Capital flows to emerging markets (EMs) has resumed since the first quarter (Q1) of 2019, 11 months after its outflow from these markets, the Central Bank of Egypt (CBE) announced in its Monetary Policy Report.
The direction of capital flows depends on the outlook for economic growth and the development of global trade tensions, the CBE said.
It added that the international bond yields have continued to decline since the beginning of the year, in line with the lower risk margin in EMs.
Meanwhile, the CBE referred to the ongoing recovery of the GDP growth supported by structural reforms, pointing out that the rise in net exports was supported by the growth of real GDP during Q4 of 2018.
According to the report, the contribution of local bank financing to the state’s fiscal deficit declined during Q1 of 2019.
On another note, the CBE said since May 2018, household savers have tended to invest more in conventional saving forms, such as deposits in banks operating in the Egyptian market for three years and more. It indicated a decrease in the rate of deposit interest to 12% and a stability on loans at 17.7% in March 2019.
The CBE expected the international food commodity prices to rise in 2020, and that the cost of most petroleum products will be covered, in addition to the fact that the automatic pricing mechanism will be applied locally according to cost developments.
The report highlighted that economic growth of Egypt’s external environment continued to soften during Q4 of 2018, registering 2.5%, down from 2.7% in Q3 and from 3.2% in Q4 of 2017, the highest pace since 2011. “Economic growth in advanced economies continued to ease for the fourth consecutive quarter to register 1.4% in Q4 of 2018, compared to 1.8% in Q3 of 2018, as slower growth in the euro area and the United Kingdom more than offset a stronger growth in Japan. Meanwhile, economic growth in the United States remained unchanged in Q4 of 2018, compared to the previous quarter. On the other hand, economic growth in emerging economies stabilised in Q4 of 2018 at 4.9%, after maintaining continuous improvement between Q4 of 2015 and Q2 of 2018. Higher growth in Russia offset slower growth in China, India, and Brazil, compared to the previous quarter,” the report read.
It noted that headline inflation of Egypt’s external environment continued to decline in January and February 2019, registering an average of 1.9%, compared to 2.3% in Q4 of 2018. Inflation in advanced economies declined in January and February 2019, registering an average of 1.5% down from 2.0% in Q4 of 2018. Meanwhile, the CBE added that inflation in emerging economies stabilised in January and February 2019, registering an average of 2.9%, after accelerating to 3.0% in Q3 of 2018. The deceleration of the inflation rate in China, Brazil, and India offset the acceleration of the inflation in Russia, compared to the previous quarter, it noted.
Global trade growth declines for 5th consecutive quarter
Moreover, the report stressed that annual global trade growth continued to decline for the fifth consecutive quarter (Q4 of 2018) to register 1.4%, compared to 3.6% in Q3 of 2018 and down from a peak of 5.3% in Q3 of 2017.
It explained that Brent crude oil prices increased for the third consecutive month in March 2019, registering an average of $66.1 per barrel, compared to an average of $57.4 per barrel in December 2018. OPEC and its partners continued production cuts until June 2019, while production from the US continued to increase.
International food prices, using the domestic consumer price index (CPI) basket weights of core food items, continued to decline on annual terms in March 2019 for the ninth consecutive month, however, by a weaker magnitude since December 2018. The decline was mainly due to red meat, dairy products, and oils, as supply conditions improved.
The report added that the Federal Reserve System kept its policy rate unchanged in January and March 2019 after raising it by 25 basis points (bps) in December 2018, marking the fourth policy rate hike in 2018.
“Moreover, the Federal Reserve decided to slow the pace of its balance sheet unwinding plan, which started in October 2017, by slowing down the reduction of its holding of government debt starting May 2019 before ending the programme in September 2019. Meanwhile, the European Central Bank also kept its policy rate unchanged in January and March 2019, while it decided to launch a new series of quarterly targeted longer-term refinancing operations with a maturity of two years between September 2019 and March 2021, each. Furthermore, the Bank of England kept its policy rate unchanged in February and March 2019, after raising it by 25 bps in August 2018 for the second time since November 2017,” the report read.
The CBE added that capital flows returned to EMs in Q1 of 2019, after 11 months of outflows that started in February 2018. The return of international capital to EMs was mainly supported by a monetary policy normalisation pause in advanced economies. However, the direction of capital flows remains subject to the economic activity growth outlook, as well as the prospects of further escalation of trade tensions.
Elsewhere, the CBE explained that the hydrocarbon trade balance registered a surplus for the first time since Q4 of 2013, while the current account deficit widened.
“After improving on annual terms for seven consecutive quarters between Q4 of 2016 and Q2 of 2018, the current account deficit widened in Q4 of 2018. A less favourable contribution from remittances, net service receipts and the non-hydrocarbon trade deficit has more than offset the more favourable contribution from the hydrocarbon surplus and net investment income,” the report read.
