For Egypt, no easy solution to high inflation
Cherished commodity. Egyptian man selects flatbread at a market in Cairo. (Reuters)
2017/05/21 Issue: 107 Page: 19
The Arab Weekly
Cairo - A recommendation by the International Monetary Fund (IMF) calls on Egypt to raise interest rates to rein in runaway inflation, a condition that poses an economic problem for Cairo, economists said.
“We either raise the interest rate or risk keeping the inflation as is,” said Rashad Abdo, an economics professor at Cairo’s Helwan University. “This is an intricate situation that needs creative solutions.”
Egypt’s consumer price inflation peaked at 32.5% in March — the highest since the mid-1980s — after officials ended the decades-long controlled foreign exchange rate regime in November 2016. That was done to eradicate a rampant foreign currency parallel market and qualify for a $12 billion loan from the IMF.
Foreign currency reserves stood at $19 billion at the time of the flotation but jumped to more than $23 billion just one month later. The figure now stands at $28.6 billion with economists agreeing that the move dismantled the parallel foreign currency market.
However, the move also resulted in a massive devaluation of the Egyptian pound, which has hit consumers hard.
Rising prices means that everyday goods are becoming increasingly unaffordable. Red meat, which before the flotation sold for $4.40 a kilo, costs $8.30 a kilo. The exchange rate of the US dollar is 18.15 pounds, up from 8.8 pounds before the flotation. For import-dependent Egypt, such a weak national currency is disastrous, economists said.
To deal with inflation, the IMF advised Egypt to raise the basic interest rate to encourage Egyptians to deposit their savings. Interest rates were “the right tool” to curb inflation, IMF Middle East Director Jihad Azour said.
The Egyptian Finance Ministry said it would consider the IMF recommendation, although it was not thought that receipt of the IMF loan was contingent on implementing the recommendations.
“Everything is subject to discussion with the IMF,” Deputy Finance Minister Mohamed Moiet said. “We are also still considering all options to bring this high inflation rate down.”
Egypt received the first $2.75 billion of the 3-year IMF loan on November 12. The second tranche — $1.25 billion — is to be delivered in the second half of June, the IMF announced during a recent visit to Cairo.
Economists said raising interest rates could create more harm than good because reduced demand would impede economic growth, raise the cost of borrowing and increase unemployment.
“These consequences must be taken into account by monetary and financial planners before applying the IMF recommendation,” Abdo said. “The people are suffering already and they cannot accept any more pressures on their budgets.”
Egyptian President Abdel Fattah al-Sisi expressed concern over the prospect of Egypt having to raise interest rates. In a May 1 phone conversation with local channel ONTV, he said such a move would put further pressure on the nation’s banks and would raise commercial interest rates.
To absorb liquidity following the pound flotation, Egyptian banks raised savings interest rates to 15% and 20%, from 7% and 8% before the flotation, attracting tens of billions of pounds. Egyptians’ deposits in the country’s banks have exceeded $150 billion, Moiet said. That also, however, put pressure on the banks’ budgets.
A new investment law, passed recently despite delays, aims to bring foreign investment back to the country by streamlining bureaucratic procedures. The law includes incentives such as a 50% tax discount on investments in underdeveloped areas and government support for new projects.
Government figures indicate that direct foreign investment jumped 39% in the first half of the current fiscal year to $4.3 billion, with even more investment expected in the second half of the year.
However, raising interest rates could threaten this by slowing economic growth and increasing unemployment. Egyptian economists said that the IMF recommendations, while working on paper, often failed to account for local realities in Egypt.
“This is why we need to think of other solutions to this problem,” said economist Wael el-Nahas. “Instead of raising the interest rate, we can increase production, something that will create more supply, which will reduce prices at the end and create jobs for the nation’s unemployed workers.”