As well as its general regulatory functions, the Central Bank of Egypt (CBE) is entrusted with implementing the nation’s monetary policy, a role that has most recently been defined by the Banking Law of 2003.
SETTING A FREE FLOAT: The CBE has therefore been the protagonist at the centre of an interesting evolution of monetary policy over recent decades. From the 1990s until 2003, the two key policy priorities it established were maintaining price stability and stabilising the exchange rate – both of which were viewed as the essential objectives in Egypt’s struggle to attract investment and spur economic growth. The consequence of this prioritisation, though, was the relegation of other important factors, such as raising export levels, promoting foreign competitiveness, controlling liquidity growth and establishing confidence in the national currency, to the status of second-tier objectives.
However, in 2003 the government moved away from its long-held view that the national interest lay in a tight grip on the nation’s currency, and implemented a free float for the Egyptian pound. The change in stance required a new framework with which to implement an altered monetary policy – now serving the dual priorities of price stability and maintaining low inflation rates as its guiding principles. This came in the form of the Monetary Policy Committee (MPC), the principle achievement of which since its inception has been the creation of an interest rate corridor, the floor and ceiling of which are defined by the overnight lending and overnight deposit rates, respectively. By setting the rates on these two “standing facilities” the MPC determines the corridor within which the overnight rate can fluctuate, and its operation of the corridor since 2005 has been widely credited with reducing the volatility of the overnight interbank rate.
INFLATIONARY EVENTS: Prior to the political upheaval of January 2011, the MPC was compelled to react to two inflationary trends with the newly implemented corridor, which had replaced the management of bank reserves as its primary operational instrument. As of September 2008 the growth of the global economy had begun making its presence felt at home in the form of rising consumption, increasing demand for labour and raw materials, and the rising cost of imported food and fuel – all of which resulted in upward inflationary pressure. The MPC, which had monitored the inflationary progression and reacted by raising the overnight deposit and lending rates, or the corridor, by 50 basis points (bps) to reach 11.5% and 13.5%, respectively.
REVERSING THE TREND: It was not long, however, before it had to move to counter a reversing trend, as the global economic crisis began to take its toll. While the domestic economy was protected from its worst ravages, Egypt’s export markets and the principal sources of foreign direct investment which had helped to fuel its economy were not.
The MPC, therefore, reacted to the threat of a slowing economy and falling inflation rates with a series of corridor rate cuts, the last of which (until its 2011 rate change) came in 2009 – leaving the corridor range for overnight lending between 8.25% and 9.75%.
The MPC did not lower this rate any further in the years immediately following the global credit crunch, concentrating instead of refining the manner in which it measured inflation – a question of key importance to the successful establishment of the corridor range. A new core inflation rate excluded the effect of volatile items, such as fruits and vegetables as well as regulated prices. Its introduction was intended to reduce the effect of exogenous shock factors, such as rising international wheat prices, on domestic monetary policy. Its adoption as a key weighting in the corridor calculation was presented as a rationalisation of the old system, which would lead to more consistent approach to inflation management. Some, however, saw a weakness in the formula: with the Ministry of Finance estimating that 40% of consumer spend was on foodstuffs, the propensity for volatile wheat prices to influence the non-consumer basket meant that its weighting in the inflation forecasting mechanism was potentially high.
RAISING RATES: The events of January 2011 put an end to the debate, as the deterioration of the nation’s fiscal position and the question of Egypt’s future economic path monopolised the attention of the financial community. The issue of the corridor rate, which had not been altered since 2009, was not a prominent one during 2011, with most observers assuming that it would be maintained at its relatively low level to counteract the effects of a cooling economy. It came as some surprise, then, when the MPC announced in November 2011 that it had decided to raise the overnight deposit rate by 100 bps to 9.25%, while raising the overnight lending rate and the seven-day repo by 50 bps to 10.25% and 9.75%, respectively. The discount rate, meanwhile, was raised by 100 bps to 9.5%. The MPC also explained the rationale for its decision. Pointing out the downside inflationary risks, it drew attention to the fact that GDP growth stood at a mere 0.4% for third quarter of 2010/11, and 1.8% for the whole year (compared to the 5.1% recorded in 2009/10). The magnitude of the decline, according to the MPC, was “larger than anticipated at the outset of the revolution” due to significant reversals seen in the manufacturing, tourism and construction sectors. The MPC then pointed to future downside domestic GDP risks in the form of the possibility of continued political unrest in the domestic sphere, the banking sector challenges facing the Euro area and weaker-than-anticipated growth rates in a number of advanced economies.
The downside risks described by the MPC were exactly those which led many observers to conclude that the corridor would remain unaltered for the foreseeable future. However, the MPC also highlighted a number of upside inflationary risks. The headline consumer price index (CPI), it pointed out, had crept up by 0.33% month-on-month in October, following a 1.43% increase in September. Core CPI, meanwhile, rose by 0.4% in October, after a 1.13% rise during the previous month. The MPC acknowledged that the sharp food price increases of July and August 2011, which it attributed to the “Ramadan effect”, had receded later in the year, and that the threat of a rebound in international food prices had abated in the light of global developments. However, it maintained that the re-emergence of supply bottlenecks and distortions in distribution posed a risk of upside inflation, warranting a rate hike.
Not everyone agreed with this interpretation of the risk environment. While it is true that bottlenecks in the supply of fuel had led to intermittent shortages of fuel, some pointed out these had been of limited duration and had been adequately, although belatedly, addressed by the transitional government. Rather, it was asserted that the higher rate would attract liquidity to cover the government’s shortage, in light of the sales of T-bills. The decision of the MPC is another example of the strain that the political uncertainty has placed on the economy. For its part, the MPC will undoubtedly be keenly anticipating a return to business as usual.