How will Egypt decision to maintain interest rates, raise reserve requirement affect the economy?

Amr Kandil , Monday 26 Sep 2022

Experts have been eyeing national and private banks’ steps in the wake of the Central Bank of Egypt's (CBE) recent decision to keep interest rates unchanged and raise the Reserve Requirement (RR) ratio for the first time in five years.

Egyptian pound
A man counts Egyptian pound banknotes at a currency exchange shop in downtown Cairo. AFP


The CBE’s Monetary Policy Committee (MPC) decided on 22 September to hold the deposit interest rate steady at 11.25 percent and the lending rate at 12.25 percent for the third consecutive time after raising the rates by three percent in 2022 – by one percent in March and two percent in May – following the onset of the Russian-Ukrainian war.

However, the CBE, led by Governor Hassan Abdullah, raised the RR to 18 percent, up from 14 percent, for the first time since October 2017 when it was raised from 10 percent.

The RR ratio, which is also known as Cash Reserve Ratio (CRR), is set by central banks and represents the percentage of total deposits a commercial bank is required to hold in reserve – predominantly as deposits with central banks with no interest in return.

Central banks usually lower the RR to give banks more money to lend and boost the economy and raise the ratio when they need to reduce the money supply in an economy by decreasing the lending power of banks, and control inflation by slowing the economy down.

The CBE’s decision came a day after the US Federal Reserve increased rates by 0.75 percent, a raise mirrored by Gulf and international central banks. The US third straight three-quarter point increase has pushed borrowing costs to the highest since 2008.

The CBE still has two scheduled meetings left in 2022 where the MPC will reassess interest rates: one on 3 November and the other on 22 December.

Impact on banks

In the wake of Thursday’s decision by the CBE to raise the RR "to tighten stance that the CBE is maintaining, by calibrating liquidity conditions,” experts disagree about how commercial banks will respond, whether by raising interest rates to attract deposits or keeping them unchanged.

"I expect at the least the majority of commercial banks to keep interest rates unchanged," Ahmed Moaty, a financial market expert, told Ahram Online.

Moaty affirmed that none of the banks nationwide had raised their interest rates as of Sunday, noting that each bank, however, may take a separate decision regarding its rates based on the amount of money they would keep and in light of the rate of demand for loans, which sees a noticeable drop.

"Before the CBE took its latest decision to raise the reserve requirement [RR], it had known that banks have had surplus liquidity," Moaty said, noting that this has been clear during the CBE's periodic weekly bids, by which the central bank takes surplus cash from commercial banks in exchange for attractive returns.

State-owned National Bank of Egypt (NBE) and Banque Misr cancelled in May high-yield 18 percent return one-year saving certificates of deposit that were issued in the wake of the Ukraine crisis after collecting EGP 750 billion in around 70 days.

On the other side, economic expert Hany Genena expects banks to possibly raise interests in response to the CBE decision.

In order to take liquidity from commercial banks, the CBE either takes money from banks as deposits at 11.25 percent returns or through the weekly bids with 11.75 percent returns, Genena said in a phone-in with MBC Misr in weekend.

As the CBE increased the return-free RR, banks may look to raise interest rates to attract liquid cash from customers, Genena noted.

Through the decision, the CBE aims to attract liquid cash from the market without bearing huge costs, Genena said, adding that he expects the CBE to bear heavy losses this year in light of the three percent interest rate increase since March.

Genena said banks might also encourage customers to invest their money in the three-year certificates of deposit, on which the RR ratio is not applied.

Genena also expressed concerns that the banks may raise the returns of weekly bids, which are provided to the government to pay its expenses.

Impact on economy

Moaty expects the CBE decision to make a positive impact on the Egyptian economy "as the central bank decided to achieve its goals without causing the state or banks to bear additional debts as a result of raising interest rates."

"Raising the interest rates, which the CBE has avoided, is not of good for the investments because it encourages individuals and funds to put money in the banks and discourages them from borrowing to establish projects," Moaty explained.

Through its decisions, the CBE seeks to achieve its pre-announced inflation target of seven percent (±2 percentage points). "That is the point when the CBE can stop using such monetary tools," Moaty said.

Egypt’s annual headline urban inflation rose to 14.6 percent in August 2022, up from 13.6 percent in July 2022, according to the CBE.

Similarly, annual core inflation – which excludes volatile food and regulated items – increased to 16.7 percent in August 2022, up from 15.6 in July 2022, said the CBE.

In a statement on its latest decision, the CBE reiterated its "commitment to achieve low and stable inflation rates over the medium term as a main condition to achieve sustainable development rates".

The CBE, like the US Federal Reserve, expects the increase in inflation to be temporary.

The past month saw a slight increase in inflation, which was triggered by the increase in the price of oil and the declining value of the Egyptian pound against the US dollars. While the price of an oil barrel hit $130 in the wake of the Ukraine crisis, the highest in 14 years, it has since dropped to range from $85 to $100.

In addition, although the Egyptian pound lost 23 percent of its value against the US dollar since the start of the Russian-Ukrainian crisis in March, the decline has now slowed, Moaty noted.

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