To what extent will interest rates impact inflation?

CAIRO – 12 July 2017: Egypt’s decision to hike interest rates by 200 basis points is still the main focus of analysts, as issued reports suggest the increased rates will have a positive impact on inflation.
In one week, the Egyptian government introduced higher fuel prices and electricity tariffs as part of its plan to reduce spending on subsidies.

The Central Bank of Egypt (CBE) also unexpectedly raised interest rates by two percent, with the overnight deposit rate pushed to 18.75 percent from 16.75 percent and the overnight lending rate hiked to 19.75 from 17.75 percent, hoping to curb inflation.

While the government expects month-on-month inflation to ease, Beltone Financial forecasted in a research note Tuesday that it expects inflation rates to register 33-34 percent in August, when effects of latest economic reform decisions are felt.

Interest rates have marginal effect on cash-based society

The current inflation rate is caused by high production costs, and it will fall as soon as the U.S. dollar exchange rate declines, Beltone noted.

“Egypt is a cash-based society, which makes impact of interest rates intangible to curb inflation,” the report said, giving example of the limited reflection of May’s 2-percent interest rate increase on the economy.

As a result of the CBE’s decision, inflation is expected to record an average of 10.2 percent in the second half (H2) of 2018, compared to an average of 30.2 percent in H2 of 2017, which Beltone said will help inflation rates to reach more or less 13 percent by the end of 2018, to match CBE expectations.

Beltone predicted interest rates on saving deposits and certificates to remain stable, highlighting that there will be no higher rates than 20-percent interest certificates offered by the National Bank of Egypt (NBE) and Banque Misr.

The research team of the investment bank advised the CBE to reduce interest rates by 300 basis points by early 2018.

Mubasher International, Capital Economics and Pharos Holding all expected in research notes on Monday that inflation rates will keep increasing before declining by the end of 2018.

More burdens on the budget

While Mubasher International projected more pressure on the state budget by LE 14 billion ($ 78.2 million) as an impact of the new interest rates, Beltone said the move will offset anticipated budget savings.

The interest rate hikes impose new pressures on the budget deficit by LE 50 billion because of the additional burden on interests of debts, “which might diminish the impact of reducing energy subsidies, which was expected to save LE 50 billion,” Beltone said.

In FY 2017/18, the debt bill amounts to LE 381 billion, which is LE 88 billion higher than the previous fiscal year, excluding the latest interest rate hike.

“The CBE decision comes to keep the high yields of treasury bills, in efforts to attract foreign investments,” Beltone said, highlighting that average yields on T-bills jumped to 20.98 percent in June, compared to 19.3 percent in May.

All recently introduced economic measures were necessary for Cairo to clinch a $12 billion three-year loan agreement with the International Monetary Fund (IMF). But it is still unclear how the government will save itself from the side effects of the reform.