Egypt's interest rate cut a welcome first step: Analysts

Deya Abaza, Saturday 3 Aug 2013

Central Bank of Egypt's decision reflects optimism as well as consensus within new government, but may not mean much unless Egypt's political situation stabilises, say experts

Central Bank of Egypt (Photo: Reuters)

Egypt's decision to slash interest rates for the first time in four years suggests a fresh attempt to revive an economy battered by political turmoil, local analysts say.

The Egyptian central bank's monetary policy committee on Thursday decided to lower the main overnight interest rate by 50 basis points, its first fall since 2009.

The deposit rate was cut to 9.25 percent and the lending rate to 10.25 percent. The bank lowered its discount rate and the rate it uses to price one-week repurchase and deposit operations to 9.75 percent.

“This decision reflects a little more comfort on the part of the Central Bank of Egypt regarding the local currency, and the urgency of getting the economy going,” Simon Kitchen, strategist at leading Egypt-based investment bank EFG-Hermes, told Ahram Online.

Walaa Hazem, fund manager at HC Securities and Investments, also saw signs of condfidence.

“The move is effectively a reversal of the central bank’s previous decision to raise interest rates in order to counter the devaluation of the Egyptian pound,” said Hazem.

In March, MPC had raised its key lending rate and deposit rate by 50 basis points each to stand at 10.75 percent and 9.75 percent respectively, for the first time since November 2011.

The Egyptian pound had been falling fast against the dollar since the central bank began auctioning foreign currency in December 2012 after having spent its diminishing forex reserves to prop up the pound since the January 2011 revolution.

But a pledge of $12 billion in aid from sympathetic Gulf nations following the ousting of Islamist president Mohamed Morsi, $5 billion of which has already been deposited at the CBE, has given forex reserves, and subsequently the ailing local currency, a boost.

The Egyptian pound is at an official average of 6.95 to the dollar, according to the CBE website. The US dollar has dropped by 0.7 percent, after averaging LE7 in mid-June.

 “It’s an opportunistic move in a sense. It is logical given that the exchange rate has strengthened over the past month as pressures on the Egyptian pound have eased, and rates on T-bills fell in July,” said Kitchen.

Egypt's new cabinet declared stimulating economic growth to be a priority.

"Ultimately, there isn't another sustainable source of closing the deficit except to get the economy running, to get growth going, to get people to work, to get incomes paid, to get taxes paid as well," Deputy prime minister for economic affairs Ziad Bahaa El-Din told Reuters last week.

Ultimately, said Bahaa El-Din, the cabinet plans to put together a “Marshall Plan” for the country’s economy, which has been severely battered by over two years of political turmoil.

“By lowering the cost of borrowing to encourage investment and growth, the CBE’s action is a first step in implementing the government’s expansionist policy,” comments Hazem.

“The move sends a strongly positive message to investors and the business community because it means the government, namely the ministry of finance and central bank are united in their vision, which is historically has been a challenge…and that’s very reassuring,” explains Hala El-Said, dean of the faculty of economics and political science at Cairo University.

As for inflationary concerns, “recent inflation has been a product of the devaluation of the pound. The outlook on that is now more stable, because of large financial flows from the GCC, which lessens the risk of inflation,” explains Kitchen. “Demand side pressures on inflation are likely to be weak because growth is slow.”

“The decrease in rates is not dramatic enough to be a cause for concern” in terms of inflation, adds Hazem.

Nor is there a significant risk that the move would lead to a dollarization. “The risk of dollarization resulting from this rate cut is minimal, as there is still a huge difference in interest rates between the pound and the dollar,” explains Kitchen.

“The risk is if the government is compelled to borrow much more in the future, which could push interest rates back up,” he argues.

But, says Kitchen, it remains to be seen whether it can be followed by further rate cuts, as the political situation is uncertain and there is still no clarity regarding the future.

“It is difficult to expect further rate cuts unless the political situation stabilises.”

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