CBE Interest rates cut marks a cross-over to a new stage in Egypt’s economic reform
Last week, the government announced that the January inflation rate was at 17%, its lowest levels since the pound’s flotation. This announcement was followed by the lowering of the interest rate and progressing to a new stage in the economic reform process.
Last Thursday, the Central Bank of Egypt (CBE) announced the interest rates cut as a logical consequence of the lower inflation rates. In this article, we will try to evoke international models of reform experiments in both Turkey and Brazil. We will discuss how their monetary policy progressed along with their reforms and lessons learned in the Egyptian experience, and how we have avoided a much worse fate than those who preceded us on this path.
First: Inflation in Egypt
Finally, inflation has become a ghost from the past, after it was growing at a troubling rate for any economist monitoring the progress of the Egyptian economy.
How to determine the appropriate inflation rate for an economy?
The rate of inflation is linked to the rate of growth and volume of consumption in the market as well as variable factors, while the appropriate rate for the Egyptian economy is set at a minimum level of 6%, medium level of 10% and a maximum level of 12%.
The CBE announced its target to reach an inflation rate of 13% by the end of this year, plus or minus 3%.
On the other hand, we have to realise that inflation is not controlled by the government but is rather targeted and tamed by various instruments, mainly the bank’s set interest rate. Therefore, we regularly see in all the data presented the CBE the linking between interest rates and inflation. For example, imagine that you are in a shooting arena, inflation is the target, while interest rate is the weapon, accordingly, you do not control the target, you control the weapon and try as much as possible to accurately reach your target.
What does a 17% inflation mean?
1. This is the biggest drop and best rate since pound’s floatation.
2. This is the first time that the real interest is equal to zero and not negative since the pound’s floatation, real interest = interest on bank deposits - inflation rate
3. Egypt drops from the list of countries with highest inflation rates, which helps to improve the mental image of the economy
Second: Interest rates in Egypt
After inflation fell, the monetary policy committee of the central bank responsible for setting interest rates held their meeting last Thursday evening. The meeting did not take long as previous meetings, especially the first six months after the flotation.
Finally, and to the favour of a lot of economists, investors and think tanks, the committee decided to cut interest rate by 100 basis points or 1% to be 17.75% instead of 18.75%
Thereafter, Governmental banks (National Bank of Egypt and Banque Misr) announced the suspension of the high yield certificates of 16% and 20% interest rates and replacing them with other certificates with15% and 17% interest rates.
Third: Factors that help to reduce interest rates
Several factors and circumstances have encouraged this decision to be taken alongside the declining inflation, such as
Unemployment dropped to 11.3% from 11.9%, which is marked as the best rate since 2012.
Growth continued to increase to 5.3% instead of 5% for the fifth consecutive quarter, which is also marked as the best rate since 2010.
Fourth: why did we raise the interest rate and why did we reduce it now?
* We raised interest rate for these reasons
1. Supporting the local currency and its purchasing power and counter reduction of support and increased prices due to pound’s floatation in an attempt to curb inflation as much as possible
2. Countering over spending and curbing expenditures, forcing people to adjust their savings and reduce spending, as spending feeds inflation.
3. The temptation for foreign institutions and investors to inject their money in foreign currency into Egyptian government debt instruments which will be characterised by the high return after raising the interest and therefore they benefit from this attractive return and the State benefits from the rising liquidity to meet its obligations and strengthen the economy.
* We cut them down for these reasons
1. Purchasing power stabilised and slightly improved, inflation has receded and some goods prices have already started to drop.
2. The community and the market absorbed the shock of the pound’s flotation and reduced the subsidies and started to recover, especially after the improvement of the purchasing manager’s index issued by Emirates NBD which measures the conditions of the private non-oil producing sector in a number of countries, including Egypt, where it rose from 48.3 points to 49.9 points
3. The suffering of the private sector due to high interest rates has caused an increase in borrowing costs and thus increased the costs of investment and the establishment of new projects.
4. The desire to pursue a policy of expansionist stimulus to the economy by encouraging investment, stimulating growth and creating jobs.
Fifth: What happened in Venezuela this week?
Inflation in Venezuela has reached 4000% meaning that a commodity purchased by 1 Bolivar in the beginning of 2017, is currently worth 4000 Bolivar. These rates are unbelievable and have rarely happened in the history of modern economy.
Notes and comment:
Venezuela is not a poor country; it has the world's highest oil reserves and it is 11th globally in oil production and export revenues. The 4000% inflation rate reflects an annual inflation rate, yet the monthly inflation rate reached 84%. Meaning that every 30 days the price increases 84%, while every 35 days more than 100%, accordingly a commodity at 1000 Bolivar today will be 2000 Bolivar after only 35 days! What was previously purchased in the Bolivian currency for one million dollars 15 years ago is now bought at only $7.00 on the black market. Of course this means a catastrophic collapse in the purchasing power of the Venezuelan currency.
It is worth noting that monthly inflation in Egypt was minus 0.2% last January, which means a near-stability in the overall average price for the second month in a row. Accordingly, we must bear in mind that this is the fate that awaited us if we did not carry out the difficult and harsh economic measures taken for reform.
Sixth: the experiences of Turkey and Brazil
Brazil signed a loan agreement with the IMF in a comprehensive reform program in November 1998 worth 18 billion dollars. Turkey signed the same year with the IMF and the total tranche after several agreements reached about 45 billion dollars.
When inflation rose to nearly 100 percent in Turkey, the authorities raised interest rates from 30 percent to 100 percent in 2001, at the beginning of reforms.
Brazil did something similar when it raised the interest rate in 2000 to the 45% limit to maintain the purchasing power of the currency.
All these developments promise accessing a new stage in the economic reform process and enhances optimism towards the future being on the right track. We expect growth to continue at 5% throughout 2018, exceeding all previous governmental and international specialists speculations for the Egyptian economy’s progress.
We forecast increased investments for the private sector which will benefit from lower borrowing interest rates and promotes expansion and new investments.
The interest rate cut is likely to reach around 4% to 5% by the end of 2018, which is likely to reach 12.75% to 13.75%, which reinforces the investment path that relies on cash circulation for developing business and the economy.
Unemployment will continue to improve in-accordance with new investments, yet is still unexpected how the market will react in response to further subsidy cuts that are inevitable and will overshadow the declining inflation, accordingly it is likely that interest rate will continue to maintain its high rates to counter inflation.
We will continue to follow the indicators track for development, which so far reflects our path on the right track and reflects a stronger optimistic view for 2018, due to the unexpected success of the reform process, which gives an indicator that this year will mark the re-launch of the Egyptian economy.