Action to manage inflation

Doaa A. Moneim, Wednesday 5 Apr 2023

The Central Bank of Egypt raised interest rates at a meeting of its Monetary Policy Committee last week but took no action on the pound.

Action to manage inflation
The pound has been devalued three times since March 2022


Expectations were rising that the Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) would take action to devalue the pound at its regular meeting last Thursday when it met to review interest rates, even though currency decisions are not part of its mandate.

However, there was no further devaluation of the currency, and the pound continues to trade at around LE30.9 to the dollar in the banks.

The fact that there was no devaluation last week does not mean that one is now off the cards, nonetheless. The dollar is currently trading at around LE35 to LE36 in the parallel market, and futures contracts have hit record levels over the past few days to break the LE40 per dollar barrier, before cooling to between LE38 and LE39.

These are signs that there may be another devaluation of the pound, according to banking expert Ahmed Shawki.

The Egyptian pound’s weak performance against the US dollar has been driven by the trade deficit, which widened in January to $2.4 billion, up from $1.9 billion in December and $2.1 billion in November, according to figures published by the Central Agency for Public Mobilisation and Statistics (CAPMAS).

This has negatively affected dollar liquidity in the local market, with this being necessary for imports. “All the signs are that the local currency will maintain its downturn over the coming six months,” Shawki told Al-Ahram Weekly.

Egypt’s external transactions recorded an overall surplus of $523.5 million in the first quarter of the 2022-23 fiscal year, against $311.4 million in the corresponding period a year earlier.

However, the current account deficit decreased by 20.2 per cent to about $3.2 billion, compared to $4.0 billion. The capital and financial account registered a net inflow of about $4.4 billion, compared with $6 billion.

The pound has been devalued three times since March 2022 when it was trading at around LE15 to the dollar.

While the MPC did not take action on the pound at last week’s meeting, it did hike key interest rates by two per cent, bringing the total hikes applied since March 2022 to 10 per cent.

According to a press release, Egypt’s annual urban headline inflation increased to 31.9 per cent in February. Core inflation also marked a historic high at 40.3 per cent. The MPC attributed the increases to factors including domestic supply chain disruptions, the depreciation of the Egyptian pound, and demand pressures along with the seasonal impact of Ramadan affecting food prices.

These factors had necessitated an additional tightening of monetary policy, not only to contain demand-side pressures, but also “to avoid broad and persistent inflationary effects that could emanate from the supply shocks, with the aim of anchoring inflation expectations,” the MPC said.

“It was also for these reasons that the largest state-owned banks, the National Bank of Egypt [NBE] and Banque Misr, have issued new three-year high-yield certificates of deposit with a fixed yield of 19 per cent and a declining yield of 22 per cent. The aim is to absorb liquidity and cool inflation,” Shawki told the Weekly.

These certificates are also designed to absorb the LE750 billion that was held in 18 per cent certificates of deposit that matured in March.

Shawki expects the dollar to anchor its gains against the Egyptian pound, at least until the MPC’s meeting scheduled on 18 May. He projects it to trade at LE33 to the dollar and to keep this level over the coming six months.

Economist and researcher at the UK Economist Intelligence Unit Ali Metwalli projects that the pound will maintain its drop against the US dollar through the second quarter of 2023 to reach around LE33 to LE34 in the spot market, mainly due to the persistence of pressure on the exchange market and continued speculative attacks on the currency.

“The CBE will continue to intervene as necessary in the market to maintain stability and prevent excessive and unwarranted currency depreciations. Some progress on the listing or direct sale of state-owned assets should provide some relief and we could see the local currency average around LE30 to LE31, which is why progress in listing the state-owned companies is very important,” Metwalli said.

Steps are underway to sell stakes in 32 state-owned companies as part of government efforts to boost private-sector participation in the economy and of reforms agreed with the International Monetary Fund (IMF).

“Raising the policy rate in the recent meeting of the MPC should alleviate some of the pressure in the exchange market, but it is unlikely to prevent some depreciation in the currency amid continued speculative attacks and negative real interest rates,” Metwalli said.

If the US Federal Reserve pauses its rate hikes for the remainder of the year, as the market — not experts — suggests, there could be a notable increase in the stability of the Egyptian pound, he added.

The Fed hiked US benchmark interest rates by 0.25 per cent at its meeting last week, continuing its tightening policy to counter high inflation.

“However, if the Fed decides to continue its rate hikes for an additional one to three months, as experts suggest, we are likely to see an elevated pressure on the exchange market and at least one more interest-rate hike by the CBE to preserve the gap in the interest rate differential,” according to Metwalli.

He stressed that less reliance on imports and more manufacturing incentives could improve the local currency outlook in the long term, adding that there are also several public and private projects that will improve foreign exchange inflows. However, current global economic challenges will continue to pose a threat to the outlook for the remainder of 2023.

Metwalli does not expect inflation to return to single-digits before the second half of 2024, amid the latest currency depreciation and still high global commodity prices compared to 2019.

“Inflation is likely to average around 26 per cent in 2023, which will limit local demand expansion and weigh on local investor sentiment. In 2024, inflation should fall to 10 to 11 per cent as global headwinds ease and investor sentiment improves,” he said.

The CBE targets an inflation rate of seven per cent (± two per cent) on average by the fourth quarter of 2024 and five per cent (± two per cent) on average by the fourth quarter of 2026, according to commitments under the IMF loan.

* A version of this article appears in print in the 6 April, 2023 edition of Al-Ahram Weekly

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