Intertwined factors will set fate of interest rates, exchange rate, FX reserves, inflation in 2019: Analysts, bankers

Hossam Mounir
27 Min Read

Analysts and bankers said there are mixed factors that determine the fate of interest rates, the exchange rate, the future of foreign exchange (FX) reserves, and inflation in 2019.

The analysts’ expectations, which were polled by Daily News Egypt, showed that interest rates will be stable until the second half (H2) of 2019, then likely to decline by 2-4%.

The Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) will hold eight meetings this year: 14 February; 28 March; 23 May; 11 July; 22 August; 26 September; 14 November, and 16 December.

In 2018, the MPC held eight meetings. In the first two, in February and March, interest rates were cut by 2% to 16.75% for deposit, 17.75% for lending, and 17.25% for credit, discount and main operations.

The key interest rates remained stable during the following six meetings that year.

Analysts also forecast that inflation will be at 10-14%, while some expect it will be up to 17.8%.

In December 2018, the CBE said it eyes inflation of 9% ± 3%, which puts it to 6-12% by the end of the last quarter of 2020.

In May 2018, the CBE said it perceived an inflation of 13% ±3% (10-16%) in the last quarter of 2018, which was realised when the inflation at the end of that year settled at 12% and 8.3% for core inflation.

According to CBE, the target was hit in May 2018 when headline annual inflation recorded an average of 15.1% in the fourth quarter (Q4) of the year.

Analysts also believe that the exchange rate of the Egyptian pound to the US dollar will remain stable in 2019 and will move in a very narrow range, while others said the greenback may be changing hands at EGP 17.25-19 until the end of the year.

According to the CBE, in 2018, the exchange rate was stable at EGP 17.65840-17.8534 for buying and EGP 17.7838-17.9738 for selling.

The fate of the FX reserves, analysts say, depends on the FX resources that will enter Egypt, and in return the amount of repayments it will make to external debt and obligations.

The FX reserves at the CBE reached $37bn in the beginning of 2018 then climbed to its highest record in November 2018 hitting $44.513bn.

However, the reserve ended 2018 with a $2bn decline when the CBE paid external debt instalments and external obligations, to fall to $42.551bn.

Interest rates to remain stable to the Q3 of 2019

Mohamed Abdel Aal, a member of the board of directors of the Suez Canal Bank and the Arab Sudanese Bank, said that the CBE will implement the same strict monetary policy to maintain the interest rates at the same level of 16.75% for deposit, 17.75% for lending, and 17.25% for core operations and discount.

Abdel Aal pointed out that the policy adopted by the CBE in 2018 has largely succeeded in achieving the target inflation that has already been set, which is 13% ±3% at the end of 2018. It also helped put the CBE on the right track to 9% ±3% to the Q4 of 2020.

There are several reasons and factors calling on the CBE to continue to maintain a high interest rate within 2019 or at least to the beginning of the Q3, according to Abdel Aal.

He explained that among these factors, maintaining the attractiveness of the exchange rate, so that the Egyptian pound has a positive interest difference between it and other currencies, especially the US dollar and the currencies of other emerging countries, as well as to face any possible inflationary pressures due to the lifting of subsidies off of fuel. The mechanism of liberalisation of the price of fuel is in its early stages on gasoline 95, which will be implemented in April 2019, but it will have a small effect on inflation.

He added that the CBE may also keep interest rates high to maintain a reasonable real return above the inflation rate for households’ deposits and savings, and also to ensure that the monetary policy is successful in targeting the new inflation rate until the end of 2020, as well as to cope with high interest rates in other emerging economies.

Moreover, the CBE may also maintain high interest rates to counter rising interest rates on the US dollar and to maintain the attractiveness to investment flows from foreign investment funds and hedge funds in Egypt’s public debt instruments.

“Interest rates are expected to continue as they are until the beginning of the Q3 of 2019 and for the CBE to ease its deflationary policy and turn into a gradual easing policy, thus reducing the interest rate at the beginning of the Q3 by 2%, followed by another 2% cut in the Q4 to stimulate economic activity,” Abdel Aal said.

FX Reserves are $42-$46bn

As for FX reserves, Abdel Aal predicted that the rate of FX inflow will be stable in 2018, where the Suez Canal achieved revenue increases by 15%, hitting $5.7bn, while remittances of Egyptians working abroad recorded $26bn.

