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.”
The sky is not falling, yet. While Egypt’s Central Bank Governor’s resignation now appears final, it does not mean that the pound is imminently going to undergo a devaluation. But it does raise questions about how monetary policy may change in the coming months, especially as Egypt’s much-needed economic reforms are being delayed by the political crisis caused by President Mohammed Morsi’s actions and a controversial constitution that now appears to be approved.
Zawya Dow Jones reports this morning:
President Mohammed Morsi has appointed Hisham Ramez the new governor of the Central Bank of Egypt, a senior official told Zawya.
“A presidential decree to appoint Hisham Ramez is expected to be issued as soon as the referendum on the constitution results are concluded,” the official said on condition of anonymity as he is not authorized to speak to media.
“According to the new constitution, a senior government official cannot take more than two terms in office. Dr. Farouk El Okdah, the current governor of the central bank has occupied this post for three consecutive terms,” the person said.
If accurate, months of speculation that Farouk El Okdah would resign at the end of the year will be over. El Okdah, a former chairman of the state-run National Bank of Egypt, came into office in December 2003. He was reappointed to a third four-year term in November 2011.
Hisham Ramez, a former deputy governor himself, will rejoin the Central Bank from Commercial International Bank, where he was appointed vice-chairman and managing director in November 2011. The Zawya story reports:
“Ramez has met with president Morsi and has accepted the appointment, especially since he specializes in management of cash reserves, and has succeeded in stabilizing the foreign exchange market in Egypt over the past few months,” the official told Zawya on Sunday.
Foreign reserves have more than halved in the two years following the revolution and stand at a meagre $15 billion. The central bank has kept a tight control over the currency and attempted to stabilise the Egyptian pound with reserves.
But economists say the depreciation of the Egyptian pound to about 6.14 pounds to the U.S. dollar shows a deliberate effort by the central bank to ease pressure on the pound and guard international reserves. The pound stood at 5.7 to the dollar two years ago. Analysts say it could reach 7 pounds to the dollar by the beginning of next year.
Contrary to speculation, the departure of El Okdah has been anticipated for several months and Rebel Economy wrote of his impending retirement (not resignation) in September.
Though the position of central bank governor is critical in any country, for Egypt the position is especially sensitive because monetary policy decisions have the potential to have enormous ramifications on the stability of the country. Having said that, El Okdah’s exit is not as dramatic as some may perceive. He does not hold his steady finger over the economic stability of the nation.
After all, his decisions are made in the context of government policy and very rarely does he make the final call. A presidential decree that gave Morsi more power over who is appointed on the CBE board is an indication of how independent the central bank will be in months to come.
Hisham Ramez may be knowledgeable in all things FX, but he will face a hard battle between succumbing to the requirements of Morsi and government and the needs of the country.