How Will Egypt’s Increase of Interest Rates by 2% Affect its Already-Deteriorating Economy?

Egypt's central bank's decision to raise interest rates for the second time in two months, by about 200 basis points, or 2 percent, in an effort to control the country's recent inflation rate hikes, has raised questions about its implications for the economy and citizens.

At its regular meeting, the Egyptian Central Monetary Policy Committee raised the rates of deposit and lending return for one night and the price of the central bank's main operation by 200 basis points to 11.25 percent, 12.25 percent, and 11.75 percent, respectively, with the credit and discount rate increased by 200 basis points to 11.75 percent.

Egypt’s decision came after the U.S. central bank announced on May 4 the largest rate increase in more than two decades, ranging from 0.75 percent to 1 percent after an earlier increase in March.

 

Economic Deterioration

Egypt's economy faces negative consequences as a result of the Russian-Ukrainian war that broke out on February 24, 2022, and foreign investors withdrew about $15 billion from Egypt's treasury instrument markets, Bloomberg reported, 21 March 2022.

The country is suffering from widening current account deficits as import costs rise, tourism revenues dwindle, domestic and external debt, interest and premiums worsen, most economic activities decline, and Egyptians suffer severely from inflation, unemployment, and poverty

On March 21, 2022, the Egyptian government pushed for a 1 percent interest rate hike, a 14 percent devaluation of its domestic currency, and talked with the International Monetary Fund (IMF) for a potential $8 billion loan.

In an official statement, the Central Bank of Egypt confirmed that the annual rate of general inflation rose to 13.1 percent in April, from about 10.5 percent in March, the highest rate since May 2019.

The annual rate of core inflation continued to rise to 11.9 percent in April from 10.1 percent in March, the highest rate since April 2018.

In the light of the risks surrounding inflation, the Monetary Policy Committee's decision to raise core rates of return was necessary to control inflationary pressures and was consistent with achieving the medium-term price stability target.

 

Right On Paper

"The Central Bank of Egypt has sought to contain high inflation rates as soon as possible in the monetary tightening policy tool of raising interest rates," said Medhat Nafi, an economist, and advisor to Egypt's Minister of Supply and Trade.

He added in press statements that the expected inflation rate was 7 percent, which may decrease or increase by 2 percent, so the expectations were 5 to 9 percent, but inflation rates exceeded 14 percent, at the end of April.

According to data from the Central Agency for General Mobilization and Statistics, the inflation rate reached 129 points for April, a rise of 3.7% from March, and the annual inflation rate recorded 14.9% in April, compared to 4.4% for the same month of the previous year.

Nafi explained that raising the interest rate results in absorbing excess liquidity, at a time when some believe that the main reason for inflation is a shock in supply and production costs."

"I think the basis of inflation is imported from Europe and America, mainly because of imports," he said.

He noted that the biggest beneficiary of the decision was foreign money flows, which the Central Bank was seeking to maintain in the short term, specifically because without them imports would cease and "the entire movement of the economy" would stop.

Maintaining that foreign flows do not exit or attract more, requires that you have really positive, or even negative interest rates as is currently the case, but "relatively better than other alternatives for foreign investors," the economist said.

"Raising interest rates means a relatively stronger pound, or at least it can withstand foreign exchange fluctuations, which means more foreign exchange flows or at least as much as possible to stop the bleeding of its exit."

 

'Actual Hardship'

"As expected, the Monetary Policy Committee decided to raise interest rates by 200 basis points to 11.25 percent for deposit and 12.25 percent for lending," said economist Abdelnabi Abdelmutalleb.

He added in press statements: "According to economic theory, raising interest rates encourages savings and helps reduce consumption, as is well known, reducing consumption will reduce demand, thereby lower prices, and then lower inflation."

"According to economic theory, the central bank's decisions are supposed to help lower prices, especially for commodities," he noted.

“But a large number of traders expect that the interest rate hike will be followed by the devaluation of the Egyptian pound and the appreciation of the dollar, so they store food goods from them,” he pointed out.

Economic analyst Mohamed Nasr al-Hawiti notes the risks of this decision by saying: “I don't think it will attract new hot money for the Egyptian market,"

"The US dollar interest rate will remain the most attractive to investors and the safest for foreign capital of all categories," he said.

"The cost of borrowing for the private and public sectors has increased, and the burden of servicing the state's domestic debt—about 5 trillion pounds—has increased by about 100 billion pounds," he said.

He said raising interest rates for the second time in two months "is causing further stagnation," predicting "a severe weakening of market buying and selling, and some sectors and activities may enter a violent recession."

He stressed that raising interest rates will naturally result in "weak movement of domestic investment and projects, especially for the private sector and individuals," and predicted that "Egyptians will go to put their money in local banks to get interest rates of up to 18 percent."

Nafi also shared the same idea: "The Central Bank pre-empted the decision to raise the interest rate by offering certificates of 18 percent return," he said, adding that "the Central Bank of Egypt has absorbed the nature of the market well."

"In the short term, the production structure will not change, you are hostage and trapped in existing structures, which rely on foreign flows of hot money to finance the demand and savings gap,” he added.