Why Rate Increase Is No Answer to 30 Percent Inflation in Egyptby
Analysts say price gains driven by costs rather than demand
Survey predicts no change at central bank meeting on Sunday
Egypt’s central bank is likely to hold interest rates on Sunday, even with inflation still soaring after the removal of currency controls last year.
Six of seven economists surveyed by Bloomberg expect the central bank to hold the benchmark rate at 14.75 percent when policy makers meet in Cairo. It last raised rates by 300 basis points on Nov. 3, the day it floated the pound as part of a plan to end a crippling foreign-currency shortage and secure a $12 billion loan from the International Monetary Fund.
Though foreign-currency reserves have surged since November, the pound has lost almost half its value against the U.S. dollar and annual inflation has risen above 30 percent, pressuring households and creating a headache for officials concerned about stability. That led to speculation the central bank would respond by raising rates, a tactic analysts say would be counterproductive because the price gains are not being driven by excess demand.
“This inflationary wave is clearly not demand-driven, it was caused by a sudden increase in costs,” said Omar El-Shenety, managing director at Cairo-based investment bank Multiples Group. That means that higher interest rates “will do little to contain it,” he said.
Consumer prices rose 1.7 percent in April from a month earlier, the slowest pace since October. Some economists saw it as an indicator that the initial shock from flotation has tapered, though they also predicted the rate will pick up again with cuts to fuel and other subsidies in the fiscal year beginning July.
The government expects inflation to average 23 percent next fiscal year, and ease to 9.7 percent the year after.
Jihad Azour, the IMF’s Middle East chief, last month highlighted interest rates as the “right instrument” to tame inflation, though he later listed them as only one option among a set of tools available to the regulator.
Egyptian authorities have also since reached a staff-level agreement with the IMF to unlock the second tranche of its loan, with the government now expecting the $1.25 billion in June. In its announcement, the lender commended Egypt’s efforts to restore investor confidence and said the central bank agrees on the need to bring inflation to single digits in the medium term.
“We are confident that the central bank has the tools to achieve this,” Chris Jarvis, the IMF mission chief for Egypt, said in the statement.
Though not a view he shares, the most compelling case for a rate increase is Egypt’s negative real interest rate, or the gap between inflation and the highest 20 percent deposit rate available from lenders, said Mohamed Abu Basha, an economist at investment bank EFG-Hermes.
“When real interest rates are negative, there are always expectations that prices will go up,” he said. “A positive real rate helps to keep inflation expectations in check."
“An appreciation in the pound will probably have a bigger impact on inflation than any adjustment in interest rates,” he said, adding that the local currency would strengthen if part of the surging foreign investment in Egyptian Treasury bills was allowed to reach the open market.
Proceeds from foreign buyers are currently kept in a fund to guarantee investors can repatriate their money if they choose.
The bank’s last rate increase has already achieved its objectives of boosting the attractiveness of the pound after the float, and encouraging saving over consumption to control inflation, according to Radwa El-Swaify, head of research at Cairo-based Pharos Holding.
“Bank deposits have already grown significantly since November," she said. "A further increase will not attract much money from outside the banking system."
But Bilal Khan, senior economist at Standard Chartered Bank in Karachi, said the central bank should tighten on Sunday, because while inflation is being driven by cost factors, other indicators -- including rising domestic credit -- suggest the economy still faces excess liquidity.
It should do so by raising rates, he said, though he added that it could also achieve the same effect by adjusting the reserve requirements for banks or the rate at its deposit auctions. Khan expects the bank to raise its benchmark rate by 50 basis points, the only economist in the survey predicting an increase.
“While monthly inflation has dropped to 1.7 percent, this is still a high rate six months after the devaluation,” he said. “Combined with the need to anchor inflation expectations and avoid inflation from becoming entrenched, a tightening of monetary policy is needed."