Pressures mount on CBE as IMF calls for interest rate hike to tame inflation

Elsayed Solyman
10 Min Read

When the Central Bank of Egypt’s (CBE) Monetary Policy Committee holds its monthly meeting to make a decision regarding interest rates later this month, pressures are mounting on them to hike interest rates after the International Monetary Fund (IMF) called on such a step as a means to tame the rising inflation.

Egypt’s inflation extended its rally in April, standing at 32.9% year-on-year (y-o-y), the highest in almost 30 years, according to official data released on Wednesday.

On 23 April, IMF managing director Christine Lagarde said at a press conference that Egyptian policymakers need to put special focus on inflation.

“Here is clearly a question that needs to be addressed, I would say, head on, and that is inflation. The other reforms have to continue, but there has to be a special focus on inflation. I think that the Central Bank and the finance minister of Egypt are both aware and will, I hope, tackle the inflation risk, which is weighing on the population,” Lagarde said.

“It is critically important that the Egyptian authorities and the Egyptian people actually endorse the proposals there in order to take the economy forward.”

The managing director of the International Monetary Fund (IMF), Christine Lagarde

The statement appeared to be a push by IMF officials to see Egypt increase borrowing costs to curb its high inflation rate.

Following Lagarde’s statements, IMF’s director for the Middle East and Central Asia, Jihad Azour, said in a press conference that “interest rates are the right instrument to manage Egypt’s inflation.”

Last week, an IMF delegate arrived in Cairo to conduct its first review of the reform measures and determine whether it would disburse the second tranche of the loan, which amounts to $1.25bn.

Most analysts surveyed by Daily News Egypt confirmed that raising interest rates isn’t the right way to tackle inflation and could result in more problems for Egypt’s already fragile economy.

On the other hand, some analysts believe that hiking interest rates could be the proper means to curb inflation.

Cost-push inflation

“I think the IMF’s push to raise interest rates as a tool to tackle inflation may miss the mark this time. This is a cost-push inflation, not a demand-driven one,” Reham Desouki, a senior economist at Arqaam Capital, told Daily News Egypt.

Cost-push inflation basically means that prices have been “pushed up” by increases in costs of any of the four factors of production (labour, capital, land, or entrepreneurship) when companies are already running at full production capacity.

“In Egypt’s case, the rising inflation is due to floating the pound last November, which resulted in the rise of production input costs, and companies have passed these hikes to consumers. Raising the interest rate has nothing to do with inflation,” she added.

“Austerity measures, which the government took after floating the pound, are weighing on the inflation too.”

When Egypt floated its currency last November, the government introduced a series of austerity measures, including tightening fiscal policies, reducing subsidies, and raising taxes, while also tightening its monetary policy by raising the interest rate by 3% to 14.75% for deposits and 15.75% for lending.

In an interview with Bloomberg TV last month, Finance Minister Amr El Garhy said, “This is all a result from supply shocks rather than a demand-driven kind of inflation.”

“The further rise in the Egyptian inflation last month, to 32.9% y-o-y, was driven entirely by stronger food price pressures. We think inflation is now close to a peak, and today’s figures are unlikely to prompt the Central Bank to hike interest rates at its Monetary Policy Committee meeting later this month,” Jason Tuvey, a senior economist at the London-based Capital Economics, wrote in a note issued on Wednesday.

Food prices, which account for 40% of the consumer price index (CPI) basket, rose by 43.6% y-o-y last month, compared with 41.8% in March.

“The sharp rise in inflation over the past six months can largely be attributed to the effects of a weaker pound. Since it was floated in the beginning of November, the currency has fallen by 50% against the dollar. This has pushed up the cost of imports, and firms have been quick to pass the hit on to consumers. Inflation has also been pushed up by subsidy cuts and the introduction of a value-added tax,” Tuvey explained.

Meanwhile, Mohamed Abu Basha, a senior economist at EFG Hermes wrote in a note that the CBE is likely to keep policy rates on hold at its next meeting on 21 May.

“Recent calls by the IMF to hike policy rates, focusing more on the medium-term impact of the recent inflationary shock, are likely to be subject to further investigation, with authorities looking for more effective tools to contain inflation,” he said.

“We note that we had argued that an appreciation of the USD-EGP, by allowing the market to have access to portfolio flows, would be a more effective way to ease inflationary pressures. We maintain, for now, our call for a minor, more symbolic rate hike, towards the end of year, pending more clarity on the IMF’s statement.

Limited tools

“I think raising interest rates could be an important tool that could be used by the CBE to curb inflation. They have limited tools to use here taking into consideration that there would be another wave of austerity measures,” Fred Haung, a Middle East senior economist, told Daily News Egypt.

Egypt is expected to introduce a fresh wave of new austerity measures starting next July, including cutting oil subsides and raising electricity prices.

“I think that the CBE will tighten its monetary policy until the end of the year, as it wants to absorb the liquidity in the market to curb inflation,” Haung added.

Egypt’s domestic liquidity rose by 4.68%, or EGP 123.1bn, to total EGP 2.75tn by the end of March 2017 when compared to February, the Ministry of Finance said, according to the latest data released by the (CBE).

The annual growth rate increased by 38.4% in March 2017, the ministry added.

“I think raising interest rate to tackle inflation is an important tool for the Egyptian Central Bank but it is all about the timing of using it. For the moment the tool proves less efficient to curb the inflation, but it should be used at least one time before the year’s end,” Joias Goknit, a senior economist, told Daily News Egypt.

Capital Economics said in a note issued on Wednesday that “we doubt today’s data will sway the Central Bank to hike rates. Instead, we think the next move in interest rates is likely to be down, albeit not until the end of this year.”

Debt piles up and cost borrowings are at stake

“Rising interest rates will weigh on the borrowing costs of the Egyptian government; monetary and fiscal policy makers are taking this matter seriously,” Ramy Orabi, a senior economist at Pharos Holding, told Daily News Egypt.

The government estimates debt servicing for the current fiscal year to reach EGP 292.5bn, representing 30% of total expenditures, compared to EGP 173bn in FY 2013/14, which represented almost 25% of total expenditures.

“The government has expressed its wariness about service debt cost, which should reflect in its monetary and fiscal policies,” Orabi added.

In its budget statement for the next fiscal year due to start in July, the government said that “the possible rise in US interest rates would make it more attractive to foreign investments from all over the world, which lowers Egypt’s chances of getting credit at reasonable borrowing costs.”

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