The Central Bank of Egypt increased key interest rates Thursday to curb the pressures of inflation less than two weeks after the government reduced fuel and electricity subsidies.
The bank said in a statement that it raised interest rates for overnight deposits to 9.25% from 8.25%, and the interest rate on overnight loans to 10.25% from 9.25%.
The statement said: “The Cash Policy Committee feels that raising the interest rate is necessary to control anticipated inflation as well as the extent of the general price increase due to the negative consequences on the overall economy in the medium term.”
Mohamed Farid, chairman of DCode Economic and Financial Consulting, explained: “The Central Bank’s main goal is to control inflation, as the markets are witnessing continuous and large increases following the subsidy cuts. The other goal is to maintain the price of Egyptian currency, as inflation leads to a decrease in currency value.”
Farid added that the government must improve business practices in order to attract investments, and that financial policymakers must work to decrease the budget deficit. If this does not occur, he said, “the suffering of a large cross-section of Egyptians will increase, especially as” the government raised taxes and general prices due to diesel and petrol increases. The government now is now calling on Egyptians to decrease consumption and put their money in banks, he said.
“The government must push hard to make its financial and investment policy succeed,” said Farid. “High interest rates will cause government debt inflation thanks to an anticipated rise in the cost of servicing debt following the interest rate increase.”
Egypt’s economy has been hit hard by the political turmoil of the past three years due to an exodus of tourists and investors. The economy grew at a meek 1.2% during the first half of the 2013/2014 fiscal year.
“Inflation in Egypt is a result of the increased cost of producing goods and elevated interest rate,” said Hany Tawfiq, Chairman of Egypt’s Direct Investment Association , “This will not benefit anyone but those with deposits, without demonstrating any positive impact on others.”
But he said that fighting inflation resulting from an increase in cash will inevitably require heightened interest rates to encourage savings rather than consumption and reduce demand. Tawfiq feels that the government must strive to reform the economy comprehensively with greater supplies of goods and services.
Inflation in Egypt has declined gradually after the highest rate in four years was recorded at 13%. It is expected that inflation will increase next month following the subsidy cuts that led to sharp fuel price increases.
“The Central Bank is surrounded by contradictions and extremely difficult conditions, and financial measures resulted in both inevitable price increases and inflationary pressures that are impossible to ignore,” said Basel Al-Hainy, former leader at Banque du Caire.
He downplayed the impact of the interest rate increases on servicing debt due to his expectation that the Central Bank will coordinate with the Finance Minister.
The cost of servicing debt in the 2014/2015 fiscal year budget is more than EGP400bn. This figure is expected to increase to over EGP500bn following the interest rate hike.