Central Bank of Egypt holds interest rate, takes other steps to control inflation

Counter to predictions, the Central Bank of Egypt decided on Thursday to fix interest rates during its monthly monetary policy committee meeting.

The deposit rate is to stay at 11.25 percent and the lending rate at 12.25 percent, it said. The central bank has hiked rates a total of three percent over this year, but held rates steady in its last two reviews. 

Analysts had predicted that the Egyptian central bank would follow the lead of the US Federal Reserve, which raised interest rates for the fifth time this year. 

High rates in the United States make the comparatively stable US debt market more attractive to investors in sovereign debt at a time of global economic turmoil. As a result, investors beat a rapid exit from emerging markets, including Egypt’s, this year, with US$22 billion draining from the Egyptian bond market over the first six months of 2022.

The loss entailed a major blow to Egypt’s foreign currency liquidity, which had depended on investor appetite for a bond market that as recently as January offered investors the most attractive real rate of interest in the world.

So why didn’t the central bank hike interest rates on Thursday to try and bring some of those investors back?

“No foreign investor will decide to invest in Egyptian debt instruments as long as they think that the value of the pound will decline” after their purchase, Mona Bedir, a macroeconomic analyst at a private bank, told Mada Masr.

The Egyptian pound dropped in value by 14 percent in March this year, as the central bank removed a de facto peg that had been in place since the 2016 devaluation of the currency. Sources anticipate that a flexible exchange rate will be a key policy condition from the International Monetary Fund, with which Egypt is in talks for another loan to help it to meet tens of billions of dollars in looming repayment schedule.

Present conditions do not allow for foreign investors to return to Egypt’s debt market, said Bedir, as another currency devaluation would entail losses for which the interest rate would not be sufficient compensation. 

Faced with rates of inflation that hit their highest in four years in August, however, analysts had expected the central bank’s monetary policy committee to hike interest rates regardless in order to control the monetary supply. But the committee pursued alternative measures on Thursday to control inflation, raising the reserve requirement for banks operating in the country.

Following Thursday’s decision, Egypt’s banks must now refrain from reinvesting or lending 18 percent of the clients’ deposits it holds of under three years’ duration. Instead, they must deposit the sums at the central bank without interest. Before Thursday, the reserve requirement stood at 14 percent.

Hiking the reserve requirement rate reduces the working liquidity available to banks, pushing lenders in turn to tighten lending conditions for clients. It’s likely that banks will respond, said Bedir, by raising the interest rates that borrowers must pay on their loans while fixing the interest rate that they pay out to customers for deposits.

The central bank’s Thursday decision to control inflation by hiking the reserve requirement instead of by increasing interest rates, said Bedir, will allow the central bank to continue making liquidity withdrawals at no extra cost. Were it to have raised rates, it would have to pay out higher yields on any further treasury bill sell-offs.

Over recent weeks, the central bank has deployed open market operations as another means to tighten the amount of liquid cash in the banking system. Between August and September, it made six consecutive offerings of LE100 billion worth of one-week treasury bills, representing the largest liquidity withdrawal by the central bank through treasury bills since November 2016, when inflation soared as a result of the devaluation of the Egyptian currency. The central bank’s treasury bill sales, said Sherif Othman, former vice president of the Arab Banking Corporation, act to reduce the liquidity in the banking system, ultimately entailing tighter lending conditions for bank customers.

With the interest rate fixed, said Badir, the central bank will be able to sell off t-bills in the future without being obliged to increase the rate of interest it pays out.