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Wednesday, 12 August 2020

The ebbs and flows of inflation

The present low inflation rates show that Egypt is reaping the benefits of the government’s economic reforms, writes Azza Radwan Sedky

Azza Radwan Sedky , Tuesday 19 Nov 2019
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One definition of inflation is the shrinking of purchasing power as prices increase.

When a sum of money can’t buy what it had bought before, in other words its value has shrunk, the standard of living shrinks. In contrast, when a sum of money can buy more than what it had bought before, in other words its purchasing power has expanded, the standard of living improves. The bottom line is that fluctuations in inflation rates speak volumes about how a country is faring and are a true indicator of standards of living.

Generally speaking, positive inflation rates stand at around two to three per cent. Dangerously high inflation, or hyperinflation, and extremely low inflation, or deflation, are both undesirable, though hyperinflation is far worse. Deflation is a reduction in the general level of prices, but as prices fall production slows and inventories deplete.

Inflation rates in developed countries like the UK, France and Germany hover at around the one to two per cent mark. Canada has a 2.4 per cent inflation rate, the US is at 1.7 per cent and China is at 2.1 per cent.

On the other side of the coin, some countries struggle with tumultuous inflation rates that reflect their economic crises: Sudan’s inflation rate is 63 per cent; Yemen’s is 41 per cent; Libya’s is 28 per cent; Zimbabwe’s is 75.66 per cent and North Korea’s is 55 per cent.

Then there are countries that have sunk to the pit of the economic abyss, and their inflation rate corroborates this catastrophe. As Venezuela’s hyperinflation rate accelerates, the economic disaster the country faces has become more evident. The inflation rate in Venezuela reached 274 per cent in 2016, 863 per cent in 2017 and 130,060 per cent in 2018. According to the journal Trading Economics, “inflation rates in Venezuela…[reached] an all-time high of 815,194 per cent in May 2019.”

Venezuela’s local currency has eroded altogether, making it defunct while goods have become prohibitively expensive. Food is now largely unavailable, store shelves remain empty, and millions of Venezuelans are fleeing the country. In footage on social media, vendors can be seen selling trinkets and souvenir bags made from Venezuelan paper currency, now considered absolutely worthless, a telling proof of how deteriorated Venezuela’s economy has become.

Now to the core issue of Egypt. How has Egypt fared in the inflation game? Prior to the 2016 price hikes, inflation rates in Egypt went from the very lowest in 1968 (-1.7 per cent) to the very highest in 1986 (23.9 per cent). There were many good years from 1998 to 2003 (average 2.3 per cent), and many significantly higher rates, especially in the late 1990s and early 2000s when inflation rates were around the 10 per cent mark.

After 25 January 2011, Egypt’s economy teetered near collapse. Tourists didn’t show up, remittances from Egyptians working abroad declined, foreign currency reserves diminished and foreign investors opted to invest elsewhere. Something exceptional had to take place.

With the much-needed International Monetary Fund (IMF) loan of $12 billion came austerity measures including the devaluation of the Egyptian pound, going to a record low against the dollar, subsidy cuts on fuel, electricity and water, and a new value added tax (VAT). Soaring inflation rates followed almost immediately, reaching 33 per cent. It was a steep uphill battle for most Egyptians, as sceptics heightened their attack on the government’s reform programme in general.

Interest rates and inflation are intertwined, so the banks raised their interest rates to record highs to counterbalance the inflation. This increased the cost of borrowing, causing products and services to become even costlier.

More importantly, the prices of goods – everything from food to services – skyrocketed in price, affecting people’s buying power and their ability to make ends meet. The Central Agency for Public Mobilisation and Statistics (CAPMAS), the state statistics agency, released a report in July 2019 announcing that 32.5 per cent of Egyptian citizens lived below the poverty line, a 4.7 per cent increase from 2015 when it had stood at 27.8 per cent.

However, a startling anomaly then occurred, which had economists around the world quite stunned. Lo and behold, the inflation rate steadily but surely went into a decline. In 2018, the inflation rate dropped to 20.86 per cent. In 2019, the rates changed significantly again, dropping to 13.2 per cent. In June this year, they were at 8.9 per cent even after another round of fuel price hikes. In August, they stood at 7.5 per cent, in September at 4.3 per cent and in October at 3.1 per cent, the lowest rate in recent years.

We need to pause and savour these numbers, for this is a triumph like no other. Then we need to understand what effect such a drop will have on the Egyptian economy and also on Egyptians.

As inflation rates steady at positive lows, the banks will lower their interest rates. The rate cuts will reduce Egypt’s local debt as it decreases the interest rate paid to lenders and as a consequence reduces the budget deficit. As investors borrow at lower rates, the cost of their products will also be lower, passing on this gain to consumers.

Lower inflation rates also drive consumption, and as they ease they encourage not only growth but also investment. More importantly, a lower inflation rate affects society as a whole as it allows its members the privilege of buying what sometimes wasn’t affordable earlier.

The US financial service Bloomberg summed it up quite succinctly by saying that “the slowdown in the rate of annual inflation is one of the [Egyptian] Central Bank’s biggest accomplishments since Egypt embarked on a sweeping IMF-backed economic programme in 2016.”

I would add that it isn’t the biggest accomplishment of the Central Bank only, but also of acts carried out by the country’s decision-makers in general. They studied the consequences of the IMF loan, knew it was going to be a challenge to all Egyptians, realised it had to be done, but, believing in Egyptians all along, went through with it.

Today, Egyptians will reap the fruits of their patience throughout the last three years. The best is yet to come.

The writer is the author of Cairo Rewind on the First Two Years of Egypt’s Revolution, 2011-2013.

*A version of this article appears in print in the 21 November, 2019 edition of Al-Ahram Weekly. 

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