With the US Federal Reserve raising interest rates last week for the second time in less than two months, the dollar has been gaining strength. This, together with the effect of the ongoing war in Ukraine on global food and oil prices, has fed fears of heavy inflationary pressures.
In May, the Fed hiked its benchmark interest rates by 0.5 per cent, the highest increase since 2000, following a 0.25 per cent (25 basis points — bps) rise applied in March. More raises are yet to come in 2022.
The March hike resonated in Egypt, causing the inflation rate during the month to reach 10.5 per cent, up from 8.8 per cent in February and then record 13.1 per cent in April marking its highest reading since mid 2019.
Egypt’s Purchasing Managers’ Index (PMI) for the non-oil private sector rose slightly in April to 46.9, up from 46.5 in March, according to Standard and Poor’s (S&P), in figures announced on Sunday.
However, the sector is still witnessing a drop in new business for the eighth month in a row amid the inflationary wave, S&P noted.
David Owen, an economist at S&P Global, said that businesses faced a further increase in material and energy costs due to the Ukrainian-Russian conflict and a devaluation of the Egyptian pound in late March.
“Manufacturers remained the most exposed to these setbacks, with increased raw material prices and supply shortfalls leading to a solid cut in goods production, although wholesale and retail and services also saw a drop in activity,” he said.
The Fed’s recent action will also have negative repercussions on emerging market economies, including Egypt, banking expert Hani Abul-Fotouh told Al-Ahram Weekly.
“The dollar will strengthen against the Egyptian pound, and this will be translated into a heavier debt-service burden and larger import bills,” Abual-Fotouh explained.
These implications, according to Abul-Fotouh, will feed inflation as well as increase the country’s trade deficit. The higher interest rates for the dollar will also lead to more hot money outflows putting pressure on reserves.
The Central Bank of Egypt (CBE) announced on Sunday that its net international reserves (NIRs) slightly rose in April to $37.1 billion, up from $37 billion posted in March. March’s NIR figure took the market by surprise, as it was $4 billion less than the previous month.
Fitch Ratings, which affirmed Egypt’s credit rating in April at B+ with a stable outlook, attributed the NIR drop to portfolio outflows and CBE interventions to smooth exchange-rate volatility by devaluing the pound by 14 per cent on the heels of the war in Ukraine.
It also noted that foreign holdings of local-currency government debt had inched down to $17.5 billion by the middle of March, a decline of $11 billion from the end of 2021 and $16 billion from their all-time high in September 2021.
The CBE’s Monetary Policy Committee (MPC) is expected to convene on 19 May to review key interest rates for the third time in 2022 amid expectations that it will opt for a hike. Responding to the challenges the war has imposed, the CBE hiked its key interest rates in March by one per cent and devalued the pound by about 14 per cent.
In a report issued on Saturday, the BNP Paribas bank expected the CBE to raise interest rates in its upcoming meeting by two per cent (200 bps).
It also expected two more one-per cent hikes in the MPC’s August and September meetings, so that interest rates hover around an average of 13.2 per cent through 2022. BNP also ruled out the pound gaining strength during the coming weeks.
Financial expert and head of the banks and stock committee at the Egyptian Businessmen’s Association Hassan Hussein said Egypt had to limit its dependence on the dollar, explaining that ongoing economic developments had increased demand for foreign currencies, especially the US dollar, to pay for imports and financial obligations.
He suggested that Egypt sign agreements with trade partners to pay in the local currency for imports from these markets. He also called for a revision of Egypt’s external borrowing strategy to stop pressure from the US dollar’s ups and downs.
Egypt topped the Arab countries in terms of its debt-to-GDP ratio in 2022, with a rate of 94 per cent. Egypt has had to expand its external borrowing to counter the impacts of global challenges on its budget.
The authorities are currently in discussions with the International Monetary Fund (IMF) for a fresh loan deal with the objective of preserving the gains of the country’s economic-reform programme and helping it to resume its second wave of reforms amid the current economic developments.
BNP Paribas expected the loan sum to reach $10 billion under the IMF’s extended fund facility (EFF), which is the same instrument under which Egypt secured a $12 billion loan in 2016 to implement its economic-reform programme that ended in July 2019.
Mohamed Sharaf, lead investment officer for the Islamic Development Bank, said that the Fed’s policy is expected to impose further pressure on the CBE’s ability to attract foreign inflows back to Egyptian pound-denominated government debt.
“Further policy rate hikes by the CBE, at least by 200 bps, will most likely be necessary to decelerate the pace of outflows,” Sharaf told the Weekly.
He added that the expected hike by the CBE would ease the pressure on the dollar exchange rate, as well as keep inflation rates within the CBE inflation target of seven per cent (±2 per cent) through the end of 2022, which is important to face imported inflation.
But the expected hike will affect the banks’ local-currency lending activities, according to Sharaf.
“The government recently announced measures for further promoting the role of the private sector in the industrial sector as a vital means to attract stable foreign direct investments (FDIs) and boost exports. The devaluation of the Egyptian pound, along with the last measures announced by the government for a more favourable ease of doing business environment and depending on local value chains, can also help in promoting the attractiveness of the various industrial sectors in the domestic market among many global investment funds and sovereign wealth funds eyeing to invest in Egypt’s real economy,” Sharaf said.
“The Egyptian economy is one of the major economies in the Middle East and North Africa region and Africa and has all the needed success factors for the proper economic transition that will be necessary to cushion the impact on the Egyptian economy of further global systematic shocks,” he added.
*A version of this article appears in print in the 12 May, 2022 edition of Al-Ahram Weekly.