Little did they know that a war would then break out, throwing oil on the fire. Since the war in Ukraine started in February, inflation rates have climbed unabated both in Egypt and elsewhere in the world, helped by other factors such as the interest-rate hikes by the US central bank the Federal Reserve and in Egypt’s case the depreciation of the local currency.

Global inflation is at a 20-year high, with expectations that it will remain at around 8.8 per cent, the International Monetary Fund’s (IMF) World Economic Outlook issued in October said. It averaged around three per cent over the past decade.

Egypt’s urban inflation came in at 18.7 per cent in November, a five-year high, while core inflation, which takes into account the prices of volatile goods, reached 21.5 per cent, the highest since November 2017.

Steven Burke, an economist at CRM AgriCommodities, an agricultural consultancy, attributed the historically high inflation rate worldwide to policymakers’ miscalculations.

He pointed out that Covid-19 had resulted in a massive supply and demand imbalance as fiscal stimulus in the form of wage subsidies and remote work had left demand relatively unscathed, while the global supply of goods was disrupted due to lockdowns and international border restrictions.

This resulted in a surge in pent-up demand and severe supply bottlenecks, which had led to a surge in price pressures globally over the past year, he said. As supply chain disruptions began to ease towards the end of 2021, the war in Ukraine dealt another blow, renewing the pressure, particularly for food and commodities and energy.

Burke said that Egypt was more susceptible to inflationary pressures due to the war in Ukraine, as roughly 85 per cent of its wheat imports come from Russia and Ukraine. The war and the resulting closure of the Black Sea grain ports sent the price of wheat soaring as a result, adding further to the price pressures in the country.  

But the prices of agricultural goods and energy have since cooled by roughly a third since their mid-year highs induced by the war in Ukraine, mainly due to higher global interest rates pushing investors out of non-interest-bearing assets like commodities, Burke said.

Moreover, as the UN-brokered Black Sea grain-corridor deal allowed the safe passage of grains out of Ukraine, a healthy amount of war-risk premium in the agricultural markets also eroded, he added. The deal was signed in July, allowing ships transporting grain from three Ukrainian ports to travel along an agreed sea corridor.

Looking ahead, Burke said, global grain supplies are expected to recover in 2023, helping to keep corn, wheat, and soybean prices on a downward trend throughout the year. Nonetheless, energy prices will probably average higher in 2023 relative to 2022, which will act to keep grain prices relatively elevated.

As a result, “despite our view that grain prices will fall in 2023, we still expect there to be several short-lived rallies and prices to stay high relative to recent years,” Burke said.

But the war alone is not solely to blame for the escalating inflation in Egypt, says financial expert Khaled Hamza, as the country was already experiencing structural problems.

Hamza said that when Covid-19 restrictions were first put in place in March 2020, Egypt’s hard-currency earnings were badly affected because of international closures and the fall in tourism and Suez Canal revenues.

Yet, despite the pressures on the external account, the value of the pound was allowed to remain stable. It should have been gradually devalued to allow market participants to absorb the shock, Hamza said.

“It was like we were subsidising foreign producers,” he explained, adding that the pressures had eventually led to two devaluations of the pound, the first in March and the second in October 2022.

Since March, the pound has lost more than 50 per cent of its value, but it has not yet reached equilibrium point, and there are rumours of another devaluation. The equilibrium point is when the banks can meet the demand for dollars easily and there is no backlog in demand.

With the pound 50 per cent weaker against the dollar, imports became notably more expensive, further feeding inflation, noted Burke. “Our inflation is imported,” explained Hamza because Egypt is a net food importer and depends on imports for many production inputs.

INTEREST RATES: To contain the rising inflation this year, the Central Bank of Egypt (CBE) has raised key interest rates by five per cent since the onset of the war in Ukraine in February.

Today, the overnight lending rate and the rate of main operations stand at 13.25 per cent and 14.25 per cent, respectively.

Prior to the hikes, the CBE had kept interest rates stable for 14 months, Hamza said. The CBE maintains interest rates unchanged as long as inflation is stable, but during those 14 months inflation was around six per cent.

The moves to raise interest rates were aimed at containing inflation as well as keeping pace with the hikes in interest rates by the US Federal Reserve to encourage carry trade investors not to quit the Egyptian market for the US bond market. Portfolio investment outflows since the Ukraine war started are estimated at around $20 billion.

In March, the US Federal Reserve raised interest rates for the first time since 2018 in an attempt to bring 40-year-high inflation in the US under control. It has announced seven consecutive hikes in US interest rates, reaching a target range of 4.25 to 4.5 per cent, and it is expected to continue raising interest rates next year.

The US rate hikes put pressure on currencies around the world, not just the Egyptian pound, Hamza said. “It is part of the war: Russia is exporting inflation to the US, and the US is exporting a weaker currency to Russia and the rest of the world, and we are caught in between,” he added.

The exit of carry trade investors from Egypt has pressured hard-currency availability at a time when hard-currency income from traditional sources such as tourism have also been affected, and the government has been paying higher prices for imports.

The CBE has also wanted to suck liquidity from the market to halt speculation on the value of the pound. In September, it increased the required reserve ratio at the banks to 18 per cent from 14 per cent with the aim of further drying up liquidity.

Hamza expects the CBE to again hike interest rates by between one and two per cent because despite the recent hikes they still remain negative, in other words lower than the rate of inflation.

Further hikes are bound to affect economic activity, Hamza said. But not everything can be fixed at once, he added, and the CBE is attempting to find a balance between inflation and growth.

If growth slows down, unemployment will rise. And if liquidity is not withdrawn from the economy, the currency will depreciate and inflation will rise.

However, Hamza said that Egypt’s economy will continue to grow, albeit slowly, commensurate with the growth in population, though per capita income will not increase. For this reason, individuals will feel the pinch of inflation more because prices are increasing and their income is not, Hamza explained.

In such circumstances, individuals should avoid reckless spending and where they can they should buy local goods.

Globally, inflation has peaked. The IMF expects inflation to decline to 6.5 per cent in 2023 and to 4.1 per cent by 2024.

 Supply chains are continuing to recover at a robust pace, and higher interest rates are helping to cool consumer demand, which is also helping to bring down price pressures, Burke said.

Moreover, commodity price growth has also slowed notably and is likely to average lower in 2023 relative to 2022, barring crude oil markets, which should also help to tame domestic price pressures, he added.

He is optimistic that the recent strength in the US dollar has likely hit its peak, helping currencies such as the pound to recover slightly in 2023 and also helping to stamp out price pressures in the economy.

*A version of this article appears in print in the 22 December, 2022 edition of Al-Ahram Weekly