Does the dropping inflation give CBE opportunity to raise interest rates?

Hossam Mounir
10 Min Read

Egypt’s increasing inflation subsided in April 2023, after several successive rises that reached their climax in March 2023, recording its highest level ever. Will this brief drop give the Central Bank of Egypt (CBE) the chance to raise interest rates in its monetary policy meeting next Thursday?

The Monetary Policy Committee (MPC) of the CBE will hold its third periodic meeting in 2023 to discuss the fate of the bank’s basic interest rates, which are the most prominent indicator of the Egyptian pound’s interest rate in the short term.

On 30 March, the MPC decided to raise the basic interest rate at the CBE by 2% to 18.25% for deposits, 19.25% for lending, and 18.75% for the credit and discount rate and the price of the main operation.

The committee stressed in a statement that the widespread rise in inflation requires more monetary restraint, not only to contain inflationary pressures from the demand side, but also to avoid secondary effects that may result from supply shocks, in order to control inflationary expectations of prices.

Last week, the CBE revealed that the consumer price index recorded a monthly rate of 1.7% in April 2023, compared to 2.4% in April 2022, and a monthly rate of 2.5% in March 2023.

The CBE indicated that the annual core inflation rate recorded 38.6% in April 2023, compared to 39.5% in March.

The Central Agency for Public Mobilization and Statistics (CAPMAS) also revealed that the annual inflation rate in Egyptian cities had declined to 30.6% in April 2023, compared to 32.7% during the previous March.

The monthly urban inflation also declined to 1.7% in April, compared to 2.7% in March.

According to the agency, the CPI for the whole country reached 169.6 points in April 2023, recording an increase of 1.8% compared to March 2023.

The agency indicated that the annual inflation rate for the entire republic was 31.5% in April 2023, compared to 33.9% in the previous March, 14.9% in April 2022.

The CBE confirmed earlier that restricting monetary policy is a prerequisite for achieving the target inflation rates of 7% (±2%) in the fourth quarter of 2024 and 5% (±2%) in the fourth quarter of 2026.

Hassan Abdallah, Governor of the CBE, said in his statements that Egypt had taken huge measures to mitigate the repercussions of the Corona pandemic and the Russian-Ukrainian war on the Egyptian economy, and he said: “We are ready to take more measures.”

On the sidelines of his participation in the annual spring meetings of the IMF and the World Bank in Washington, he said that the main focus of the CBE in the current period is to curb inflation to a range between 5% and 9%, by the fourth quarter of 2026.

He pointed out that the CBE was analyzing different models to understand the motives behind inflation figures. The analysis showed that high inflation in Egypt was not only driven by commodity prices, but also by supply-side problems such as the recent accumulation of imports (at ports) that resulted from previous policies.

Abdallah stressed that the CBE did not and will not hesitate to use monetary policy to deal with inflation.

The CBE governor noted that since March 2022, Egypt has raised key interest rates and devalued the local currency, and “those were important steps.”

He also explained that the CBE and the Ministry of Finance have daily coordination between fiscal and monetary policies in order to face the ongoing economic challenges, adding, “We work closely with the Cabinet and we have all the support from the political leadership.”

Banking expert Mohamed Abdel-Aal believes it is difficult to predict interest rate trends during the coming period.

Abdel Aal said: “As we live in harsh economic conditions and suffer from an unprecedented rate of inflation, the reaction of the monetary authority in most countries of the world is usually to use the most important and well-known tool to combat inflation, which is raising interest.”

He continued: “This is what has already been done through the succession of crises in the last three years, including Europe and the United States of America. This tool was also used in Egypt with the beginning of the implementation of the economic reform program and the repercussions of the Corona pandemic, and also to contain the inflation that prevailed during the period of repercussions of the Russian-Ukrainian war.”

The interest rate was raised by a total of 10% over the course of a year, during the last five meetings, the first of which was on March 21, 2022 and the last on March 30, 2023, when the interest was raised by 200 basis points to 18.25% for deposits and 19.25% for lending.

Abdel Aal asked whether the contemporary economic conditions that the country is dealing with require continuing to use the policy of raising the interest rate, with the aim of containing inflation. He wondered if other mechanisms could be better suited for this phase. 

“In my opinion, the mechanism of raising the interest rate will not help in the short and medium term in addressing the current situation related to Egyptian inflation, which now seems immune to the mechanism of raising interest, and has become more affected by other factors such as exchange rate variables first, and the rise of everything imported. In addition, because we import much more than we export, raising interest exacerbates the trade deficit, and of course the increase in the cost of financing the budget deficit. All of these are indicators that put pressure on the exchange rate, and because there is an inverse relationship between inflation and the exchange rate, any devaluation means a rise in the rate of inflation, assuming other factors remain constant,” he explained.

He went on to explain that the effectiveness of the interest rate mechanism in containing inflation locally, and after a long period of its use, may not be the best method currently,” according to Abdel-Aal.

He also pointed out that saying that most countries in the world are still continuing to pursue interest-raising, and they are trying to contain inflation and bring it down to its set targets, is unfounded, because the use of this mechanism requires that a favorable financial and monetary infrastructure be available to them, but the economic conditions and problems in Egypt are different from the conditions and problems of other countries that are continuing their attempts to confront inflation by raising interest rates.

“We differ relatively from those countries in the extent to which the interest-raising mechanism is able to influence at an appropriate time the volume and changes in credit, and the structure of the economy must be sufficiently flexible, allowing changes in interest rates to bring about a targeted change in prices, wages, income, production and employment. It also requires that the liquidity resources of commercial banks be within limits that necessitate the need to carry out discount operations in an appropriate size, and then the effect will be tangible in cases of raising interest,” said Abdel-Aal.

 He continued, “We agree with banking experts that the policy of raising interest may not work at the macroeconomic level in both its monetary and financial aspects, and therefore it could be expected that the monetary authority will use other mechanisms along with the interest rate mechanism when possible. Abdel-Al stressed that it is important to point out that addressing the existing deficit in net foreign assets is important, because this deficit represents an indirect increase in domestic liquidity “money supply”, and there may be a tendency to tighten the conditions for granting bank credit, especially in consumer financing activities.

“Predicting the committee’s decision this time, and actually every time, is very difficult. I believe, however, a “fixation” will be the most likely decision,” said Abdel-Aal.

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