Last week, Egypt’s Central Bank decided to hike interest rates to slow down inflation and curb a sliding pound.
But what are the economics behind the move? What does it really mean to raise interest rates and what impact does this have?
Contributor Isabel Esterman has drawn up a genius cartoon to explain all.
She says that this is, of course, hugely over-simplified. In order to keep it at a manageable length, the cartoon glosses over things like how fractional reserve lending actually adds to the money supply, repo and discount rates (we don’t need to get that technical anyway…), as well as examples of when these theories don’t work – all topics for another day.
Still, we hope this is enough to make people feel more confident tackling something like the CBE Monetary Policy Committee’s most recent press release.
Could Egypt’s new central bank governor Hisham Ramez, who replaces Farouk Al Okdah, signal a shift in policy from tightly controlling the exchange rate of the pound – as it has done for nearly a decade – to introducing a more balanced currency market driven by supply and demand?
Yes, the business community tells Al Arabiya’s Carina Kamel.
“The priority now is to have an orderly currency market,” said Osama Mourad, a financial analyst. “We have been able to get rid of the responsibility of the exchange rate which was seen clearly from the new governor’s statement.”
Over the weekend, Ramez sent a strong message to Egypt and the financial world, who are closely watching developments in Cairo, that “the bank’s number one priority was overseeing a ‘balanced’ currency market and that the central bank ‘has all the tools needed to intervene'”, according to the Al Arabiya report.
He sought to reassure jittery investors (and simultaneously enter himself into the club of Egyptian officials unruffled about the state of the economy) by saying “there is no reason to worry” about price movements on the Egyptian pound which has lost nearly 6% of its dollar value in the past two weeks. “The situation is not out of control.”
Yet, control is the last word that comes to mind when describing Egypt’s economy.
With demand for dollars still high, almost daily dollar auctions have continued to drive the pound lower.
The scale of dollarisation was also highlighted when Egypt signalled that the $2 billion loan from Qatar arrived in December, implying that the money had already been eaten up defending the currency.
What is more worrying, however, is how the transaction exposes the fragility of Egypt’s economy:
“Without Qatari aid, Egypt was on course for a full-blown financial crisis and, perhaps, a forced deal with the IMF by February,” Said Hirsh of Maplecroft said, according to Reuters.
Once again, Egypt has been bailed-out by its big brothers, giving the government little incentive to make much-needed reforms, including in the costly energy subsidy system.
Another indication of how Egypt is living hand-to-mouth is the constant rollover of debt.
Egypt’s Finance Ministry said on Thursday it would offer $1 billion of one-year treasury bills for auction on January 14. This would effectively roll over maturing US dollar-denominated bills from last year.
Though it alleviates pressure on Egypt’s creaking budget, the country will now have to refinance around $2.5 billion in 2013. Dependance on local banks to buy into these securities is highly unsustainable.
Economists have said that the rate of spending on interest payments on bonds and bills is now exceeding the rate at which the government spends on energy subsidies. Egypt is spending about 15% or 16% of its budget on these payments now. A considerable amount.
The upside is that Egypt’s treasury yields are attractive to foreign investors who look at emerging and frontier markets. Egypt has among the most attractive yields of the frontier markets, according to Silk Invest, the London-based investment banking boutique:
Silk Invest CEO Zin Bekkali says in a note to investors:
“Interest rates in developed markets have reached unsustainable levels in both the government and the corporate sectors. Frontier markets currently offer one of the worlds’ most interesting fixed income opportunities with the potential for double digit returns in hard currency, local currency as well as for corporate bonds.”
Yesterday, the Egyptian pound slid to a new record low of around LE6.51 to the dollar, as demand for dollars remained strong.
It was despite Qatar providing the nation with an economic lifeline by sending $2.5 billion in aid to help it tackle a currency crisis.
The central bank has allowed the pound to slide by about 0.5% a day against the dollar since it introduced a new currency regime on December 30, according to data from Reuters.
Until the new regime was imposed, the currency had lost just 6% in the two years since Egypt’s revolution that overthrew president Hosni Mubarak. But in last past 11 days the fall has accelerated, with the pound losing 5% on the interbank market.
But what does this mean in the long-term?
Using interviews I did with two former Egypt Central Bank governors (part of this appeared in a story I published today in the International Herald Tribune), Rebel Economy looks at two different perspectives on the new currency regime:
1. Mahmoud Abul Eyun, Central Bank governor until 2003, and oversaw Egypt’s historic flotation of the pound and eradication of the black market:
He criticized the timing of the new measures, saying they should have been adopted at least a year ago and that the late reaction will hit vulnerable people the hardest.
