Economic growth in Egypt: Good or bad news on interest rates?

Hani Abou El-Fotouh, Friday 18 Dec 2020

The Central Bank of Egypt will decide the direction of interest rates in its last meeting of 2020 next week, but what will this mean for different stakeholders

Good or bad news on interest rates?
Abou El-Fotouh

The Central Bank of Egypt’s (CBE) Monetary Policy Committee (MPC) meets regularly to decide the direction of key interest rates in Egypt. These are closely watched by banks, lenders, analysts, and economists as they are crucial in almost every financial and investment decision-making process.

The MPC cuts key interest rates to stimulate economic growth, as lower financing costs can encourage borrowing and investing. However, when rates are too low, they can encourage excessive borrowing and push up inflation, which eats up purchasing power and could undermine the sustainability of the desired economic growth.

The growth issue seems simple on the face of it, but it is rather complicated. The MPC’s press release for November 2020 stated that real GDP growth for the 2019/20 financial year in Egypt had recorded 3.6 per cent compared to 5.6 per cent a year earlier. The decline in growth was mainly due to the partial lockdown measures that were implemented to contain the repercussions of the Covid-19 pandemic, coupled with a decline in consumption and contraction in investments. This was also reflected in the increase in the unemployment rate, which recorded 9.6 per cent in the second quarter of 2020 up from 7.7 per cent in the previous quarter.

The CBE has several monetary policy tools, among which is the interest rate, to control inflation. In June 2005, the CBE introduced an interest rate corridor, where the overnight lending and the overnight deposit rates between the banks define the ceiling and floor of the corridor, respectively. By setting the rates, the MPC determines the corridor within which the overnight rate can fluctuate. It thus uses the corridor to achieve the CBE’s goal of keeping inflation under control and sustaining economic growth. Changing the corridor rates influences the money supply, beginning with the banks and eventually reaching consumers.

The corridor rates are the basis for bank-to-bank lending. Banks charge their customers using the CBE base rate after adding a margin that is generally not less than three per cent above the base rate depending on factors such as their assets, liabilities, income, and creditworthiness.

The challenge for the MPC is to strike a balance between stimulating economic growth, on the one hand, and maintaining the control of inflation as well as sustaining the appeal of the country’s securities in the international debt markets on the other.

The MPC will opt for raising interest rates when the economic growth rate is high. Rate increases are used to slow inflation and return growth to more sustainable levels. Very high interest rates, however, mean more expensive financing and could lead the economy into a period of slow growth or even contraction. Interest rate cuts could help borrowers save money by reducing interest payments on certain types of financing that are linked to the base rate.

But when the MPC cuts interest rates, the banks will typically lower the rates paid on the cash held in banks such as certificates of deposits, time deposits, and regular savings accounts, and thus depositors usually earn less on their savings. But customers who have already purchased a certificate of deposit, or have an existing time deposit, will not be impacted by a rate cut.

But what about ordinary households? And small savers and depositors? The MPC decided at its last meeting on 12 November to cut the CBE overnight deposit rate, overnight lending rate, and the rate of main operations by 0.5 per cent to 8.25 per cent, 9.25 per cent, and 8.75 per cent, respectively, their lowest since early 2016 when Egypt devalued its currency.

This cut was the third in 2020. As a result, the state-owned National Bank of Egypt (NBE) and Banque Misr have stopped offering savings certificates with a 15 per cent yield. The two banks started to issue these certificates in March immediately after the CBE reduced interest rates by three per cent in one go in the wake of the Covid-19 pandemic in order to protect savers.

The consecutive interest rate cuts will impact the household sector and small depositors, especially since the investment alternatives for them are very limited in the light of the spiraling prices of real estate and gold, which were considered the most important investment vehicles for this sector. The stock exchange and mutual funds are also generally not a preferred option for the household sector, particularly pensioners and fixed-income individuals who may consider them to be a kind of risky gambling.

This situation may remind us of the 1980s, a decade characterised by the low interest rates offered by the banks, the rise in gold prices, the stagnation of the real-estate market, and the economic recession in general. Those years witnessed the emergence of money-investing activities that attracted the savings of tens of thousands of Egyptians in return for a monthly or annual return that sometimes exceeded three per cent per month, with those in charge sheltering under the cloak of Islamic finance and investment.

Unfortunately, this money-investing activity has started to re-emerge in recent years due to the lack of suitable investment options to accommodate small savings in the household sector, as well as the continuous interest-rate cuts. That is why it is necessary to develop investment vehicles and instruments to address the needs of this segment and not leave them to be the victims of bogus money-investment promoters.

While we are encouraging efforts to stimulate economic growth, the interests of the household sector, and particularly of small depositors, must be preserved.

*The writer is an economic expert.

*A version of this article appears in print in the 17 December, 2020 edition of Al-Ahram Weekly.

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