Is it Hard Conditions Or Failure Policies?! … A New Chapter of the Egyptian economy

By: Free Economist

 07 July 2017

  Egypt has struggled to recover its economy following the 2011 revolution, which drove away tourists and foreign investors, both primary sources of foreign currency. Although Egypt has received more than $23 billion in aid from Saudi Arabia, UAE  and Kuwait in the 18 months since President Mohamed Mursi was ousted in 2013. Since the transparency and accountability do not exist,  the government wasted all these billions of dollars on the unknown and unplanned projects, also on defending Egypt’s overvalued currency.  Additionally, this scale of financial aid did not continue indefinitely due to the oil price crash. 

 Failed economic policies had led to making the Egyptian government forced into the embrace of the IMF after a chronic dollar shortage and a spike in inflation that has led to hoarding most of the strategic goods such as of sugar, rice and medicine. The oil collapse has also impacted on Suez Canal shipping tolls and remittances from Egyptian workers in the Arabian Gulf. The macroeconomic image can be seen in a few of records: a fiscal deficit hit 12% of GDP; growing public debt (110% of GDP) and high unemployment (over 12%).

In November 2016, the Egyptian government increased the price of subsidised fuel and electricity by around 50%, brought in new taxes and allowed the Egyptian pound to float, in order to obtain a $12bn loan from the International Monetary Fund (IMF). The expectation of IMF and the Central Bank of Egypt (CBE) about the inflation rate will increase from 15% to reach around 20% in 2017. To hinder the expected inflation, the CBE decided to raise interest rates by 3% and launched new saving certificates with a 20% interest rate for 18 months, as well as three-year certificates with a 16% interest rate. A huge spike to avoid inflation getting out of control.

However in reality, there was a huge difference between government and IMF predictions on the one hand and the real inflation rate recorded on the other; the inflation increased rapidly to above 30 % in the first quarter of 2017. The annual food and beverage prices, which make up the largest single component of the inflation basket, rose 41.1 % last March, with accelerated by 2 %month-on-month. Egypt has not witnessed such a high rate of inflation over the past 100 years.

 High inflation means significant rises in the prices of commodities, which means people lose their purchasing power and an increase in the unequal distribution of wealth among its population. Wealthy people and businessmen who keep their saving in foreign currency will get their assets increase whereas the poor will become poorer and the middle class will fall under the poverty line.

The concept of Egyptian Central Bank's policy is that raising interest rates is the easy solution for high inflation. Naturally, if inflation is high, this means the economy has been growing quickly, investment has been growing, and demand for goods and services has been high.  Therefore, high-interest rates will discourage investment and demand, which later leads to decrease prices for goods and services, hence helping to control inflation.

 In fact, this policy is only valid in the case of the inflation caused by an increase in aggregate demand. While the Egyptian situation is totally different, the reasons for growing inflation are driven by the supply side due to: an unexpected increase in the prices of goods due to the unplanned devaluation of the Egyptian Pound; the rise in customs duties that increased the price of imports even further; the restraints on importing transactions led to made the imports unavailable or limited with much higher prices; the reduction in energy subsidies that increased local production and transportation costs across the board.

In these cases, increasing interest rates is a useless and irrelevant tool as it will discourage demand, but inflation will not be controlled because prices did not rise firstly because of high demand but fairly due to increases in the costs of supply.

 On the other hand, the consequences of the ineffective hike in interest rates resulted in the cost of borrowing to the private sector from banks reaching 20%. At such expensive interest rates, it is hard for the private sector to borrow and invest, deepening the current recession further. In addition, as the government is the largest borrower from the local banks, every 1% growth in interest rates meant more than an LE20 billion increase in the cost of public debt and consequently expanded the budget deficit by more than LE60 billion.

In spite of, these facts, the IMF still insists on describing interest rates as the “right instrument” to control inflation and does not stop asking Egypt to work on curbing its accelerating inflation through hiking interest rates. Unfortunately, last May Egypt’s Central Bank again accepted the terms of the IMF and raised key interest rates by 2% in order to receive the next tranches of the loan.

The only beneficiaries from that situation are investors who represent international funds focused on investing in government bonds. They saw the extremely high-interest rates on Egyptian treasury bonds as it reached 8.15% for 30-year US dollar bonds as a perfect opportunity to make money. Although Inflows from portfolio investors are critical to supporting the Egyptian pound, it was a very expensive choice, and it was possible to achieve the same result with lower costs.

  Presently, after more than seven months from the adoption of this failed policy, so far, the large hike in interest rates has had no noticeable effect on inflation. Such frustrating outcomes should not have been a surprise because higher interest rates cannot correct the price rises related to the currency float. Instead, such a policy has wider damage on public finances and the private sector, thus decreasing the prospects of economic recovery in the short and medium term.

 On the other side, Bills of the failed economic policies in Egypt as usual, have to be paid by middle and inferior social class from their incomes and purchasing power. In the last week, the government raised the fuel prices again up to 55%, doubled the cost of cooking gas and increased electricity prices by up to 42 %, starting this month, which will lead again a boost to an already surging inflation.

Personally, I have no doubt that, this cycle of increasing the difficulty that’s already widespread will continue as long as these failed policies exist. The pound’s purchasing power has deteriorated, and millions of Egyptians will drop below the poverty line while property, savings and local investments will gradually evaporate.

To be continued....