Raising the interest by 2%: Facing inflation may lead to recession

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The Central Bank of Egypt decided, at its meeting, Thursday evening, to raise the overnight deposit and lending rates and the central bank’s primary operation rate by 200 basis points, to reach 11.25%, 12.25% and 11.75%, respectively. The credit and discount rates were raised by 200 basis points up to 11.75%.

The Monetary Policy Committee stressed that achieving low and stable inflation rates in the medium term is a prerequisite for supporting the purchasing power of the Egyptian citizen and achieving high and sustainable growth rates.

The Central Bank said in a statement that global economic activity is slowing due to the continuation of the Russian-Ukrainian war and that the trade sanctions imposed on Russia and the resulting bottlenecks in the chains of supply have led to an increase in essential world products, such as world oil and wheat prices, in addition to affecting the world supply of wheat due to bad weather and low yields in some regions. The statement added that global financial conditions continue to be tight as central banks abroad continue to tighten monetary policies by raising interest rates and cutting back on buying assets to contain the high inflation rates in their countries. Additionally, the recently imposed lockdowns in China raise concerns about the potential of exacerbated disruptions to global supply chains.

Also, the statement said that before the outbreak of the war between Russia and Ukraine, preliminary data indicated that domestic economic activity continued to increase during the fourth quarter of 2021, with real GDP registering a growth of 8.3%, the second-highest growth rate since the third quarter of 2002. This was partly supported by the resumption of change in the tourism, construction and industrial sectors and the positive base period impact caused by lower growth rates over the same period of 2020 due to measures to contain the Covid-19 pandemic. Regarding the labour market, the statement indicates that the unemployment rate decreased during the first quarter of 2022, registering 7.2%. The rise in employment rates explains this decline.

CBE’s statement also pointed out that the annual general inflation rate rose to 13.1% in April 2022 from 10.5% in March 2022, recording the highest rate since May 2019. The yearly rate of core inflation (which excludes vegetables, fresh fruit and goods and services whose prices are fixed administratively) continued. It rose to 11.9% in April 2022, from 10.1% in March 2022, the highest rate recorded since April 2018. This increase was mainly driven by the rise in food prices, which was also caused by the increase in non-food prices.

The statement concludes that while food and non-food commodities were affected by the depreciation of the Egyptian Pound on March 21, 2022, and its seasonal pattern, many other factors contributed to the rise in food commodity prices, such as unfavourable weather conditions and high fertilizer prices, which resulted in a supply shock in tomatoes. Additionally, the Russian-Ukrainian war’s impact on wheat prices and other food prices, the continued “seasonal” impact of the month of Ramadan, and the impact of the holiday “season” in April 2022 contributed to an increase in the prices of other basic foodstuffs. The central bank increases interest when the inflation rate in the economy rises, i.e. the prices of goods and services increase. The general index of consumer prices for the whole Republic, “inflation rate”, reached 129 points for April, recording an increase of 3.7% from March. The annual inflation rate was recorded at 14.9% for April, compared to 4.4% for the same month of the previous year, according to Central Agency for Mobilization General and Statistic’s data.

The Central Bank of Egypt targets an average annual inflation level of 7% (plus or minus 2%) during the fourth quarter of 2022. According to inflation data, interest rates are expected to increase by an additional 200 basis points during June or July’s meeting. Egypt recently witnessed a significant increase in the prices of commodities, especially food commodities, and a decline in the exchange rate of the Egyptian pound against the dollar.

Adverse effects of the decision

According to analysts and experts, the Central Bank of Egypt’s decision to increase the interest rate by 2% will affect many sectors because most of the articulations of the economic cycle are involved, in particular employment, the production, weak market and weak purchasing power. In short, high unemployment and low growth have adverse effects on the working environment, especially since the import component of many Egyptian goods and products is significant and is purchased in hard currencies, which indicates a substantial increase in prices over the coming period of inflation.

According to experts, the most significant risks of the Central Bank of Egypt’s decision are also represented in markets’ stagnation, the decline in the growth rate and the damage to the stock exchange and investment, as the period of the liquidity cycle within the markets declines. Experts confirm that Egypt is the largest borrower from the International Monetary Fund, succeeding Argentina. Therefore the Central Bank’s decision will affect the interest of the external debt, and Egypt borrows from the inside by guaranteeing treasury bills, which affects the overall deficit and the primary surplus in the state’s general budget, as well as the direction of the government and private business sector to borrow With greater interest, this has a negative impact which negatively affects its ability to expand the business.

Experts confirm also that Egypt is the largest borrower from the International Monetary Fund, after Argentina. Therefore the Central Bank’s decision will affect the interest of the external debt. Egypt borrows from the inside by guaranteeing treasury bills, which affects the global deficit and the primary surplus in the state’s general budget, as well as the direction of the public and private business sectors to borrow with greater interest, which has a negative impact and will affect its ability to expand the business.

Egypt is heading for the fourth time in the last six years to obtain a loan from the International Monetary Fund. Egypt began its path of borrowing from the International Monetary Fund in 2016 by getting a loan of about 12 billion dollars to finance an economic reform program. It also obtained a loan through the rapid financing mechanism worth 2.77 billion dollars. The third loan was $5.2 billion under the Credit Standby Program. What indicates a real crisis in the Egyptian economy is what Egyptian Prime Minister Mostafa Madbouly announced on May 15 that the foreign funds that have left Egypt since the beginning of the year amount to $20 billion.

The government is over-borrowing

The government is currently heading towards excessive external borrowing since 2016 and the militarization of the economy, with the value of Egypt’s external debt reaching around $146 billion at the end of last year, up from 34 billion dollars in 2012, an increase of over $100 billion. It has also been pointed out that the rise in the volume of foreign loans over the past five years is worrying, especially about loan repayment dates, in addition to the interest that weighs heavily on the general state budget, calling on the government to disclose timelines, dates and sources of loan repayment.

The case prompted the deputy of the Egyptian Parliament’s Planning and Budget Committee, Yasser Omar, to say that raising the value of the foreign debt to $146 billion is difficult and leads us to a dangerous situation; however, if it matters, then the most important thing is to spend the loans in the proper channels. He explained that borrowing to pay employees’ salaries or importing from abroad without injecting direct investments that help increase the growth rate is an imminent danger to the future of the Egyptian economy.

The economic expert, Asma Hassan, considered that the current government’s moves, such as increasing the interest rate, are insufficient. Some go in the wrong direction, as there is still an insistence on relying on external borrowing and hot money to revitalize the economy, despite their severe risks. The government is determined to take care of non-urgent economic activities such as roads, bridges, and the New Administrative Capital project while neglecting vital sectors such as agriculture, reopening closed factories, supporting industry, exports, and direct investments.

Asmaa said that reforming the economy and resolving the current financial crisis in Egypt does not require selling off state assets – including strategic sectors such as ports and banks – but requires good management of resources, fighting corruption and tax evasion, stimulating investment, rebuilding the industrial base, and working to increase dollar resources, including from exports, direct investment, remittances from expatriates abroad and tourism.