Abdel Aal expects that the reserves will reach $42-$46bn in 2019 according to the imports size and other sovereign financing needs.

He added that these expectations come in light of the recovery of tourism revenues and the expectations of lower imports bill, as a result of the decline in oil prices and prices of strategic goods and imported inputs of production, as well as the expectation of Egypt to receive new tranches of the International Monetary Fund (IMF) loan, in addition to wanting to cover eight-months’ worth of imports.

Inflation of 12%-14%

Abdel Aal expects an inflation rate between 12% and 14% in 2019, and for the MPC to reach its target for inflation at 9% ±3% in 2020.

Furthermore, Abdel Aal said that the strict monetary policy of the CBE achieved its target by the end of 2018, then introduced a new one to be achieved in 2020.

“Despite expectations that some inflationary pressures will occur in mid-2019 by removing fuel subsidies, other opposite factors can offset these expected inflationary waves, where we expect the price of domestic and imported basic commodities that affect inflation to decline,” Abdel Aal said.

Exchange rate of EGP 17.25-18.5 to the dollar

Abdel Aal expects a stable exchange rate at EGP 17.25-18.5 in 2019.

According to Abdel Aal, the pound is not expected to face pressure in 2019, as economic engines continue to perform well, and FX reserves continue to rise, in addition to a lack of increased imports bill, the success of the float of the pound in 2016, and the attractiveness of the interest rates on the pound.

A year full of challenges and pressures on central banks

Tarek Metwally, former deputy managing director and member of the board of directors of BLOM Bank Egypt, said that 2019 will be a challenging year at both the domestic and international levels, increasing pressure on monetary policy makers and central banks.

He added that there is fear that current policies will lead to an inflationary recession. It is therefore time for Egypt to focus on increasing productivity, which is the next step in the economic reforms, to create more jobs and new markets, reduce poverty rates and start the era of the fourth-generation industrial revolution, in addition to creating non-conventional solutions to fight inflation, other than the use of the weapon of high interest rates.

According to Metwally, talk about the future outlook for interest rates and the exchange rate of the pound against the dollar and inflation is difficult, in light of the volatility of global markets, especially emerging economies, and the trade war between the major countries, such as America and China on the one hand, and between America and the European Union on the other. The US policy is hiking interest rates on the dollar in 2019, but at a slower pace, which would impact the movement of funds and investments and stock markets globally. 

He pointed out that there are internal factors that also affect any future expectations, namely the continuation of the economic reform programme, the liberalisation of energy and fuel prices, the plan of reforming subsidies and transferring them to cash support, as well as the persistence of high inflation rates during the previous two years, and the public debt service that eats up the bulk of the revenue.

Interest rate cut is more likely in H2 of the year

Metwally sees a cut in the interest rate in 2019 is viable, especially in H2 of the year, projecting the cut to be 2%-3%, as long as inflation, FX rate, and hard cash inflow, continue improving.

As for the exchange rate, which has come to have a major role in determining the interest rate trends next to inflation, it should move to EGP 17.5-19 in 2019 in light of the need to attract more money to invest in government debt instruments, after the sharp decline which recently exceeded $8bn, as well as in view of the modest indicators of foreign direct investment, mostly directed to the oil and gas sector away from industrial, agricultural, and services sectors.

Reaching single digit inflation is difficult

As for inflation, Metwally believes it will move around 12%-14% until the end of 2019, which will fall below the previous targets of single digit inflation in 2019.

He pointed out that these expectations come in light of the continued real political will to implement the programme of economic reform in full, and the required full liberalisation of energy and fuel prices, taking into account external conditions.

Moreover, he expressed his reservations about the policies adopted in the fight against inflation, which depends heavily on the interest rate, which led to a stable high interest rate for over two years, which in turn affected the state budget and debt service.

Additionally, he pointed out that this has caused us to turn in a vicious cycle between high inflation and fear of the exchange rate, the attractiveness of the interest rate to attract foreign investment to government debt instruments, thus increasing the burden of the budget and public debt and its service and the impact of what is happening in emerging markets (EMs). “We are in a circle waiting for all factors to improve. This calls for new non-conventional tools,” he stressed.

As for the FX reserves, Metwally believes that its arrival to $42bn and coverage of six-months’ worth of imports in December 2018 is very good, given the current circumstances.

He stressed the importance of increasing the reserves from real resources of FX, not through borrowing, noting that although borrowing was acceptable with the beginning of economic reform, it is no longer acceptable now, with external debt levels reaching a high level, increasing its cost and pressure on the budget.

