What's next for Egypt after US Fed raised interest rate?

Amr Kandil , Friday 6 May 2022

With the US Federal Reserve (Fed) deciding to increase its interest rate by a rare half-percentage-point — the largest increase in two decades — in an effort to reduce burgeoning inflation that is running at a four-decade high, major economic impacts are looming for countries worldwide, especially emerging markets like Egypt.

File photo of the Central Bank of Egypt's headquarters in downtown Cairo, Egypt. Reuters

The Fed's move, which aimed to reduce the economic stimulus that has contributed to rising price pressures, is expected to affect emerging markets by encouraging capital flight, raising the rates on sovereign debt, and destabilising their currencies, according to observers.

“The Fed's decision to raise the interest rate usually negatively affects emerging markets,” Ahmed Moaty — a financial market expert — told Ahram Online.

The Fed, which last raised its rates by a half point in 2000, normally raises interest rates by a quarter of a percentage point.

Medhat Nafei — economic expert and adviser to the minister of supply and internal trade — noted that the Fed's decision means “more pressure on emerging markets, which will have to pay off their debts and their interests in a relatively more expensive dollar.”

These countries will also have to borrow again to pay off their debts with higher interest rates, Nafei explained on his official Facebook page.

The rise in the dollar exchange rate also affects these countries’ imports and increases trade balance deficit, especially in the event a state depends on importing necessities from abroad.

Following the decision, foreign investors who have invested in emerging markets to take advantage of higher rates of return are expected to transfer their funds to the American market to benefit from the increase in dollar value and the rise in rates, Moaty noted.

“More trade balance deficit surely means weaker national currencies against the dollar; this will complete the noose,” Nafei wrote.

Expected Egyptian response

While the Fed's decision to raise the interest rate negatively affects emerging markets, its impact differs from one country to another, Moaty said, expecting the latest Fed decision to have a “very slight” impact on the Egyptian economy, “though the matter is still not crystal clear.”

In Egypt, experts in the meantime presume that the CBE will raise its interest rates again by 0.5 to 1.5 percent. While experts differed in their opinion on the expected rate of increase, they agreed that it would mean to avoid a possible decrease in the real-interest rate amid a spike in inflation.

In the past few days, central banks in many countries, including the UK, Saudi Arabia, the UAE, Kuwait, and Qatar have announced raising their interest rates in tandem with the Fed's recent decision.

Moaty expects the CBE to raise the interest rate by 0.5 to 1 percentage point or keep it unchanged during its next meeting, noting that the CBE depends in its decision on economic figures and indicators rather than the Fed's decisions.

“The situation [in Egypt] is contrary to Gulf countries and the UK, whose central banks take interest rate decisions immediately based on the Fed's decision,” Moaty said.

“The CBE will wait after the Fed's decision to check whether huge foreign funds have been withdrawn from the Egyptian market and whether this has a significant impact on the economy,” Moaty said.

The CBE’s probable decision to increase the interest rate will seek to fight inflation in Egypt and curb the possible withdrawal of foreign funds from the country.

While it is hard to predict the bank’s next decision, it is likely that it will apply a further increase to the interest rate in order to avoid a decrease in real-interest rates amid the significant rise in inflation, Nafei said.

Furthermore, Moaty said that Egypt has already taken measures since last month, including a rise in the interest rate by the CBE based on the Fed's earlier announcements to raise the interest rate several times during this year.

A few days after the Fed's previous decision to raise the interest rates by 0.25 percent in mid-March, the CBE raised its key interest rates in an unscheduled meeting by one percent for the first time since 2017 and set a meeting for 19 May to discuss a further adjustments to the rates.

Following the CBE’s decision, the USD’s trading price reported an increase to record EGP 17.4 for purchase and EGP 17.5 for sale across local banks, before the Egyptian pound plunged to its lowest value in nearly five years against the USD, with one USD currently trading for EGP 18.5.

At the time, the bank attributed its decision to the global inflationary pressures caused by the COVID-19 crisis and the recent Russian-Ukrainian conflict, which spiked inflation globally since 24 February.

In February, Egypt’s inflation rate reached its highest level in almost 30 months to surpass the CBE’s initial inflation target of 7 percent (±2 percentage points) by the end of 2022.

The country’s annual headline inflation jumped in February to 10 percent, up from 8 percent in January, driven mainly by the significant rise in food and beverage commodities, according to the Central Agency for Public Mobilisation and Statistics.

Along with increasing the interest rate, the Fed announced plans to shrink its $9 trillion asset portfolio starting next month and indicated that it aims to impose a series of additional half-point increases throughout 2022.

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