2017 witnessed the aftermath of the floatation of the pound and the beginnings of the government’s economic reform programme. What were your expectations for the economy at the beginning of the year and how did they turn out at the end?
The year saw some unexpected rises and falls. First there was the exchange rate. As the black market rate was around LE12 to LE13 to the dollar on average in the few months preceding the floatation, people considered this was the rate at which the economy could operate. However, due to several changes throughout the year we ended up with a LE4-5 differential between these expectations and the reality. The dollar was trading this week at LE17.9.
Another surprise was the way lots of companies coped with the increases in their costs, ending the year with substantial increases in their profits. The food and beverages companies are the best examples of this: Juhayna recorded a 36 per cent increase in the third quarter of 2017 as compared to the same quarter of last year, while Domty registered a 50 per cent increase over the same period. The sales figures of these companies were inflated soon after devaluation, but that was due to the fact that they increased their prices to cover hikes in the costs of production inputs, especially imported ones. However, in the last two quarters, the volume of their sales, as in the numbers of units sold, increased as well.
Such better-than-expected performance resulted in a positive GDP growth rate, to the contrary of what usually happens after devaluations, as these are often followed by two quarters of negative growth, especially in economies that heavily depend on imports. This happened in Brazil and Argentine after they floated their currencies, for example. Prices get higher and purchasing power does not increase instantly with the cost curve, so the demand for products across the board falls. This did not happen in the same aggressive way in Egypt, which witnessed positive growth rates through all the three quarters following the depreciation.
Why was this? I believe that there is a huge discrepancy between the official figures and the real wealth available in the economy. There is a lot of hidden wealth that was able to compensate for the dollar crunch. Also, it is surprising how the introduction of the austerity measures did not stir social unrest or demonstrations, and this is something even foreign analysts ask how it was achieved. I believe that when people reach a certain level of frustration due to unmet demands, they become too exhausted to complain.
The government has boasted of the noticeable improvement in many economic indicators. How do you see the improvement in the foreign reserves in the light of the fact that this is mainly financed by debt?
I would add here a very important indicator, though one that has not been receiving much limelight, which is the net foreign assets, which reflects all the banks’ liabilities versus the assets they have in foreign currencies. Last year, this figure was negative $12 billion, which means the banking sector owed its clients locally and globally $12 billion. This was indicative of the fact that there was no dollar liquidity in the sector, which was why the Central Bank of Egypt (CBE) imposed daily and monthly limits on credit and withdrawals in foreign currencies. This figure now is positive $10 billion — meaning we added a whopping $22 billion since the floatation.
The foreign reserves are mainly financed by debt, but in fact this was the essence of the IMF programme [that provided Egypt’s $12 billion loan]. We had a funding gap of $31 billion over three years. No one would have offered to invest in the country unless there had been signs of potential improvement in the economic indicators, and these would not have been realised unless there had been improvements in net foreign assets and reserves. The plan was to acquire long-term loans and use part for accumulating reserves and another portion for covering the banks’ uncovered positions. Thus, both the banking sector and the economy at large look in better shape.
The CBE is currently trying to strike a balance between having high reserves and keeping the foreign debt at its current level of $79 billion. Next year we will have to pay $12-13 billion in debt payment dues. I assume we will replace this with the same sum of new loans with suitable maturities. This technique will guarantee that the foreign reserves figure won’t decline and that of the foreign debt won’t increase.
There is also a plan to issue $4 billion in euro bonds in the first quarter of 2018. While before the floatation we used to borrow to increase the reserves, we are now borrowing to repay the loans. So it is a case of swapping between maturing loans and new ones.
Foreign investment in Egyptian treasuries has reached $19 billion. Do you think it will remain this high when the CBE lowers interest rates?
I think we are in a phase when while some of those investing in these instruments are liquidating their holdings, others are still entering the market, which is why the overall figure was $19 billion without a change for almost the whole of last month.
Here I want to highlight one fact: in 2010, interest rates were only six or seven per cent, and we had $10 billion of investment in treasuries. This means that fears that investors will flee the market once interest rates are lowered are unfounded. Such investors usually compare between the risks and the yield of the treasuries.
In our case, any future drop in interest rates or yields will be accompanied by an improvement in growth rates and in the overall economic outlook, which means less risk. I believe what we will see is a time lag between the exiting of some investors who are real risk-takers, those who entered the market soon after devaluation, and the entrance of new investors who want to invest in an economy with potential.
One of the main features of the year was the spiralling inflation rate. Why did the CBE’s moves to increase interest rates fail to rein this in?
One bad surprise of the year was inflation. We believed that the increase in prices during the countdown to the floatation meant that producers had included the increase in the dollar rate in the black market in the value of their products. So we did not expect further sharp hikes in prices after it. However, prices increased by rates we haven’t seen in decades.
