Egypt's monetary policy-makers will be walking a tight rope as they decide on interest rates, writes Niveen Wahish
The Monetary Policy Committee (MPC) of the Central Bank of Egypt meets Thursday 17 September to decide on changes to the current overnight deposit and lending rates. The overnight deposit rate, overnight lending rate, and the rate of the CBE's main operations are currently unchanged since January at 8.75 per cent, 9.75 per cent, and 9.25 per cent, respectively. The discount rate stands at 9.25 per cent
Ideally, economists would expect to see a rate cut, especially with recent data showing improved growth and a drop in inflation rates. CBE monetary policy targets price stability.
The core consumer price index (CPI) computed by the CBE declined by 0.23 per cent month on month in August 2015 compared to an increase of 0.30 per cent in July. The annual rate dropped to 5.61 per cent in August, from 6.49 per cent in July, its lowest since January 2013, according to Pharos Research, and 240 basis percentage points below the CBE's implicit target. The core inflation rate discounts the price of volatile items such as fruit and vegetables.
The headline CPI released by the Central Agency for Public Mobilisation and Statistics (CAPMAS) increased by 0.36 per cent month on month in August 2015 compared to an increase of 0.71 per cent in July. The annual rate also slowed to 7.88 per cent in August from 8.38 per cent in July on the back of a favourable base effect from the previous year.
But despite these figures things are not straightforward. This time around the MPC, which meets approximately every six weeks, has to weigh in a number of other factors when taking a decision to cut rates. One of these, according to Pharos, is "a higher-than-usual risk of a steep pound devaluation versus the dollar over the coming few weeks."
Talk of devaluation surfaced strongly last week when the Minister of Investment Ashraf Salman, speaking during the Euromoney Conference in Cairo said that the priority currently lay in preserving Egypt's hard currency reserves, implying that a devaluation of the pound was imminent. The reserves fell to around $18 billion in August, the lowest level since March 2015.
The minister's words caused havoc in the markets, causing a shortage of dollars as dollar holders abstained from selling in anticipation of higher prices. This has now died down, according to Mohamed Al-Abyad, head of the foreign exchange bureaus division at the Federation of Chambers of Commerce, who said that the temporary hike in dollar prices that occurred after the minister's statement was now over.
Salman's words also came in for harsh criticism, with economist Mustafa Al-Assal saying that "it was not his function to talk about the dollar. That is up to the CBE." Al-Assal believes the statements were highly disruptive to the market, and the benchmark EGX 30 index lost around 3.5 per cent following Salman's words.
Al-Assal acknowledges that with the shrinking foreign currency reserves, the CBE has a problem.
Nonetheless, he does not believe devaluation will be beneficial to Egypt. Contrary to the popular belief that devaluation means increased exports, Al-Assal says the Egyptian economy is not efficient enough to allow for this and other factors will cause the value of exports to drop.
He said devaluation would only be beneficial to exporters and investors if it came with a battery of reforms, including reduced red tape and better infrastructure.
Another banker who preferred to remain anonymous agreed that devaluation alone would not attract investments. The latter would only happen as a result of reforms and the resolution of pending disputes, he said. If there was not enough production and improved living standards for all Egyptians, then devaluation would only mean that everything would become more expensive and accordingly inflation would rise.
Pharos says that if the CBE keeps the rates unchanged, "we will automatically process the decision as a sign of an imminent and steep pound devaluation versus the dollar or a fully-fledged shift to a flexible exchange rate regime."
But the price hikes that would come with that would have serious political and social implications, Al-Assal said, "like shooting in the dark."
He said the CBE should cut 50 basis points to jumpstart the economy. A cut in interest rates would work in favour of the government, as it would be paying less interest on its borrowing from the domestic market to cover its budget deficit. Preliminary 2014/15 figures show a budget deficit of 11.5 per cent.
It remains to be seen what decisions the CBE will take. A depreciation of the pound may be inevitable sooner or later. Prime Holding expects it by the end of the year, "leading to increasing importation costs, especially after paying the government's upcoming dues in September and October, namely US$1.25 billion of maturing US-backed bonds and repaying the US$1 billion loan from Qatar, respectively."
Several investment banks expect the pound to lose more of its value against the dollar to reach LE8.20 by the end of 2015/2016 and LE8.6 in 2016/2017.
© Al Ahram Weekly 2015
