Contrary to Expectations … Why did Egypt’s Central Bank Decide to Fix Rates?

Contrary to Expectations ... Why did Egypt's Central Bank Decide to Fix Rates

Contrary to the expectations of financial institutions, the Central Bank of Egypt (CBE) decided to fix interest rates, a decision about which readings varied.

Economic analyst Mustafa Abdel Salam described the decision as “logical and bold,” saying there are several reasons for this: The first reason is that “a large part of inflation in Egypt is currently imported, and is due to external drivers due to the increase in the price of food, petroleum derivatives, raw materials and intermediate goods, and therefore containing inflation in Egypt would not be solved by increasing the interest rate and withdrawing cash from the markets, but in increasing production and exports, reducing non-essential imports and strengthening the pound.

Abdel Salam added, “Many institutions had bet on a rate hike by no less than half a percent, to preserve the hot foreign money invested in Egyptian debt instruments, whether they are bonds or treasury bills, and this reason does not exist in light of the exit of 90% of these funds, and the difficulty of returning them at the present time, especially with the increase in the interest rate on the dollar and the attractiveness of investments in low-risk and high-return US bonds and bills.

Hot money signifies currency that quickly and regularly moves between financial markets, that ensures investors lock in the highest available short-term profit on interest rate differences.

Among the reasons, according to Abdel Salam, is also, “the success of the banking sector in withdrawing a large part of the liquidity in the market by offering the National Bank of Egypt and Egypt saving certificates of 18%, and this certificate attracted EGP 750 billion, and part of this liquidity could have entered the foreign exchange market to speculate on the dollar, which has not happened in light of the withdrawal of this huge amount of liquidity from the banking sector, which encouraged the central bank to fix the interest rate without fear of increasing demand for the US currency by speculators.”

Abd al-Salam added that the Central Bank took into account in its decision, “the keenness to increase the burden of the public debt, which has worsened sharply in recent years, especially since the government is the largest borrower from the banking sector, and that in the event of an increase in the interest rate by 1%, this would cost the public budget about EGP 30 billion annually, and perhaps more, as debt service, according to Egyptian officials.”

Abdel Salam pointed out that the decision to increase interest rates is a “bitter medicine”, saying that it “negatively affects the economy, especially investment opportunities, as it raises the cost of money and borrowing, and therefore central banks stay away from it, unless they swallow it as a bitter medicine in the context of dealing with high inflation.”

As for fears of foreign investments fleeing due to high interest rates, Egypt is looking for diversification of funding sources, and a tendency to benefit from common interests and the existing economic understanding with Arab countries, which may help Egypt compensate for its loss of foreign hot money with foreign direct investment (FDI) from rich Gulf countries.

The CBE’s Monetary Policy decided, in its meeting yesterday to fix the overnight deposit and lending rates and the bank’s main operation rate at 11.25%, 12.25%, and 11.75%, respectively.

The credit and discount rates were also fixed at 11.75%.

Meantime, according to the central bank, the annual core inflation rate rose to 13.3% in May 2022, compared to 11.9% in April.