“Nevertheless, the deficit of net exports of goods and services continued to narrow in Q4 of 2018 on annual terms for the eighth consecutive quarter. This was due to a more favourable contribution from imports of goods and services, mainly those related to the hydrocarbon sector, which more than offset the less favourable contribution from exports.”
The CBE explained that the hydrocarbon trade balance continued to improve on annual terms for the fourth consecutive quarter to register a surplus in Q4 of 2018, for the first time since Q4 of 2013. The improvement was mainly driven by lower imports, which coincided with the accelerating annual pace of domestic natural gas production.
Furthermore, the non-hydrocarbon trade deficit continued to widen on annual terms in Q4 of 2018 for the fifth consecutive quarter. This was mainly due to a less favourable contribution from imports, which more than offset the more favourable contribution from exports.
The report noted that the service surplus continued to increase in Q4 of 2018 on annual terms for the eighth consecutive quarter, yet its pace of growth declined to the lowest level since Q1 of 2017.
“The slower annual pace was mainly due to a less favourable contribution from net receipts from tourism as well as other services, which more than offset a more favourable contribution from transportation, excluding government services and Suez Canal tolls. Meanwhile, remittances declined on annual terms in Q4 of 2018, for the first time since Q2 of 2016. Net Foreign Direct Investment (FDI) inflows resumed its annual decline in Q4 of 2018 for the second consecutive quarter due to higher gross outflows, after witnessing an annual increase in Q2 of 2018 for the first quarter since Q2 of 2017. Portfolio flows excluding Eurobonds continued to register a net outflow in Q4 of 2018 for the third consecutive quarter amid unfavourable global conditions for emerging markets, though at a slower pace compared with the previous two quarters. This, however, was mostly offset by net inflows from commercial banks’ net foreign assets. Meanwhile, gross international reserves stabilised in April 2019 for the second consecutive month at $44.2bn, after increasing in February 2019 supported by the issuance of Eurobonds by the Ministry of Finance,” the report read.
Real GDP growth rose to 5.5% in Q4 of 2018
The report highlights that real GDP growth rose to 5.5% in Q4 of 2018 from 5.3% in Q3, while unemployment rate dropped to its lowest rate since 2010.
It explained that higher net external demand for Egyptian goods and services reinforced a more balanced expenditure structure and supported the rebound of economic growth since the fiscal year (FY) 2017/18. Meanwhile, the contribution of domestic demand to GDP growth remained contained, and the unemployment rate dropped to 8.9% in December 2018, the lowest rate since December 2010.
The CBE added that the recent improvement in the contribution of net exports was mainly driven by the continued drop in real imports, while the growth of real exports was slightly strengthened after four feeble consecutive quarters. On the other hand, the contribution of private domestic demand to GDP growth weakened due to the drop in the contribution of private consumption and investments. Meanwhile, public domestic demand stabilised during the same period, as the slight rebound of public consumption contribution was offset by the slight drop in the contribution of public investments.
It explained that at the sectoral level, growth stabilised compared to the previous quarter, as the boost in the contribution of public sector to GDP growth was offset by the weakness in the private sector. The increased contribution of the public sector to the GDP was primarily due to the rising contribution of natural gas extractions, while that of other sectors remained stable. The contribution of the private sector to the GDP growth dropped due to weaker growth in the tourism sector, which more than offset the improvement in the construction sector.
In addition, available leading indicators for the non-hydrocarbon sector mostly point to weakening activity in Q1 of 2019. The Purchasing Managers Index (PMI) average level in Q1 of 2019 weakened compared to Q4 of 2018, despite improving in March 2019 and the manufacturing index continued to contract in January 2019, albeit by a slightly lesser degree compared to Q4 of 2018. Furthermore, the number of tourist nights contracted on annual terms in January 2019 for the first time since November 2016, and total car sales grew on average at a slower pace in January and February 2019, compared to the average pace registered in Q4 of 2018. On the other hand, Suez Canal net tonnage grew on annual terms at a slightly higher pace in January and February 2019 on average compared to Q4 of 2018.
In the hydrocarbon sector, natural gas production continued to increase strongly on annual terms, yet at slower pace during January 2019, compared to the average pace in Q4 of 2018.
Broad money growth continues to decline supported by fiscal consolidation
Following the fading of the exchange rate revaluation effect in Q4 of 2017, annual M2 growth continued to decline to an average of 11.6% in Q1 of 2019, supported by fiscal consolidation and the containment of other broad money counterpart assets’ growth. In Q1 of 2019, the negative annual contribution of foreign nonbank financing of the fiscal budget deficit eased, in line with the monetary policy normalisation pause in advanced economies. This was more than offset by the decreased contribution of bank financing of the fiscal deficit in addition to the expected drop in contribution of external financing compared to Q4 of 2018.