“We have been waiting for this for a long time, at least two years. The bank has unfortunately lost a lot of foreign currency, and this is the price that has been paid for the late decision.”
“This is going to add a lot to the fiscal burden if the government continues to have subsidies,” Mr. Abul Eyoun said.
Abul Eyoun predicts a 20 percent jump in the price of staple goods if the government cannot finance its deficit and if the pound continues to slide.
“It is a dilemma, and I feel that this government and central bank will have to go through hard times,” he said.
Ismail Hassan, Central Bank governor in the 1990s and now heads Misr Iran Development Bank in Egypt:
He welcomed the Central Bank’s move and said it heralds a new era of currency management.
“I don’t think there is room for the word devaluation. Devaluation was used in the past when we had a fixed price, and now the alternative is the central bank not interfering heavily in the market,” Hassan said.
The new regime means devaluation, a product of central bank measures, would be replaced by market forces of natural depreciation where the real value of the pound would be discovered.
Egypt’s Central Bank yesterday published a strangley frank statement that sheds light on the country’s terrible spending habits and signals how the Morsi administration is losing its grip on the economy.
Just hours after the country’s president Mohammed Morsi made a speech to declare the economy was showing signs of improvement, the Central Bank said it plans to start foreign-exchange auctions in order to preserve foreign reserves after they plunged to “minimum and critical” levels.
The new mechanism, which comes into effect today, will support the dollar interbank market.
The Egyptian pound is subject to a managed float but these auctions will mean the exchange rate is determined by the market rather than the Central Bank. It is a clear response to the depreciation of the pound, which fell to 6.1858 a dollar on Friday, near the lowest level in eight years.
A wave of dollarization, where the public have swapped their pounds for dollars, has exacerbated the pressure on the currency and the ability for the Central Bank to manage the pound’s fall. If you want to read more about Egypt’s currency situation, Rebel Economy put this guide together a few days ago.
$14 billion for the import of petroleum products and foodstuffs.
$8 billion for the payment of premiums and interest on foreign debt.
$13 billion to cover the exit of foreign investors from the local debt market.
The Central Bank said the total of $35 billion was financed from reserves plus other foreign exchange inflows.
It is the clearest sign yet of how Egypt’s costly energy subsidies have eaten up some of the country’s reserves to fund petroleum imports. Just this morning the ministry of finance said it has prepared $50 million to cover “urgent” petroleum import needs.
Debt service payments in foreign debt is also significant considering the country boasts about low external debt.
Even so, the renewed transparency from the finance ministry, central bank and the presidency is a positive step toward communicating to the public the situation on the ground, something that has been missing for several months. With it, Egyptian officials have explained that the country is not in danger of going bankrupt as several media reports have signalled. This morning Mumtaz el Saeed, Egypt’s finance minister said it was all an “illusion” and a “myth”.
It is unlikely that Egypt will go bankrupt simply because it is too big to fail but also because of the large amount of domestic debt Egypt has which can be rolled over easily unlike foreign debt which carries expensive penalties if not paid on time.
However, the country could get stuck in a perpetual cycle whereby debt is always rolled-over with no fear of default, supported by a cushion from foreign donors such as Qatar, Saudi Arabia and Turkey.
Do not be surprised if Egypt’s central bank governor Farouk El Okdah leaves his post in the early part of next year. Even though he yesterday vehemently denied that he planned to resign, his retirement has been on the cards for months (not just rumours but who is likely to replace him).
Yesterday Zawya Dow Jones reported Hisham Ramez, who was the former deputy central bank governor, is to take El Okdah’s place. But analysts regarded the fact that El Okdah had attended a cabinet meeting this week as proof he was not leaving.
That is poor judgement considering his move will have been planned for months, and an announcement of resignation or retirement is not likely to be followed by a swift departure. It is also likely that El Okdah does not want his departure to appear political amid the tumultuous situation in Egypt. The sensitivity of the situation means the leak to the local press must be managed with impassioned denials.
Management changes are however dwarfed by a more serious development at the central bank, as Noha Moustafa of Egypt Independent explains:
The most critical development within the Central Bank will be the impending amendments to the law governing its activity, which experts are concerned will infringe on its independence.
State-run Al-Ahram reported early in December that President Mohamed Morsy plans to issue a decree to amend the statutes that govern the bank and its officials, giving himself the authority to appoint members of its governing board.
The modifications reduce the number of board members and give the president the right to nominate the next CBE governor without the usual recommendations from the prime minister.
