Egypt's monetary policymakers changed the interest rate direction after two years of stagnation. Niveen Wahish finds out why and Nesma Nowar reports on what measures banks have taken The Central Bank of Egypt (CBE) took everyone by surprise when it decided to hike the interbank and discount rates last week. After two years of keeping the rates unchanged, the monetary policy committee of the CBE decided to raise the overnight deposit rate by a whole percentage point, to 9.25 per cent while raising the overnight lending rate and the seven-day repo by half a percentage point to 10.25 per cent and 9.75 per cent, respectively. The discount rate was also raised by one percentage point to 9.5 per cent. In the press release announcing the hike, the Monetary Policy Committee (MPC) attributed the need to hike rates to upside risks to the inflation outlook because of the re-emergence of local supply bottlenecks and distortions in the distribution channels. It also cited downside risks to domestic GDP including the political transformation and "fiscal and banking sector challenges facing the Euro Area and possible spillovers to other regions along with weaker than anticipated growth rates in a number of advanced economies." However, these reasons are not new. They were cited by the MPC when it kept the rates unchanged weeks before. The new variable, according to banker Passant Fahmy, was the fact that government owned banks, since the beginning of November, led a trend to raise interest rates on deposits. "The CBE did not need to raise interest rates now, if it were not for that factor," said Fahmy. She explained that government owned banks, due to the fact that they had been heavily lending the government through their purchase of treasury bills, had run low on liquidity. "They needed to raise the interest rates on deposits to attract depositors." With higher interest rates on deposits, banks needed to increase their lending rates as well, but could not do so because lending rates were tied to the overnight lending and deposit rates, added another banker who preferred to remain anonymous. "The interbank rates had to increase so banks could put up their lending rates." The fact that the yield on the treasury bills had reached unprecedented heights also made the decision easier. "If lending to the government, which is normally considered risk free, was yielding such high interest rates, then lending to individuals, which usually comes with higher risk, should become more expensive as well," the source said. The average yield on 182-day Treasury Bills (T-bills) jumped to over 14.5 per cent from around 14 per cent last week. Fahmy blames the banks' thirst for easy investment of treasury bills for the situation in the market today. Instead of lending the government, she said, they should have been lending the private sector. In fact, the bank's excessive exposure to government bonds was a cause for a downgrade of their local currency and foreign exchange deposits late October by Moody's, the credit rating agency. The credit downgrade included five banks, namely the National Bank of Egypt, Banque Misr, Banque du Caire, Commercial International Bank and Bank of Alexandria. Moody's said that these banks' exposure stood at between four and seven times their equity bases. According to Fahmy, "the mismanagement by the public banks will mean an increase in the cost of funding for the whole market." She believes the Egyptian economy is undergoing tough times and people need to be encouraged to borrow and invest. "With rates up, people will refrain from borrowing." In fact, it is always believed that high interest rates affect the appetite for setting up new projects or investing in the stock market. But the Egyptian Association for Finance and Investment have said, in a statement, that they do not expect the increase in interest rates to influence the size of investments, more affected by the political and security situation. However, they said that it "may put further pressure on the stock market and will limit the profitability of the listed companies which depend on borrowing to expand financially." But one thing the interest rate hike may do is, according to the anonymous banker, help prop up the value of the Egyptian pound by encouraging people to deposit in pound, so as to make higher returns, rather than convert their savings to dollars. Since the outbreak of the revolution, the value of the pound has been sliding, breaking the LE6/per dollar barrier last week following the reoccupation of Tahrir Square by the revolutionaries. With the pound losing value and the prevailing uncertainty, there has been an increasing tendency to convert savings into dollars. Dollar denominated deposits have been growing as opposed to a slower growth for Egyptian pound deposits. CBE figures show that in January 2011, dollar deposits were growing at 2.2 per cent. That growth rate reached 12.8 per cent in July. But while Egyptian pound deposits were growing at 13.5 per cent in January 2011, that growth rate fell to 7.1 per cent in July 2011. But Fahmy believes it would be wrong to support the pound at this stage given the current sorry status of the Egyptian economy. "Keeping a strong pound encourages imports." She acknowledges that prices will shoot up if the pound is left to slide, but she says "that will only be the case for one season. When imports become too expensive, local production may kick in once again." Pre-emptive move Last year Sherine Ahmed had deposited LE100,000 at one of the national banks for three years at an interest rate of 9.5 per cent. Today she is thinking of withdrawing that amount, at the risk of paying a fine. She wants to redeposit the sum and take advantage of the higher interest rate national banks recently started offering. In fact early in November, the National Bank of Egypt and Banque Misr, Egypt's largest public sector banks, raised the interest rates on their three-year Egyptian pound certificates to reach 11.5 per cent, up from 9.5 per cent. This move prompted other private sector banks to raise the interest rates on their deposits as well. According to Hamdi Abdel-Azim, professor of economics and former president of the Sadat Academy for Administrative Sciences, banks have raised interest rates in an attempt to attract deposits and provide liquidity for domestic government borrowing. "Banks have a great chance to make profits from such high yields," he said. "This is considered a secure investment for banks." Abdel-Azim also attributed the increased interest rates to the need to boost demand on local currency by making its yields more attractive. Raising the interest rate "encourages people to put their deposits in Egyptian pounds rather than foreign currencies," he said. Iman El-Ayouti, senior economist at the Egyptian Centre for Economic Studies, gives a similar explanation. She said that although Egyptian citizens have for long complained of particularly low interest rates, the timing of this move can partly be explained by commercial banks' need to pool much needed funds for government lending purposes through purchasing the government's treasury bills. In November 2011, the yield on the six-month treasury bills was 13.8 per cent and 14.7 per cent on one-year bills, both marking the highest levels since late 2008. She added that the move might be also oriented towards encouraging citizens to save as a means of releasing their hoarded cash holdings. "We hope to see banks direct their funds to investment-oriented projects, in addition to their shouldering of the budget deficit." El-Ayouti said. "Investment is a dire need for job creation at this delicate juncture." Meanwhile, Abdel-Azim stated that increasing interest rates could be counter-productive for investment and the stock market. However, he believes the investment climate and stock market are already in a critical situation as a result of the country's political instability. As for how long the interest rates might remain this high, Abdel-Azim expects they may decrease but not before a year. One source at Crédit Agricole Bank, who asked not to be named, agreed with Abdel-Azim. Increasing interest rates, the source said, might harm the economy by discouraging investment, because people may prefer to put their money in banks and receive a fixed monthly interest rate. According to the source, the interest rates announced by the two public banks are exaggerated. He explained that his bank introduce an interest rate of 10 per cent on the three year certificate of deposits, which was considered the highest interest rate. The source said that after the two banks announced their 11.5 per cent interest rate, depositors started to withdraw their deposits from his bank in order to benefit from the higher interest rate. "Normally differences between interest rates introduced by banks do not exceed 0.5 per cent, however this time the difference is 1.5 per cent," the source said. "I may be no longer able to attract depositors." The source added that not all banks will be able to increase their interest rates, as each bank has its own strategy and liquidity pressures which are key determinants for such a decision. He said he believes that the two public banks' move was taken primarily to maintain the current deposits they have and to provide enough liquidity for lending by attracting more depositors.