According to the CBE, other components of counterpart assets M2 claims on the private sector which slightly picked up. The decline in M2 growth favourably coincided with an annual increase in broad money velocity which suggests lower room for noninflationary money growth.
Meanwhile, following its decline between Q2 of 2017 and Q1 of 2018, the contribution of claims on the private sector to M2 growth continued to pick up in Q1 of 2019. Similarly, inflation adjusted L/C claims on the private sector continued to witness annual increases since Q1 of 2018, after recording annual contractions in 2017. The recovery was especially evident for claims on the private business sector, while claims on the household sector recovered by a relatively weaker magnitude.
Within the components of M2, CIC as a percent of L/C deposits in M2 continued to decline in Q1 of 2019 for the third consecutive quarter recording a ratio below its long-term historical average, which suggests lessening currency holding behaviour. Meanwhile, the annual growth of F/C deposits in US dollar as well as the dollarisation ratio defined as F/C deposits to total deposits in M2 broadly stabilised during Q1of 2019.
Moreover, the structure of household deposits in L/C continued to be dominated by deposits for more than three years since May 2018, following one and a half years of dominance by deposits less than three years amid the introduction of 1.5-year saving certificates at a higher rate compared to longer term saving certificate rates. The reversal of the structure of household deposits is consistent with redemptions of these certificates since May 2018, given their cancellation by public banks in late April 2018.
The report revealed that annual growth of M0, adjusted by total excess liquidity, continued to decline in Q1 of 2019 for the sixth consecutive quarter due to CBE balance sheet operations which lowered excess liquidity growth. The money multiplier, measured as the ratio between local currency components of broad money and M0 as defined above, increased slightly in Q1 of 2019, following its broad stability between Q4 of 2017 and Q4 of 2018. This was mainly due to lower excess liquidity as a ratio of L/C deposits in M2, the CBE said.
In another context, the CBE noted that real monetary conditions remained tight, backed by receding inflationary pressures as well as previous policy rate increases, notwithstanding the cumulative 300 bps policy rate cuts in Q1 of 2018 and Q1 of 2019.
After declining between December 2018 and mid-February 2019, excess liquidity rose between mid-February and mid-March 2019 before stabilising to record an average of EGP 734.5bn (13.8% of the GDP) during the maintenance period ending of 8 April 2019, compared to EGP 665.4bn (12.5% of the GDP) recorded on average during the maintenance period ending 11 February 2019.
Meanwhile, interbank activity remained relatively stable since April 2018, with interbank rates remaining below the policy rate by around 30 bps, as higher long-term absorption tenors offset the effect of higher short-term absorption of excess liquidity. Concurrently, the interbank yield curve shifted downward post the 100% transmission of the 100-bp policy rate cut on 14 February 2019.
Moreover, the CBE added that yields for L/C government securities declined to 14.0% net of tax in March 2019 and 13.8% during the first two issuances in April 2019, the lowest since May 2018. This compares to the 15.6% recorded on average during Q4 of 2018 and January 2019, prior to the 100-bp policy rate cut in February 2019. The 1.6p.p. decline in March 2019 was due to the increase in demand reflected by higher coverage ratio which recorded 2.3x in March 2019, compared to 2.0x recorded during Q4 of 2018 and January 2019 before declining to 1.6x during the first two issuances in April after being affected by EM developments. Nevertheless, treasury yields inched down further during the beginning of April 2019, supported by lower accepted-to-required ratio, which was more than enough to offset the decline in demand. The accepted-to-required ratio recorded 0.8x during the first two issuances in April 2019, compared to 1.1x recorded in March 2019 and 1.0x in Q4 of 2018 and January 2019.
Meanwhile, Egyptian Eurobond yields have been declining since the beginning of 2019 in line with the improvement in the risk premium for EMs, after increasing during most of 2018. Moreover, Egypt’s CDS spreads remained relatively low compared to the majority of peers with similar sovereign credit rating. Furthermore, Egypt’s credit rating was upgraded by Moody’s in April 2019 and by Fitch Ratings in March 2019, following the upgrade by S&P in May 2018.
“In the banking sector, March 2019 data reflected partial transmission of the 100-bp policy rate cut on 14 February 2019 to rates of new deposits, which declined to 12.0%. The limited transmission in the magnitude of 0.7x the policy rate cut was due to adjustment of flexible deposit rates, as fixed-rate saving certificates more than or equal to three years remained broadly unchanged,” the report added.
“Meanwhile, rates of new loans remained relatively stable to record 17.7% in March 2019 due to the weaker impact of loans at subsidised interest rates. As a result, interest rate margins widened to 5.7p.p. compared to 4.6p.p. recorded on average between April 2018 and January 2019.”