The amendments may also affect the positions of the some of the bank’s board members (all well known in the Egyptian business community), Moustafa points out:
Due to their current posts, some of the bank’s board members that may be affected by the changes include both Amer and Barakat, as well as chairman of Banque Misr Abdel Salam al-Anwar, former chairman of HSBC Egypt Mona Zulfacar [the chair of EFG Hermes], legal expert and board member of EFG-Hermes Alaa Saba [former CEO at Beltone] and economic expert Ziad Bahaa Eddin, who is also the former head of the Egyptian Financial Supervisory Authority.
The central bank has been lauded for its work in the last decade including a smooth flotation of the currency and the elimination of a black market. But these amendments, if eventually passed, will likely pit the new governor against the president in a battle for independence.
For those expecting President Morsi to enact his long-awaited reform plans, here is evidence that it is now or never:
Egypt’s budget deficit increased to LE80.7 billion ($13 billion) during the first five months of the current fiscal year 2012/13, which starts in July, the Ministry of Finance reported on Sunday in a bulletin, Ahram Online reported.
The same period of last year witnessed a budget deficit of LE58.4 billion ($9.5 billion).
That means, since Mohammed Morsi has been in power, the budget deficit has widened by almost 37%.
Supporters say Morsi is planning to implement nationwide subsidy reforms and tax hikes after the parliamentary elections (which should start in two months from the referendum passing, but nothing has been formally announced). But wasn’t Morsi’s presidential campaign resting on the Renaissance Project and all the economic boosts that he claimed would come with it after he was elected? What’s happened to that? We have not heard anything related to the project for months and months.
Morsi, in the context of his dogged determination to go ahead with the constitution, already has a slim mandate to enforce tough austerity measures. But the more he waits, the less people he will please. It’s now or never.
The one silver lining for Egypt, as Rebel Economy has pointed out before, is its 83 million consumer market. That has brought the Gulf banks to Egypt to snap up banking assets ripe for picking, despite the political risk.
Now Egypt’s supermarkets are looking attractive too. Reuters reports:
Dubai’s Majid Al Futtaim (MAF), is in talks with Egypt’s Mansour Group, owned by billionaire Mohammed Mansour, to buy its supermarket business in a deal valued at $200 million to $300 million, three sources aware of the discussions said.
Mansour Group, also the largest distributor of General Motors cars in Egypt, is aiming to sell supermarket chain Metro and discount grocery store Kheir Zaman, the sources said, speaking on condition of anonymity as the matter is not public.
These “Egypt bulls” see low valuations after the revolution and are willing to take the risk of the political situation. It’s always been said that retail is a defensive market because the sector is able to weather any crisis. After all, no matter what people will always shop.
Farouk al Okdah, Egypt’s central bank governor, will be chairing a monetary policy meeting this afternoon to decide on whether to change the country’s interest rates. It is just days before an International Monetary Fund delegation is due to arrive in Egypt to consider the country’s $4.8 billion loan request.
Egypt is likely to play it safe and maintain the benchmark deposit rate at 9.25% because of pressure on the domestic currency.
But what are the impacts of changing interest rates?
Nothing is more controversial in business and finance than banking, as we saw yesterday with the media storm that erupted after the departure of Vikram Pandit as chief executive of Citigroup.
But the most contentious of all are the central banks. These are organisations sitting at the juncture of both economic and government policy.
Yesterday we saw how controversial this industry can be when the governor of Iraq’s Central Bank was booted over allegations he had intentionally weakened the value of the Iraqi dinar against the US dollar.
“The cabinet decided to authorise Abdelbassit Turki, the head of the Board of Supreme Audit, to run the central bank indefinitely,” Prime Minister Nuri al-Maliki’s spokesman Ali Mussawi said, adding that Sinan al-Shabibi had been suspended from his post by the anti-corruption watchdog.
It was a busy day yesterday for Egypt’s business community, as another big business conference in just a few months was held to entice foreign investors back to Cairo.
But before we get to that, cast your eye on this “Formal Apology” made to Bank of America /Merrill Lynch, from Egyptian bank EFG Hermes on behalf of one of their analysts. This was an email sent yesterday to clients:
We sincerely apologize to Bank of America – Merrill Lynch (BAML) and our / their clients for a note titled ‘Recent Saudi Weakness: Summary Of Local Chatter’ sent by our sales desk in Dubai. The note, written by a junior employee of EFG – Hermes in Saudi, failed to highlight the source of the information or that the material was prepared by BAML and not his own. It is with the utmost sincerity that we apologize to BAML and our clients for this embarrassing oversight.
EFG Regional Trading Team
Not just journalism that attracts plagiarism…
Yesterday, the country’s prime minister Hisham Qandil tried to woo investors saying he wants the country to become a mecca for investments and officials are determined to boost confidence to revive an economy battered by last year’s unrest that ousted President Hosni Mubarak.
Here’s a round-up of the most important news (with some gossip behind of the scenes of the Euromoney conference):