Monday,24 September, 2018
Current issue | Issue 1276, (31 December 2015 - 6 January 2016))
Monday,24 September, 2018
Issue 1276, (31 December 2015 - 6 January 2016))

Ahram Weekly

CBE rates rise

The Central Bank of Egypt increased interest rates last week, worrying commentators, reports Sherine Abdel-Razek

Al-Ahram Weekly

The Central Bank of Egypt (CBE) raised overnight interbank rates by 0.5 per cent last week for the first time in almost a year citing high inflation and pushing the overnight deposit rate to 9.25 per cent and the lending rate to 10.25 per cent.

 The move came on Thursday, a week after the originally set date for a decision on the interest rates. The week witnessed discussions between the CBE and the government to design policies for fiscal consolidation, current account outturns, and the implementation of urgent structural economic reforms, as noted in a CBE statement.

Besides a weakening currency and declining foreign reserves, Egypt is facing an escalating inflation rate and a slow economic growth rate, a combination that makes the CBE decision look like walking on egg shells.

“Given the balance of risks surrounding the inflation and GDP outlooks, the MPC [monetary policy committee] judges that a rate hike is warranted to address inflationary pressures and anchor inflation expectations,” the CBE said in a statement.

Inflation in Egypt rose to 11.1 in November, the highest in five months. The country’s currency crisis caused business activity to contract the most in more than two years in November, according to the Emirates NBD Purchasing Managers Index.

While the economy’s growth rate came in at 2.6 per cent in the first quarter and increased to 4.5 per cent in the second quarter of last year, “the strong growth figure for the second quarter masks the fact that domestic demand was weak, and the headline GDP figure was only pulled up by a collapse in imports,” stated a note by the research firm Capital Economics.

“More timely data suggest that economic activity is still sluggish. Industrial production contracted by eight per cent in September,” it added.

The statement also noted that the CBE and the government of prime minister Sherif Ismail were co-designing policies to narrow the country’s budget deficit to “sustainable levels” and avoid double-digit inflation over the medium term.

They had also agreed to work towards reducing Egypt’s trade deficit “by initiating a strategy aimed at encouraging local production to meet domestic market needs and enhance imports substitutions,” the Capital Economics note said.

The CBE indirectly urged the public-sector banks to raise rates on three-year certificates of deposits in November as a means to support the Egyptian pound. The move to increase the overnight rates last week aimed at “passing on the defensive cost from the banks to the government and the corporate sector, primarily to ensure the participation of the large private banks in the defensive exercise,” Hany Genena, head of research at Pharos Securities, commented.

Market observers, including Genena, believe that the stability in the yields of treasury bills and bonds since November suggests that the CBE hopes to shield the government from these costs. Alternatively, the CBE may be seeking a commitment by the government to cut spending, so that raising interest rates will not have an adverse effect on the budget deficit through higher treasury yields.

Yields on Egypt’s treasury bonds rose only modestly at auction on Monday, ignoring the official rate rise, and bankers quoted by Reuters said the state banks had bid aggressively for the new debt to hold down government borrowing costs.

This was the first auction after the 0.5 per cent rate increase, and it was expected that government debt yields would increase by at least 0.5 per cent. However, the yields of treasury bills rose by less than 0.2 per cent.

The CBE statement also outlined the government’s policy mix through the new year, with main features being reducing its borrowing requirements and capping imports together with encouraging local substitutes.

The CBE tightened import regulations last week by requesting banks to open the letters of credit needed to import goods only after the importer had paid 100 per cent of the value of the imports, compared to the earlier figure of only 50 per cent.

Distortions in Egypt’s imports breakdown have been a common topic on prime time talk shows and social media, especially after the deputy CBE governor criticised statements about the high value of Egypt’s imports of lingerie and underwear. In 2014 Egypt imported $202 million worth of lingerie.

Other than capping imports and dealing with balance-of-payments distortions, the outlined policy mix, according to Genena, gives the green light for the government to push the production cost curve upwards by raising taxes, mainly VAT, and slashing energy subsidies.

It also allows local producers to pass on higher costs to consumers in the absence of competition from significantly cheaper alternatives. “So in effect the decision to raise rates is in fact a decision to pass on the cost to the consumer more than producers or the government,” Genena concluded.

What makes this argument stronger is the fact that the World Bank’s country strategy for Egypt over the coming four years underscores the importance of dealing with budgetary distortions, in other words slashing subsidies.

The Bank has said that it will offer Egypt $3 billion in loans in three instalments over the next three years. The second and third tranches of the loans will be subject to “satisfactory implementation of the multi-year reform programme,” according to a World Bank statement.

Commentators have been asking whether Egypt can maintain its protective approach to the pound forever and say that the World Bank loan together with the recent Saudi assistance package will buy the government time but will not prevent an eventual devaluation.

Saudi Arabia agreed this month to invest 30 billion riyals ($8 billion) in Egypt through its public and sovereign funds and is set to renew a deal to provide oil products to the country for five years on favourable terms. There is also talk that it might buy Egyptian local debt instead of depositing dollars in the CBE.

Egypt is facing an acute dollar crunch that is being exacerbated by the decline in tourism, causing the problem of late dues to foreign oil explorers starting to resurface.

Sources from the oil companies told Reuters that Egypt had asked oil and liquefied natural gas (LNG) suppliers to extend payment terms to 90 days after delivery instead of the usual 15 days. Short of dollars, Egypt has also cancelled the purchase of six gasoil cargoes initially scheduled for early January, oil market sources said.

However, a day after the Reuters report was published CBE governor Tarek Amer told reporters that the CBE had injected $8.3 billion into the market between 29 October and 24 December and denied that Egypt had had problems paying for energy imports.

He said the CBE had allocated $400 million in liquidity to the petroleum sector last week, but did not reveal the source of the new injections.

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