Geopolitical events cast shadow over expectations of pound’s interest, reserve, inflation

Hossam Mounir
12 Min Read

The geopolitical events in the region surrounding Egypt cast a shadow over the experts’ expectations regarding the future of the pound against the dollar, interest rates, foreign exchange reserves and inflation in 2020.

According to a number of experts who have been polled by Daily News Egypt, these events make the prospect of the future extremely difficult, especially as they are closely related to foreign investments in government debt instruments, and oil prices, which are two major determinants in forecasting the future of the pound’s exchange rate, interest, reserve, and inflation.

This is confirmed by Mohamed Abdel Aal, a banking expert and member of the Board of Directors of the Suez Canal Bank, who pointed out that these events turn expectations into mere wishes and dreams.

Regarding the future of the pound’s interest rates, Abdel Aal said that annual inflation decreased to single digits by the end of December 2019, to reach 6.8% compared to 11.1% at the end of December 2018. This was the biggest evidence of the success of the Central Bank of Egypt (CBE)’s monetary policy in controlling inflation, and bringing it to its lowest level in nine years. The bank achieved its target of 9%(+/-3%), which paves the way for the possibility of further rate cuts -up to 200, or 300 basis points gradually- until the end of 2020.

Abdel Aal stressed that the timing of the rate cuts will not only be linked to the rate of inflation, but there is another set of interconnected factors that may advance, or delay this measure.

He explained that one of these factors is the effect of geopolitical developments on the cash flows of the Middle East region, including Egypt, and reviewing the feasibility of any interest cuts, and its relationship to the development of public debt on the one hand, and the cost of debt on the other, as any interest reduction of 1% equals EGP 10bn reduction in the cost of public debt.

He said that among the factors is the impact of any reduction on the employment ratio for deposits in banks, and the extent of its incentive for investors to borrow. Currently, the ratio of loans to deposits in banks ranges between 42 to 44%, which is a very low rate.

Also among the factors is the evolution of the yield curve on 10-year treasury bonds, the 3-month bills, and the degree of change between them, as this indicator is one of the most important determinants that members of the Monetary Policy Committee (MPC) consider when making an interest rate decision, as the committee considers the effect of any interest reduction on this curve.

According to Abdel Aal, these factors also include the evolution of the Liquidity Coverage Ratio (LCI), which means good assets that are rapidly converting to liquidity, and the extent of the impact of any interest reduction on the numerator and denominator of that ratio.

Also among the factors is the measurement of the results of the process of automatic pricing of gasoline at its next session, in light of the rise in oil prices globally, and the impact of this on inflation in the future.

“The committee may see in the next stage the possibility of reducing the compulsory reserve ratio at the CBE, as an alternative to reduced interest, or use the two together gradually, and thus return liquidity to the banks and, in turn, re-employ them, although I do not see a need for that in light of the initiatives launched by the CBE to encourage industry and tourism,” he said.

Abdel Aal stressed, “We must look at the package of cuts that occurred throughout 2019, amounting to 4.5%, and we measure and evaluate their effects on macroeconomic indicators accurately, so that the future interest rate is dealt with in a balanced manner, after having played its role in targeting inflation efficiently.”

With regard to the exchange rate, he expects the Egyptian pound to remain stable, and to continue its strong performance against other currencies, supported by the continued improvement of macroeconomic indicators, specifically the recovery of tourism, where its revenues are expected to reach $15bn this year, and the stability of the Suez Canal revenues despite the slowdown in world trade, with more growth expected in remittances from Egyptians working abroad to reach $28bn, along with improved export indicators.

“It is true that there are fears of high oil prices and its impact on the oil import bill, but it will be lessened by the increase in Egypt’s exports of natural gas, which will rise in price with higher oil rates,” he explained, noting that the prime minister took over the investment portfolio and the formation of an investment committee that he chairs to help solve the problems that face the growth of direct investment during the recent period. And if these efforts succeed, this will help the flow of more foreign exchange.

“I confirm my expectations for the stability of the price of the pound with its tendency to rise up to a balanced rate, achieving the interests of all dealers of all kinds, according to the conditions of supply and demand, where the dollar can reach a price level between EGP 14-15 in stages,” according to Abdel Aal.

Regarding the future of foreign exchange reserves in 2020, Abdel Aal believes that it is expected to grow to reach $50bn by the end of 2020.

He said it depended on several factors, including the payment of loan installments and their interest, the offering of long-term bonds to pay due debt, and the movements of gold prices included in the reserve, taking into account the provision of payments for foreign investments in government debt instruments through banks, not the CBE. Thus, the CBE would receive foreign exchange surplus and channel it to support the reserve.

As for the direction of inflation in the new year, Abdel Aal sees that inflation will be within CBE’s target of 9% (+/-3%), ranging from 7 to 9%, pointing out that some estimates raise it to 10%, but the CBE will be keen to keep it below the target level.

Tarek Metwally, a banking expert, also stressed that the expectations seem very difficult, in light of the current tensions and turmoil in the Middle East, and their repercussions during the coming period, and the extent of their exaggeration or curtailment.

He said he will assume that the impact of this crisis is short-term and limited-impact, and reason and interests will be prevalent to avoid the devastating effects on the region and the world. Based on the best scenario, which is the calm of the situation in the region, Metwally expects the CBE to continue the policy of monetary easing, and to reduce the interest rate on the pound to levels less than 10% during 2020, to encourage investment, production, and employment, and in line with the initiatives launched to revitalise the markets. This comes in light of the decline of inflation rates, as well as facing any possible contraction or slowdown during the coming period.

Regarding the exchange rate, Metwally explained that the coming period is expected to be characterised by fluctuation in the movement of the dollar, as it will remain within EGP 15.5-16.5, due to internal challenges to the success of the second stage of the economic reform programme, which requires attracting more direct investments, increasing production and export, reducing the trade balance deficit, ensuring the sustainability of growth and foreign exchange sources, and reducing dependence on investment in domestic debt instruments.

As for the direction of inflation, Metwally expects a further decline in it, in light of the appearance of signs of a slowdown in the movement of the market, which helps the monetary policymaker to have more flexibility in reducing interest rates.

He said that all the above have a direct impact on the cash reserve in light of the growing rates of tourism and investment in domestic debt instruments with a slight growth in Egyptians’ remittances and the Suez Canal revenues.

Metwally believes that the export rates still need more work to make leaps during the coming period, noting that in light of these factors, the foreign exchange reserve is expected to move between $45-$47bn by the end of 2020, which is an acceptable rate in light of the challenges and conditions in the region.

He noted that if the conflict develops in the Middle East region, regarding the Libyan-Turkish and the American-Iranian crises, it will have an impact on the economies of the region, including Egypt.

Monette Doss, vice president of research at HC Securities, expects general stability in foreign reserves over 2020 supported by sustainable foreign currency inflows from tourism, oil import savings, and potential expansion in oil exports.

Doss believes that Egypt’s sovereign debt will continue to attract carry trade due to the positive real interest rate offered.

During 2020, the Egyptian government is due to repay some $11bn in foreign currency debt, the bulk of which is maturing gulf deposits, the terms of which are like to be extended over another period.

In the budget, the government expects total foreign debt repayment of $3bn over fiscal year 2019-2020 which will be largely offset by planned international bond issuances of $4.5bn.

Looking at inflation differential between Egypt and its trading partners, Doss would expect 5% depreciation in the EGP over 2020.

“We ,however, believe that this could be largely mitigated by continued foreign currency inflows into the economy through its different channels,” she said.

Doss also expected interest rate cuts of 1.5-2% in 1Q 2020 and inflation to average 7.5% during the year.

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