2% drop in interest rates

Zakaria Salah, a banking expert, predicted a 2% drop in interest rates in H2 of the year.

With regard to FX reserves, Salah believes the fall in reserves in December 2018, can be offset through the remaining tranches of the IMF loan.

Salah also predicts the stability of exchange rate in 2019, as imports are tightened and exports are hiking, which would also improve the balance of payments.

According to Salah, a slight increase in the rate of inflation is expected, as a result of the government’s move to completely lift fuel subsidies.

Crucial factors in determining interest rate expectations

Hany Aboul Fotouh, a banking expert, sees decisive factors in setting interest rate expectations in 2019.

He explained that the first of these factors is to reduce the annual rate of basic inflation, which fell from 33% in July 2017 to 7.9% in November 2018, as well as to strike a balance between encouraging investment and maintaining Egypt’s competitiveness in world debt markets.

Furthermore, he stressed that the impact of hot money outflow from the Egyptian debt market is due to rising interest rates in EMs, as well as the effect of raising the interest rate on the dollar, which cannot be ignored, in conjunction with the reduction of interest rates on domestic debt instruments, which may provide an incentive for foreign investors to transfer their investments to the dollar zone.

“There is no doubt that there is a difficulty in the private sector to access bank financing at an appropriate cost, as the price of lending exceeds 18%, and therefore it should be considered by policy makers so as not to harm the local investor,” according to Aboul Fotouh.

“As the government is the largest borrower from banks, monetary policy makers must consider that the stability of interest rates at high levels is a major burden on the public budget, because the government will direct a large part of its resources to repay the debt and its benefits,” indicated Aboul Fotouh

FX reserve

The CBE announced the decline of its FX reserves by about $1.963bn in December 2018 against the background of the payment of external obligations.

He noted that this was the first decline in two years, adding that the reserve went through very difficult stages, falling to $16.687bn in June 2014, then rising slowly to $44.513bn in November 2018, which is very high in accordance with international standards on FX reserves.

He pointed out that the rule of the central banks is usually to keep FX reserves covering at least three months of imports in foreign currency, but in Egypt the reserves cover eight months. In addition, external financial inflows, such as direct investments and stock market investments require the state to have equal value for its hard cash commitments.

According to Aboul Fotouh, the fate of the FX reserves during 2019 is linked to the CBE’s policy of restructuring its components to be longer-term, as well as providing foreign currency commitments to national projects and paying off other liabilities.

Furthermore, he pointed out that in light of the improved performance of the Egyptian economy and the growth of FX reserves, the stability of the pound exchange rate against the dollar is expected during 2019 and could yet suffer a new limited depreciation by the end of the year.

“Inflation in Egypt is expected to be under 10% at the end of 2019, as optimistic estimates indicate 9% inflation in the coming two years,” he said.

“To achieve these expectations, the government must play a strong and effective role in controlling markets and protecting consumers from harmful trade practices such as monopoly. A fair and orderly competitive environment should also be created to help reduce prices and reduce inflation,” elaborated Aboul Fotouh.

No movement in corridor rates

Monette Doss, equity analyst, banking & macro at HC Brokerage, said that they expect no movement in corridor rates over 2019 so they expect the CBE to maintain overnight deposits and lending at 16.75% and 17.75%, respectively, throughout 2019.

“We expect the exchange rate to average EGP 18.9 to the US dollar over 2019, implying that it will reach EGP 19.8 / USD by December 2019.”

HC also expects inflation to average 17% over 2019.

“We believe improved current account dynamics coupled with higher momentum in private investments should drive GDP growth. Egypt’s current account will almost breakeven in FY 20/21e, according to our estimates, on tourism receipt reaching pre-revolution levels, stable growth of Suez Canal revenue, and remittances channelled through the official banking sector. Their rebound has already been rejected in a dispute current account deficit at $5.9bn in FY 2017/18 compared to a deficit of $14.4bn a year earlier, according to data released by the CBE.”

HC added they also expect the recent massive oil and gas discoveries to result in shifting Egypt to become a net energy exporter by FY 2020/21e and attract foreign direct investments (FDIs). This should also be further aided by the government’s current efforts to pave the way for a more favourable regulatory environment for production sharing agreements with foreign oil companies operating in Egypt. With planned government investments in renewable energy projects and the construction of new cities such as the New Administrative Capital and Al Alamein, HC expect economic growth to reach 5.5% in FY 2018/19e, in line with the IMF estimates. In the following years, HC expects the private sector contribution to increase as the CBE reserves monetary easing and the government’s partial asset sale programme gains traction.

