Egypt Seen Raising Rates to 11-Year High After Inflation Surge

  • Price growth at seven-year high before expected boost from VAT
  • Economists also predict second currency devaluation this year

Egypt Seen Raising Rates to 11-Year High

Egypt’s central bank will likely raise its key borrowing costs to the highest level in more than a decade, as it tries to curb surging consumer prices amid growing speculation of another currency devaluation to ease the country’s dollar crunch.

The Monetary Policy Committee will raise the benchmark overnight deposit rate by 50 basis points to 12.25 percent, the highest since at least 2005, according to the median estimate in a Bloomberg survey. Four of seven economists predict an increase, ranging from 25 to 100 basis points, while none forecast a cut. Inflation accelerated to 15.5 percent in August, the highest level since at least 2009.

The meeting comes before an imminent $12 billion International Monetary Fund loan to finance a government program that seeks to restore investor confidence. But steps including lower electricity subsidies, a new value-added tax and weaker currency risk exacerbating Egypt’s economic hardship, at least initially, because they are expected to push inflation even higher.

“Higher inflation will be the cost of aggressive reforms in the short-term, and we believe it a reasonable price to pay for much needed policy actions lifting the overhang on Egypt’s economy,” said Reham El Desoki, senior economist at Dubai-based Arqaam Capital. The bank may raise rates by one to three percentage points “to attract investors and help curb inflation stemming from the fiscal reforms, and from a devaluation that we expect to happen soon,” she said.

Luring Investors

The central bank raised borrowing costs by 1.5 percentage points in March -- days after it weakened the Egyptian pound by almost 13 percent and promised to adopt a more flexible exchange regime -- as part of a strategy to attract foreign investors. It increased the benchmark by another percentage point in June.

So far, the measures haven’t led to the return of even a small portion of the more than $10 billion of foreign-held treasuries withdrawn from the country following the 2011 uprising against former President Hosni Mubarak. Egypt’s international reserves of $16.6 billion are still about 50 percent below their pre-2011 levels, while the pound has been trading on the black market at about a 30 percent discount to the official rate against the dollar.

That’s led to speculation the bank is preparing a repeat dose.

The new VAT will add about 2 percentage points to inflation, and the central bank may "want to lay the ground for an upcoming Egyptian pound adjustment" as the government closes in on the IMF deal, said Mohamed Abu Basha, a Cairo-based economist at EFG-Hermes who predicts a rate increase of 50 basis points.

Funding Boost

Egypt is making “very good progress” in filling the funding gap of $5 billion to $6 billion stipulated by the IMF, Deputy Finance Minister Ahmed Kouchouk said on Monday. If approved, it would be the IMF’s largest-ever assistance package in the region.

Higher rates will put further pressure on the state budget, where interest payments already account for about a third of expenditure and about 67 percent of tax income, according to official data. Average yields on Egypt’s 12-month notes rose to 16.4 percent this week, the highest since Bloomberg started tracking the data in 2006.

The government is mitigating the impact by diversifying funding sources, Kouchouk said, including borrowing from the World Bank and selling international bonds. Officials plan to narrow the budget deficit to 9.8 percent of gross domestic product in the current fiscal year, down from about 11.5 percent last year.

    Before it's here, it's on the Bloomberg Terminal.