For Egypt, no easy solution to high inflation

May 21, 2017
Cherished commodity. Egyptian man selects flatbread at a market in Cairo. (Reuters)

Cairo - A recommendation by the International Monetary Fund (IMF) calls on Egypt to raise interest rates to rein in runaway inflation, a condition that poses an economic problem for Cairo, econo­mists said.
“We either raise the interest rate or risk keeping the inflation as is,” said Rashad Abdo, an economics professor at Cairo’s Helwan Univer­sity. “This is an intricate situation that needs creative solutions.”
Egypt’s consumer price inflation peaked at 32.5% in March — the highest since the mid-1980s — af­ter officials ended the decades-long controlled foreign exchange rate regime in November 2016. That was done to eradicate a rampant for­eign currency parallel market and qualify for a $12 billion loan from the IMF.
Foreign currency reserves stood at $19 billion at the time of the flo­tation but jumped to more than $23 billion just one month later. The fig­ure now stands at $28.6 billion with economists agreeing that the move dismantled the parallel foreign cur­rency market.
However, the move also resulted in a massive devaluation of the Egyptian pound, which has hit con­sumers hard.
Rising prices means that every­day goods are becoming increasing­ly unaffordable. Red meat, which before the flotation sold for $4.40 a kilo, costs $8.30 a kilo. The ex­change rate of the US dollar is 18.15 pounds, up from 8.8 pounds before the flotation. For import-dependent Egypt, such a weak national curren­cy is disastrous, economists said.
To deal with inflation, the IMF ad­vised Egypt to raise the basic inter­est rate to encourage Egyptians to deposit their savings. Interest rates were “the right tool” to curb infla­tion, IMF Middle East Director Jihad Azour said.
The Egyptian Finance Ministry said it would consider the IMF rec­ommendation, although it was not thought that receipt of the IMF loan was contingent on implementing the recommendations.
“Everything is subject to discus­sion with the IMF,” Deputy Finance Minister Mohamed Moiet said. “We are also still considering all options to bring this high inflation rate down.”
Egypt received the first $2.75 billion of the 3-year IMF loan on November 12. The second tranche — $1.25 billion — is to be delivered in the second half of June, the IMF announced during a recent visit to Cairo.
Economists said raising interest rates could create more harm than good because reduced demand would impede economic growth, raise the cost of borrowing and in­crease unemployment.
“These consequences must be taken into account by monetary and financial planners before applying the IMF recommendation,” Abdo said. “The people are suffering al­ready and they cannot accept any more pressures on their budgets.”
Egyptian President Abdel Fattah al-Sisi expressed concern over the prospect of Egypt having to raise interest rates. In a May 1 phone conversation with local channel ONTV, he said such a move would put further pressure on the nation’s banks and would raise commercial interest rates.
To absorb liquidity following the pound flotation, Egyptian banks raised savings interest rates to 15% and 20%, from 7% and 8% before the flotation, attracting tens of bil­lions of pounds. Egyptians’ de­posits in the country’s banks have exceeded $150 billion, Moiet said. That also, however, put pressure on the banks’ budgets.
A new investment law, passed re­cently despite delays, aims to bring foreign investment back to the country by streamlining bureau­cratic procedures. The law includes incentives such as a 50% tax dis­count on investments in underde­veloped areas and government sup­port for new projects.
Government figures indicate that direct foreign investment jumped 39% in the first half of the current fiscal year to $4.3 billion, with even more investment expected in the second half of the year.
However, raising interest rates could threaten this by slowing eco­nomic growth and increasing un­employment. Egyptian economists said that the IMF recommenda­tions, while working on paper, often failed to account for local realities in Egypt.
“This is why we need to think of other solutions to this problem,” said economist Wael el-Nahas. “In­stead of raising the interest rate, we can increase production, something that will create more supply, which will reduce prices at the end and create jobs for the nation’s unem­ployed workers.”