Perceived conflicts, inflationary pressures, delayed monetary easing, and effects of potential EGP depreciation should subside on tenant fundamentals. “In our opinion, we expect renewed inflationary pressures by June 2019 as the government will undertake another round of subsidy cuts, possibly raising energy prices by 40% -50%, after which we expect oil price indexation to be applied,” it added.  “We forecast inflation will average 16.8% in FY 2018/19e on the anticipated moves. As the economy absorbs the price shock, we expect the CBE to resume monetary easing and cut policy rates by 250 bps in H2 of 2019/20e before making another similar rate cut in H1 of 2020/21e. Applying our inflation forecast to a real effective exchange rate (REER) model yields 9% EGP depreciation by December 2019. Despite pinpointed medium-term challenges, we believe the economic fundamentals remain intact and expect the government to achieve its budget deficit target of 8.6% of the GDP in FY 2018/19e, respectively, international oil price movements, and, on our estimates, to narrow further to 6.4% the following year. On our numbers, domestic debt should decline to 80% of the GDP in FY 2018/19e from 84% last year due to successful fiscal consolidation. Also, accounting for expected external debt repayment and planned issuance of new debt, we expect external debt to decline to 33% of the GDP from 37% currently.”

Moreover, carry trade is still an attractive schedule potential for further EGP devaluation. Due to recent global monetary tightening, Egypt has seen total portfolio outflows of about $8.1bn since March from its treasuries market, with total foreign holdings declining to $13.1bn in September 2018. HC added that these outflows were mainly funded by the banking sector, which saw its net foreign asset position of $4.1bn in March shift to a net foreign liability position of $3.9bn in September. “This, in our view, coupled with IMF reserve management guidelines limiting the CBE’s ability to intervene in the interbank system, supports our view of another upcoming round of EGP devaluation. Despite recent global monetary tightening, we see 1-year T-bill rates stabilising at 19% in H2 of 2018/19e from an average 17.8% over the same period last year. We have already seen yields cool off to 19.78% from a high of 19.88% because of increased liquidity in the pickup in corporate borrowing. Despite the potential of further EGP devaluation, we believe carry trade is still attractive at these levels given resilient fundamentals. That said, we expect some $3.1bn in foreign portfolio inflows in FY 2018/19e,” it concluded.

Inflammatory shocks

Beltone believes inflationary pressures will remain subdued over H1 of 2019.

It added that they do not see any triggers to inflammatory shocks, at least over Q1 of 2019. It noted that despite starting the automatic fuel price indexation mechanism for gasoline 95, prices are fixed till March.

“We still expect an average increase of 20.6% in all petroleum products prices, following the implementation of the mechanism on other products towards the end of Q2 of 2019, where we expect a 2.5%-3.5% addition to headline inflation. We believe the low headline reading in December 2018 can accommodate inflation to remain within the 14%-15% range following the move, which implies lower inflationary pressures in H2 of 2019 than previously expected,” Beltone said.

“We reiterate our maintained interest rates call in FY 2018/19e; yet, there is room for a cut upon several checks,  the normalisation of headline inflation affirms the CBE’s view of contained inflationary pressures and partnerships Q4 of 2018 average (15.1%) to the targeted zone at 13% (+/- 3%),” Beltone noted.

As inflation outlook will remain a hostage to the uncertain trajectory of oil prices, and amidst the tight global and regional monetary policy, it reiterates the view of stable interest rates in FY 2018/19e and a possible cut by end of 2019, depending on the spill over of the increase in energy prices. “Meanwhile, the new inflation low, for the first time since the EGP float, may open the door for an earlier cut that will depend, in our view, on many factors: i) January inflation reading to confirm the downward trend, even as food volatility dissipation ends; ii) foreign outflow from the fixed income in December to assess its magnitude, which we expect to slow down in 2019; and iii) depletion in banks’ NFAs in December, which we expect to remain within $1-2bn average depreciation rate, eliminating the need to support the local currency. We reiterate our view that treasury yields will remain persistently elevated, above the pre-interest rates cut, disregarding interest rates policy direction for various other reasons,” it concluded.

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