The idea of hiking interest rates to limit inflation would only apply if the increase in prices stems from high demand for products, which is not the case in Egypt. However, the CBE introduced a three per cent increase on the day of the floatation, translated into a hike in deposit rates and the issuance of certificates of deposit bearing 16 and 20 per cent rates.
However, two further increases in May and July, each of two per cent, had a zero effect on the market. The market did not witness what is known as the “transmission of policy”, which is transferring the effect of the increase to the market. For this to happen, the banks should increase interest rates on their short- and long-term saving deposits to absorb liquidity from individuals. Meanwhile, the government ups the yields on treasury bills to attract money from the banks. However, looking at treasury-bill yields, we find that yields before the four per cent increase were higher than after the hikes.
As for the banks, only the National Bank of Egypt increased its short-term deposit rate by two per cent after the first hike and one per cent following the second hike. Meanwhile, almost none of the private banks have changed their long-term deposit rates. The four per cent increase was not transmitted to the economy.
The inflation rate started to ease down in the last four months of the year, but this has not meant a decline in prices. When will we see a real drop in the prices of goods and services?
This stems from the fact that the inflation figures do not represent the actual increases in prices, due to the fact that the basket of commodities used to calculate inflation has not changed in decades and is thus not indicative of current consumption trends.
If there is an improvement in the exchange rate from the current LE17.9 to LE16 or LE17 to the dollar on average next year, the costs of companies will decrease. This will encourage them to make discounts and offers on their end products, giving them an edge in a highly competitive market due to limited purchasing power. This could be very obvious on fully imported goods like cars, as their prices could decline by an equal percentage to the decline in the exchange rate.
However, the expected decline would not take prices to their pre-floatation levels. Away from the official inflation figures, prices across the board increased by 100 per cent, so no matter how great the expected decline may be, prices will never return to 2016 levels.
Looking into the market indices, the EGX30 Index, tracking the performance of the 30 most active shares on the Egyptian stock market, has increased year-to-date by only 18 per cent. Why?
In the first year after the floatation, the main indices of the stock market rebalanced themselves by the same percentage as the decline in the currency’s value, as the assets of all listed companies increased in value because of the floatation. Some people entered the market to hedge against losses they had incurred on the currency.
The EGX30 Index does not reflect the real performance of the market as a whole. It reflects the performance of the most active shares. Moreover, the composition of the index means that it is dominated by certain stocks, especially the Commercial International Bank (CIB) which alone constitutes 40 per cent of the weighting. So when the shares of the CIB lose LE3-4, the index also loses a chunk of its value. Moreover, investors do not take their investment decisions according to the track record of the index as a whole. They look at the individual companies in the index.
Banks in Egypt
Do you think the market lost some of its appeal due to the hikes in interest rates and the increases in yields on certificates of deposits?
If we look at the traded companies, we find that, compared to the 20 per cent rates offered by the banks or treasury bills, some companies realised 60 and 70 per cent increases in profits. So there are equity investments that are much more lucrative than deposits and treasuries.
While the corridor rate on deposits is 18.75 per cent, the real interest rates on bank deposits are much less. And while the 20 per cent yields are high, they are offered on certificates with short tenures, a fact that makes investors hesitant to abandon relatively good yield investments in the long term to buy them.
What are your expectations for interest rates in 2018?
I expect to see a gradual easing of monetary policy by small cuts throughout the year. The cuts in the interest rates shouldn’t be introduced in an aggressive way, contrary to the earlier hikes. We increase interest rates with the aim of collecting all the available liquidity to control inflation and exchange rates. On the other hand, in the case of reducing rates we want to get rid of liquidity in the banks and direct it to the market. If this happened abruptly, the situation would be disastrous.
Any cuts in the rates would lower the cost of borrowing and would be accompanied by an expansion in activities because companies haven’t made many capital expenditures due to the political and economic turmoil since 2010. This would lead to an increased demand on the dollar and a parallel increase in the exchange rate, so we have to be very cautious when decreasing rates. The CBE should start by reducing them by 0.5 or one per cent maximum, and the overall reduction by the end of 2018 should be around four or five per cent.
What about the inflation rate and exchange rates?
Regarding the inflation rate, the base effect should last until August, and by then it should be at 13 to 14 per cent. On exchange rates, 2018 is a clear year, meaning that after a year of manoeuvring around LE17-18 to the dollar, companies are adapting to them. We have started to see some recovery in exports, and we might see an appreciation in the value of the pound if the ban on Russian flights to Sharm El-Sheikh is lifted. I believe we might see exchange rates falling to slightly below LE17 to the dollar.
Maintaining an undervalued currency through channelling any extra dollar revenues into the reserves is a main pillar of the economic reform plan moving forward. This would continue to hinder imports and give edge for exporters and encourage foreign investors to invest in sectors that are based on exporting. In all, this should ultimately flip the country from a consumer-based to investment-based. This will happen through a slower economic recovery but a more sustainable one.
*This article was first published in Al-Ahram Weekly