Balancing interests
While some experts claim that a drastic interest rate cut is long overdue, others believe that the negative consequences should not be overlooked. Niveen Wahish reports
When the Central Bank of Egypt (CBE) cut the discount rate from 11 per cent to 10 per cent last November, observers took this as an indication that the CBE intends to push interest rates down. The discount rate is the rate which the CBE lends to commercial banks, which in turn has a direct effect on the banks' credit lending rates.
But since then, interest rates have failed to move in the desired direction. Today they average 8.5 per cent for three- month, six-month and one-year deposits. Interest rates on loans meanwhile continue to hover around 13-14 per cent.
For a brief period, interest rates on deposits fell to as low as six per cent just before the new foreign exchange regime was announced late January of this year. Following the announcement, interest rates began to climb again. Some experts had attributed the move to the fact that the CBE wanted to encourage individuals to hold onto their Egyptian pounds by offering a high interest rate compared to that for the dollar which did not surpass 2.5 per cent. A high interest rate on the local currency helps support the currency's value by encouraging individuals to keep their savings in the local currency. But despite the success of such a move during the early 1990s when Egypt's foreign exchange regime was first liberalised, the interest rate differential, which is the difference between the interest rate on the pound and that on the dollar, failed to support the value of the pound. At the current exchange rate, dollar deposits according to CBE figures reached the equivalent of LE101 million in April 2003, up from LE94 million in January.
As Mounir Hindi, a professor of finance at the University of Alexandria, put it "the dollar is no longer a currency, but a commodity with a value that increases by the day." He explained that dollar holders do not care about the interest rate. In six months the value of the dollar increased officially from LE4.6 to LE6.2, roughly a 30 per cent increase against the pound. "Using the interest rate differential does not work in a troubled economy," Hindi said.
While the reasons for maintaining high interest rates are unfounded, the next logical move, experts stress, is for an interest rate cut, particularly on loans. High interest rates have in the past couple of years increased the cost of finance for project setup or expansion. They have also been an added burden on defaulters inflating the sums they owe to banks.
According to Enayat El-Naggar, a financial consultant, "The only way to improve the value of the pound and encourage people to hold onto it is by improving the performance of the economy and that will not happen in the lack of new investments." She acknowledges the fact that interest rates are not the only factor affecting investments, "but in times of recession it is crucial to encouraging new funds to be pumped into the economy". New investments would provide job opportunities, a lack of which is currently affecting the purchasing power of individuals making the recession worse.
Because of relatively high interest rates offered by banks individuals find keeping their money in the bank a more profitable option than investing their money in a new venture. "Why risk making an investment when they receive a reasonable return on their deposits?" questioned El-Naggar.
However she acknowledged that new mediums for investment must be developed. "The bond market must be developed and people made more aware of it." She is optimistic that the activation of the mortgage law will provide an investment opportunity, but investment banks must still be created to channel people's savings into productive projects.
Until alternative investments are available, depositors' welfare should not be overlooked, argues Pacinthe Fahmy, general manager with Misr International Bank (MIBank). She believes that though interest rate cuts are a logical step, its negative consequences should not be underestimated. "There are people who live on the interest rate they receive on their deposits," she pointed out, elaborating that affecting their income will be reflected in their consumption patterns, thus aggravating the recession.
Fahmy stressed also that interest rates are not the only factor affecting investment. "Investments need economic stability and clear monetary and fiscal policies." Fahmy cited the fact that interest rates on the dollar were lowered nine times and yet investments in the US are still unsatisfactory, while in Japan interest rates are around zero per cent, but have failed to stimulate the ailing economy.
Yet, while many believe that an interest rate cut is in order, there are no signs that a cut is imminent. In fact, according to one source who preferred to remain anonymous, the CBE has lately been withdrawing excess liquidity from the market by selling treasury bills.
Excess liquidity should induce banks to encourage individuals and investors to take out loans by charging them low interest rates. Why the CBE should be trying to collect excess liquidity from the market remains unknown. Until press time, the CBE failed to respond to questions posed by Al-Ahram Weekly in this regard.
