Photographer: Shawn Baldwin/Bloomberg

Egypt Stocks Drop Most in World After Surprise Rate Increase

  • Central bank sees inflation risks despite monthly rate decline
  • IMF said last month taming inflation was policy priority

Egyptian stocks fell the most in the world on Monday after the central bank unexpectedly raised interest rates to contain surging prices, a month after IMF remarks that were seen favoring higher borrowing costs to tame inflation.

The EGX 30 Index closed down 2.5 percent, the most among indexes tracked by Bloomberg. The Monetary Policy Committee raised the benchmark overnight deposit rate by 200 basis points, or two percentage points, to 16.75 percent, the bank said late Sunday. The lending rate was also raised by the same amount to 17.75 percent. All but one of the seven economists surveyed by Bloomberg had forecast the rate to stay unchanged.

The pound has lost almost half its value against the U.S. dollar since the government removed restrictions on the currency in November and raised interest rates by 300 basis points. The move helped finalize a $12 billion loan from the IMF and encouraged new international investments. Authorities also introduced value added taxes, and raised the price of subsidized fuel. While those steps won praise from investors, they also helped push the inflation rate to over 30 percent -- its highest level in decades.

In justifying the decision, the MPC said that while the decision to raise borrowing costs in November had helped contain “underlying inflation excluding supply shocks,” the balance of risks related to the inflation outlook “has tilted more strongly to the upside with recent economic and monetary data releases pointing to strengthening demand-side pressure.”

‘Right Instrument’

The move comes a month after the IMF said curbing inflation should be Egypt’s top priority. The fund described interest rates as the “right instrument” to tame inflation, though it later listed them as merely an option. The two sides reached a staff-level accord this month to unlock the second installment of the loan, with the IMF saying it was “confident” that the central bank had the right tools to achieve its target.

Raising interest rates “appears to the result of pressure from the IMF,” said Jason Tuvey, Middle East economist at London-based Capital Economics.

It also reflected the challenge confronting the government and President Abdel-Fattah El-Sisi. Officials are determined to move forward on reforms key to securing international investments, but are also mindful of the potential for unrest that could come from a surge in prices in a nation where nearly half of the almost 93 million live near or below the poverty line. El-Sisi has already pledged “protective” measures to help the poor, including increasing subsidized food rations.

Read More: IMF Seen Signaling Preference for Higher Egypt Borrowing Costs

Prices rose 31 percent annually in April. Some analysts, however, point to the slowing of the month-on-month rate as evidence that the initial shocks linked to the economic reforms have eased.

Sunday’s decision “is the textbook answer to high inflation,” said Reham El-Desoki, senior economist at Dubai-based investment bank Arqaam Capital, who predicted the regulator would hold rates. However, recent data and the “weak” impact of monetary policy decisions on inflation in Egypt “do not warrant an additional rate increase,” she said.

Some businesses also worried that the increases would stymie borrowing and undermine growth.

The rate increase “will not cause inflation to go down because it rose on currency
devaluation, not on higher demand,” said Mohamed El Damaty, vice chief executive officer of food maker Domty, describing it as a “primitive decision.”

Why Rate Increase Is No Answer to 30 Percent Inflation in Egypt

Charlie Robertson, chief economist at Renaissance Capital, said in a research note that the move “shows a commitment to getting inflation back down again.”

“Currency stability – which should be supported by the higher interest rate – will help drive down month-on-month inflation,” he wrote. “Currency appreciation should help more.”

The government expects inflation to average 23 percent in the next fiscal year, and ease to 9.7 percent the year after.

— With assistance by Tamim Elyan

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