The price of reform

Maha Rashied, Tuesday 15 Oct 2024

The ongoing coupling of high inflation and rising interest rates needs to come to an end, writes economist Maha Rashied

The price of reform

 

Egypt’s recent economic crisis reached its zenith between late 2023 and early 2024. However, the underlying factors contributing to this turmoil have long been entrenched in the nation’s economic landscape, echoing issues that have persisted since Egypt’s transition to a market economy.

 For decades, Egypt has grappled with recurring structural budget and current account deficits, often relying on external financial assistance, debt issuance, and geopolitical support as stopgap measures. The latest crisis followed the same familiar trajectory. The Ras Al-Hekma deal emerged at a critical juncture, providing essential capital inflow that helped restore some level of confidence in the economy. Together with the policy adjustments made on 6 March, this paved the way for an enhanced International Monetary Fund (IMF) agreement, which subsequently encouraged other international financial institutions to extend their support to Egypt.

Despite recent improvements — including a general decline in inflation, a return of international investors, and a relatively reformist government — there remains a pervasive anxiety that reliance on historical practices could lead to unsustainable and potentially unpleasant outcomes. The effective use of current foreign currency injections is crucial. Without strategic deployment, these funds may not yield the desired economic stabilisation.

Inflation in Egypt has surged to alarming levels, averaging 34 percent in 2023, and while there has been some easing, recording 26.4 per cent in September, it remains significantly high. However, real income growth has remained negative since 2022, eroding discretionary income and depleting household savings, which further diminishes the purchasing power. High interest rates further complicate these challenges by restricting borrowing capacity, making it harder for households to cope with the prolonged economic strain.

 While Egypt’s inflation rate remains high, there has been a notable downward trend since March 2024. Inflation rates continued to decline until August and September, when the upward trajectory resumed, largely due to fiscal consolidation reforms, including hikes in fuel and electricity prices. These developments underscore the complexities of managing inflation in an evolving economic landscape, highlighting the need for careful policy considerations moving forward.

 In response to historically high inflation rates and the desire to achieve positive real interest rates, the Central Bank of Egypt (CBE) implemented significant policy rate hikes in March, maintaining those rates since then. Concerns regarding the cost-push nature of inflation are valid; pressures from the high interest rate can impose an unnecessary burden on the economy without delivering the anticipated benefits. With the US Federal Reserve commencing policy cuts in September, there is growing incentive for the CBE to consider loosening its monetary policy, which currently remains at high levels. However, the recent interruption in the downward trend of inflation may prompt the CBE to postpone any rate cuts while aiming to attract capital inflows through interest differentials.

 At Dcode EFC, we anticipate that the CBE will hold rates steady in October, with potential reductions of up to 150 basis points in 2024. We project that annual inflation will gradually decline, with a more pronounced decrease expected in February 2025 due to favourable base year effects. This anticipated decline could enable the CBE to manoeuvre more freely and significantly lower rates by about nine by the end of 2025, fostering a more stable economic environment. A clear data-driven focus by the CBE is essential for lowering inflation and inflation expectations towards the target.

The twin deficit — current account and fiscal budget — has been worsening. On the regional front, Egypt has faced significant challenges due to negative spillovers from the war on Gaza, primarily through depleted revenues of the Suez Canal. Locally, the fiscal stance has also been curbed by the rising debt service and the widening oil trade deficit as a result of the energy shortage that reached critical levels, amplifying the urgency for fiscal consolidation. The duration of this strain remains uncertain, posing a significant vulnerability to the economy. Continued inflationary pressures threaten to diminish purchasing power further, while elevated borrowing costs and a waning appetite for investment add to the economic challenges. In addition, the lag in monetary policy implementation — often spanning three to four quarters — means that potential relief may not be immediate. As Egypt faces these multifaceted challenges, it is imperative for policymakers to adopt a strategic and flexible approach to ensure economic resilience and stability.

Moving forward, structural adjustments and a flexible exchange rate regime are essential for addressing existing imbalances. It is increasingly clear that fostering sustained productivity growth is vital, necessitating greater involvement from the private sector. Only through these measures can Egypt hope to break free of its cyclical economic challenges and build a more resilient future. Fiscal consolidation is a crucial component of the necessary reforms in Egypt. However, it is prudent to consider a more measured pace to prevent further strain on the Egyptian populace. Without decisive action, the consequences for everyday Egyptians could be dire.


* A version of this article appears in print in the 17 October, 2024 edition of Al-Ahram Weekly

Short link: