CAIRO: While Egypt s economy has been hit by the global economic crisis, the turmoil may turn out to have a silver lining. An unintended consequence of the slowing economic growth is that falling commodities prices are significantly lessening inflation, which in turn has allowed the Central Bank of Egypt (CBE) to cut its interest rates to stimulate spending. The CBE has historically pursued a restrictive monetary policy, but considering the continued fall in inflation, it has agreed on February 12 to reduce its key rates for the first time since April 2006. The overnight deposit rate was lowered 100 basis points to 10.5 percent, while the lending rate was cut by the same amount to 12.5 percent. This cut signals a clear shift in policy. Looking back in time, the CBE raised lending rates by 250 basis points between February and November 2008. And in December, although inflation declined to 18.3 percent, it kept the key overnight deposit rate unchanged at 11.5 percent and the overnight lending rate at 13.5 percent. But with inflation continuing to drop and economic growth further contracting, down to 4.1 percent in the fourth quarter of 2008, the CBE decided to change its course. The market has already been responsive to the cuts. Egypt s benchmark stock index rose nearly 3 percent following the CBE s move, gaining 2.65 percent to 3,696.26 points on February 15. The CBE s move is likely to encourage borrowing and consumer spending. Additionally, the government has taken a number of measures to shore up the economy with the aim of reversing slowing growth. Egypt has committed to double its economic stimulus plan to LE 30 billion ($5.4 billion), with much of the funding destined for public spending, in particular on financing new infrastructure projects. Other targets include slashing the cost of industrial production, bolstering exports and stimulating the local market, while simultaneously increasing incentives for foreign investors. Egypt has been a major recipient of foreign direct investment (FDI) in previous years, but according to an International Monetary Fund (IMF) report published in January, FDI is expected to fall to $8 billion in 2008/2009, which would represent a significant decline from the $12.1 billion registered in 2007/2008. With overall gross domestic product (GDP) growth predicted to ease from 7 to 4-5 percent in 2009 according to various sources, the government has taken immediate action to cushion the effects of the crisis and is planning to spend half of the stimulus package in the first six months of 2009. The plan should help make up for lost revenue from sectors that are strained by the recession. Egypt depends heavily on foreign currency-generating activities, particularly from tourism, worker remittances and tolls from the Suez Canal. In the past few years these sources of revenue have all steadily increased their contributions, but they are all expected to decline in 2009. In addition, Egypt is a net exporter of oil and with prices expected to continue to fall in 2009, the state budget could be negatively affected, pushing the current account balance into a deficit. While the contracting economy is causing increasing concern, it also offers some respite from the levels of inflation that have troubled Egypt recently. In 2008 the government s economic policy was mainly focused on reducing inflation, which, according to various sources, reached a peak of 23.6 percent in August, due to high food, fuel and rent prices. However, the latest figures indicate that inflation has steadily decreased since the last quarter of 2008 due to weakening demand and falling international commodity prices, reaching 18.3 percent in December 2008 and 14.3 percent in January 2009. It is projected to lower even further to 10 percent in June, although it will remain above the government s target rate of between 6 and 8 percent. Inflation has long been a cause for concern in Egypt and despite attempts to regulate it through monetary policy, the drop in global commodities prices has been the main factor behind the ease in inflation. Most important has been the fall in bread and cereal prices. From March 2007 to March 2008 prices increased by 48.1 percent. In the nearly 12 months since then, however, wheat futures have dropped by 44 percent on the Chicago Board of Trade and have declined 44 percent on Euronext in Paris. Food and beverages make up 43.9 percent of the total weight of Egypt s consumer price index (CPI) so the lower prices have had a sizable effect on the overall inflation rate. Obviously, the increased spending for the government s new measures will be financed through loans and will likely put some pressure on Egypt s finances, since it comes at a time when government revenues are likely to fall. Still, the decline in commodity prices and the subsequent drop in inflation will make daily life a bit easier for Egyptians and by relaxing its stringent monetary policy and increasing its stimulus package, Egypt has shown that it can respond with flexibility and comprehensively to the challenges of the recession. -This article was first published by Oxford Business Group on February 27, 2009.
