the whims of sellers is a must," Kheir Eddin said, adding that there must be some sort of interference either through negotiation with wholesalers or by opening parallel sales points, where the government can offer goods at cheaper prices. But these sales points have to be able to absorb the demand so that crowding does not push buyers towards greedy sellers again. Both El-Nashar and Kheir Eddin hope to see the implementation of a decision announced this week by the minister of social solidarity that the law of the military ruler, whereby violators will be subject to military court, will be applied to those who smuggle commodities or manipulate prices in any way. "Better market regulation and more competition will bring prices down," El-Nashar says. Another factor which is often blamed for pushing inflation up is the increase in wages, and such a wage increase is indeed on the horizon. The minister of finance announced this week that a minimum and a maximum wage will be applied starting January. However, in a recent study, El-Nashar found out that the effect of nominal wages on inflation is the least in a series of other more effective factors which include a nominal exchange rate, inflation that has accumulated over the years and the real output, namely production. Kheir Eddin adds that, "production has not really increased at a time when demand is the same, if it hasn't in fact increased." Yet she is hopeful that imposing a maximum wage will put a break on demand. Kheir Eddin does not envy CBE decision-makers, because there is no clear threshold indicating when inflation could become dangerous to growth. A study spanning the period from 1981 to 2006 did not specify when inflation was good for the Egyptian economy and when it could impede growth. As such the CBE has to be very alert, recommends Kheir Eddin. Nevertheless, she is not worried that a rise in interest rates would affect investment. "At this point, security is more important to investors," she said. In fact an interest rate hike could prop up the value of the pound, something the CBE has been working hard on maintaining since the revolution, sometimes by directly injecting dollars into the market and making sure demand is satisfied. In all, the CBE has reason to believe it is on the right track for now. "Lower prospects for growth should limit upside risks to the inflation outlook," the MPC press release says, adding that "given the balance of risks on the inflation and GDP outlooks and the increased uncertainty at this juncture, the MPC judges that the current key CBE rates are appropriate."
