Three Charts Show Egypt’s Dilemma as Central Bank Meets on Ratesby
Analysts say costs to finance budget may prevent tightening
Prices have surged since central bank devalued pound in March
Soaring inflation and a long-running dollar shortage suggest Egypt’s central bank has ample reason to raise interest rates when officials meet on Thursday. On the flip-side, doing so would increase interest payments for a government trying to plug a hole in its finances.
A Bloomberg survey shows economists are split, with three predicting a hold and three predicting an increase to the benchmark rate.
These charts illustrate the bank’s dilemma.
The central bank raised Egypt’s key interest rate by 1.5 percentage points to 10.75 percent in March, days after weakening the pound by the most in over a decade in a bid to end the currency black market and attract foreign investment. It also said it would adopt a more flexible exchange rate regime, a promise that is yet to materialize.
The downside of the devaluation was clear by May. Annual core inflation, a measure of price increases of non-volatile consumer goods, reached 12.23 percent, the highest level since 2009, from 9.51 percent in April. On the black market, the Egyptian pound still traded at 10.96 per dollar, compared to the official rate of 8.88.
Government measures to boost revenue are also expected to raise prices, including further cuts to electricity subsidies and the implementation of value-added taxation. The central bank will probably raise the key rate by 50 basis points to try to peg back inflation, which may reach 15 percent in the second half of the year, said IHS Global Insight director Bryan Plamondon.
In its monetary policy committee meeting on April 28, the central bank kept rates unchanged in expectation of a “lagged effect” from the March increase. The bank said in December it aims to avoid “double-digit inflation rates over the medium term.”
The government’s budget deficit makes a further raise difficult. Even with planned revenue-saving measures, economists expect it to be 11 percent of gross domestic product in the fiscal year starting July 1. Meanwhile, about a third of public expenditure goes to servicing public debt, which stood at 98.4 percent of economic output in December, according to the finance ministry.
“The government’s extremely high cost of funding is the overriding issue here,” said Hany Genena, head of research at Beltone Financial Holding. "The government is already in a dire situation. Even a 25- or 50 basis-point increase would translate into billions of pounds in extra expenses."
“Excessive money printing” has contributed to rising prices, even as oil and food prices have dropped globally, said Genena, who expects the bank to hold rates on Thursday. “It’s the mix of the dollar shortage and deficit monetization that lies at the heart of Egypt’s inflation dynamics.”
The government has borrowed about 500 billion pounds ($56 billion) from the central bank since 2011, according to official data. As of April, the government absorbed 35 percent of liquidity injected into the economy by the central bank, crowding out banks seeking to loan to businesses and households.
The central bank is unlikely to risk damaging the government’s efforts at fiscal consolidation, “given that the impact of higher interest rates on inflation is likely to be modest,” Jean-Michel Saliba, a Middle East and North Africa economist at Bank of America Merrill Lynch, said in an e-mail.