In equity markets, the CBE stated, real prices recovered since the beginning of the year after declining in 2018, supported by net buying mainly by Egyptian investors. Since the beginning of the year, the EGX 30: USD index recovered by a cumulative 20% outpacing the MSCI Emerging Markets index’s 11%. Meanwhile, real unit prices in Q1 of 2019 inched down in the secondary market as the demand continued to shift from the secondary market toward the primary market, given more flexible payment plans offered by numerous developers in the wake of tight liquidity conditions.
Annual core inflation records single digits for 9th consecutive month
The CBE said that annual headline inflation recorded 14.2% in March 2019, compared to 14.4% and 12.7% in February and January 2019, respectively. Meanwhile, annual core inflation continued to record single digits for the ninth consecutive month, averaging 8.6% between July 2018 and March 2019, the lowest rate in more than two years.
“During Q1 of 2019, annual headline inflation has been generally affected by unfavourable base effects given exceptionally low monthly inflation rates in January and February 2018. This comes after annual headline inflation was affected by fiscal consolidation measures as well as price volatility of fresh vegetables due to transitory supply shocks in the second half of 2018,” the report stated.
“Nevertheless, given the containment of underlying inflationary pressures, annual inflation of services and retail items continued to record single digits for the sixth and fifth consecutive month, respectively, while annual inflation of core food items continued to record single digits for the tenth consecutive month. In the meantime, annual inflation of volatile food and regulated items remained elevated, which contributed to widening of the spread between annual headline and core inflation rates.”
Consequently, the CBE explained, contribution of non-food items to annual headline inflation has been broadly stable since November 2018, while contribution of food items experienced volatility since August 2018. Recently, annual contribution of food items remained broadly stable in March 2019 after increasing in January and February 2019, mainly due to volatile food items, following its decline in November and December 2018.
Meanwhile, monthly headline inflation was mainly driven by food inflation since August 2018, while non-food inflation has been contained. Inflation of fresh vegetables was the main contributor to food inflation. Despite higher than expected price increases in February 2019, fresh vegetable inflation was broadly in line with seasonal patterns, except for higher potato prices. This comes after a supply shock specific to potatoes and tomatoes elevated inflation of fresh vegetables in September and October 2018. However, it was partially reversed in November 2018 and by a larger extent in December 2018.
In March 2019, potato prices increased for the second consecutive month, contributing on average by 30.1% to monthly headline inflation. Prices of tomatoes declined after increasing for two consecutive months.
In the meantime, according to the CBE, prices of core food items inched up slightly since January 2019, mainly due to higher prices of poultry which increased for the third consecutive month in March 2019, contributing on average by 15.8% to monthly headline inflation. In addition, prices of rice as well as fish and seafood increased for the sixth and third consecutive month, respectively.
Average monthly core food inflation witnessed domestically since January 2019 was largely consistent with monthly international core food inflation, after diverging between August and December 2018. International core food inflation continued to be mainly driven by prices of dairy products and red meat since December 2018, while contribution of poultry prices was negative since February 2019.
Finally, after the CBE’s Monetary Policy Committee decided to cut key policy rates by 100 bps in its meeting on 14 February 2019, it decided in its meeting on 28 March 2019 that current policy rates are appropriate to achieve the inflation target of 9% (±3p.p.) in Q4 of 2020 which was declared in December 2018.
Real GDP growth is expected to continue recovering, benefiting from continued structural reforms, despite being affected by potential fiscal consolidation measures. The primary fiscal balance is targeted to record a surplus of 2.0% of the GDP in FY 2018/19, compared to a surplus of 0.1% of the GDP in FY 2017/18 and a deficit of 1.8% of the GDP in FY 2016/17, and is targeted to maintain this surplus thereafter.
Meanwhile, the overall fiscal deficit is targeted to decline to 8.4% and 7.2% of the GDP in 2018/19 and 2019/20, respectively, compared to 9.7% in 2017/18 and 10.9% in 2016/17, and is targeted to continue declining thereafter.
The outlook for Brent crude oil price incorporated in the domestic inflation outlook remained unchanged compared to the previous Monetary Policy Report, while spot prices remain subject to volatility due to potential supply-side factors as well as geopolitical risks. Domestically, cost recovery for most fuel products is expected to be reached and automatic fuel price indexation to underlying costs is expected to be implemented. Meanwhile, international food price forecasts, relevant to Egypt’s consumption basket, are expected to decline slightly during 2019 before increasing in 2020, according to the CBE’s report.
In addition to international commodity price developments, risks surrounding the inflation outlook from the global economy continue to include trade tensions and economic growth developments.
In the interim, domestic risks continue to include the timing and magnitude of potential fiscal consolidation measures and the evolution of inflation expectations.