Wednesday,24 April, 2019
Current issue | Issue 1364, (12 - 18 October 2017)
Wednesday,24 April, 2019
Issue 1364, (12 - 18 October 2017)

Ahram Weekly

Deflationary measures

The Central Bank of Egypt’s moves to increase banks’ cash reserves could help to curb inflation, reports Safeya Mounir

Deflationary measures
Deflationary measures

The Central Bank of Egypt (CBE) decided on 10 October to raise its bank reserve requirements to their former ratio of 14 per cent. This rate was applied from 2001 to 2012 before it dropped to 10 per cent after the 25 January Revolution.

In a statement, the CBE said that Egypt’s banks were showing “improved economic indicators”. Therefore, it was now appropriate to raise the banks’ reserve ratio to its previous rate of 14 per cent, it said. 

“The CBE’s decision to raise the cash reserves goes in parallel with its decision to raise interest rates. The CBE was obliged to make this call,” Hani Tawfik, former chair of Egypt’s Direct Investment Association, said. 

In its attempt to curb inflation, the CBE has raised interest rates three times since November 2016. Annual urban consumer price inflation reached a peak of 33 per cent in July, cooling down slightly to 31.9 per cent in August. The main cause behind the hike in inflation was the floatation of the pound in November 2016 followed by fuel subsidy cuts and the adoption of a new value added tax (VAT).

Increasing the cash reserves will decrease liquidity and should push down inflation rates, though it will also increase the banks’ cost of capital, Tawfik warned. He explained that while the banks were obliged to put aside 14 per cent of their cash as reserves, they would nonetheless have to pay interest on the whole sum to depositors. 

“It is a pre-emptive move to pull liquidity from the banks,” Tawfik added. It would constitute an obstacle to investment because of the rise in the cost of lending from the banks that would follow, he said.

Reserve requirements are the amount of cash a bank must hold in reserve against deposits made by customers. Bank deposits of three years or more are excluded from cash reserves. During the first quarter of the current fiscal year, there was an increase in the amount of money in circulation resulting in more liquidity. 

The aim of increasing the cash reserves is to hold cash close at hand in case a bank’s customers demand their deposits back at once. It is also a monetary policy used by central banks to pull back or increase liquidity in the marketplace, accordingly affecting the inflation rate. The more cash there is in circulation, the more demand there is for products and services, leading to inflation. 

Eman Negm, a senior economist at Prime Securities, an investment bank, believes the CBE decision is an alternative to raising interest rates — a tool also used to control inflation. She expected a decision to decrease interest rates at the next CBE monetary policy meeting on 16 November.

The CBE has said its policies aim to decrease inflation, which is why it authorised the floatation of the pound in November 2016 and has increased the interest rates on deposits since then several times to reach seven per cent.

According to a 28 September statement by the CBE, when it kept interest rates unchanged a contractionary monetary policy was necessary to achieve targeted inflation rates. At the same time, the CBE’s open market operations resulted in absorbing local liquidity.

Hiking the banks’ reserve requirements was an expected move, according to Negm. She pointed out that the International Monetary Fund’s first review of Egypt’s economic reform programme had recommended that the CBE stop increasing interest rates and increase the banks’ reserve requirements.

She expected the decision to last until inflation rates reached 13 to 14 per cent, as targeted by the CBE.

The writer is a freelance journalist.

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