Egypt slashes interest rates to attract new investments

The latest interest rate raise aimed to absorb the huge liquidity in the market brought by foreign currency hoarders selling dollars.
Sunday 08/04/2018
A trader works at the Egyptian stock market in Cairo. (Reuters)
Ups and downs. A trader works at the Egyptian stock market in Cairo. (Reuters)

CAIRO - Egyptian policymakers are pinning their hopes on an interest rate cut to attract foreign and local investments, create jobs and boost business activities.

The Central Bank of Egypt cut the overnight deposit and lending rates by 1% to 16.75% and 17.75%, respectively. It was the second rate cut of 1% in less than two months.

“This is a step in the right direction,” said Mukhtar al-Sherif, an economics professor at Mansoura University. “Lower interest rates will encourage investors to expand their businesses and motivate market activities.”

The Central Bank raised interest rates last year after the November 2016 decision to float the Egyptian pound, a move that almost doubled the exchange rates of currencies against the Egyptian pound.

The latest interest rate raise aimed to absorb the huge liquidity in the market brought about by foreign currency hoarders selling dollars to benefit from the new exchange rate.

Before the flotation of the Egyptian pound, a US dollar was worth 8.8 Egyptian pounds, official figures indicated. Following the flotation, one US dollar was equivalent to 15 Egyptian pounds. The current exchange rate stands at 17.6 Egyptian pounds for one US dollar.

In November 2016, Egypt’s urban inflation rate was 19.4%, the highest recorded in eight years. In February, urban inflation dropped to 14.4% from 17.1% in January. This, economists said, encouraged the interest-rate cut.

“The interest-rate cut would have never been possible without this declining inflation, which, in a way, is a reflection of the success of economic reform policies pursued since November 2016,” said Alia el-Mahdi, an economics professor at Cairo University. “Raising the interest rates was necessary to bring the inflation rate down but the same raise had negative consequences.”

One of the consequences was an increase in bank deposits at the expense of investment.  Deposits in Egypt’s banks rose from $156.9 billion in October 2016 to $182.8 billion in October 2017.

The cost of borrowing also became very high as banks imposed 20% rates on loans. The local business climate suffered as a result. Although this did not affect unemployment, which dropped to 11.3% in the last quarter of 2017, down from 12.4% in 2016.

Egyptian policymakers will be checking local factors, including inflation rates ahead of the holy Muslim month of Ramadan. The inflation rate may fall to less than 10% by mid-May, analysts said.

Egypt’s main challenge will be to maintain a stabilised foreign exchange rate to boost the business climate and attract more foreign investment.

“The presence of a stable foreign exchange rate is very important for investments,” Sherif said. “Fluctuations in the exchange rate have devastating consequences for business.”

There are hopes that a stable foreign exchange rate would attract investments and stimulate economic growth. The government is targeting a 5.8% economic growth rate in fiscal year 2018-19. Egypt’s fiscal year begins July 1.

However, that growth rate, economists said, cannot be achieved unless the government institutes measures on a variety of fronts. Bringing the inflation rate down and encouraging investments, especially foreign direct investments, is just the first step.

There is also a need for measures to raise the economic growth rate, including increasing production, reducing consumption and reducing imports.

Despite a lower exchange rate of the Egyptian pound that increases exports by giving Egyptian goods an edge against goods from other countries in foreign markets, Egypt’s balance of trade with almost all countries is not tilted in the country’s favour.

“Egypt has an imbalanced trade with almost all trading partners,” said economist Abdel Mutaleb Abdel Hamid. “If this shows anything, it shows that we need to increase production because increased production means fewer imports and more exports, both requirements for economic growth.”