By: Abdel-Hafez El-Sawy*
In mid-June 2016, the Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) made a decision for increasing the interest rates on deposits and loans by 1%. Accordingly, the interest rate on deposits reached 11.75%, and the interest rate on borrowing from the Egyptian banks reached 12.75%. The Monetary Policy Committee (MPC) attributed the decision to confronting the rising inflation, which reached 12.3% in May 2016 on an annual basis.
The vision of the MPC, as well as some economists, focused on analysing the situation in the light of the terminology and the treatment of monetary policy, as if the matter was limited to some monetary determinants within a narrow perspective in the context of the impact of interest rate on inflation, for dealing with both recessions and boom.
However, the MPC press release, that is published on the CBE’s website, refers to the main reason for the high rates of inflation, namely the negative contribution of the industrial sector in the gross domestic product (GDP), and that such a negative contribution had two aspects: the first is in a continuing decline in the activity of the extractive industries, and the second is the negative contribution of the manufacturing industries. In contrast, the construction sector came at the forefront of the top sectors with regard to its contribution to the GDP, as well as the services sector.
We also find that even the sectors that have contributed positively to the GDP lead to raising the inflation rates rather than stabilizing or reducing them. The construction sector relies heavily on imports, both the import of raw iron and timber, or the import of tools, machinery, production inputs and intermediate goods, including chemicals and others. Thus, this positive contribution of the construction sector to the GDP fuels inflation because of the low value of the Egyptian pound, and the high exchange rate of the dollar, which constitutes the backbone of the import process for the construction sector. Perhaps the constant rises in the price of iron and concrete are a testament to the fact that the construction sector is a source of high inflation.
Also, the positive contribution of the services sector to the GDP comes from the high contribution of the government service sectors of education and health. However, the Egyptian services sector is still characterized by the weakness of the added value, and it depends mainly on the import of technology, not resettling or producing them locally.
According to the mechanism of the monetary policy for raising the interest rate on deposits to encourage depositors to restrict their spending on consumption and direct them toward saving to take advantage of the high-interest rate, we find that this mechanism does not have a positive impact, as the inflation rate of 12.3% in May, 2016 was more than the new interest rate that the Committee decided on June 16, which was 11.75%.
The depositor still sees that depositing his money in banks has a negative effect, where the inflation rate is higher than the interest rate on deposits. Thus, what is the advantage that depositors will get out of putting their money in banks if they will reap losses from their deposits in the end? This talk assumes that the inflation rate will remain unchanged at the end of the year, but projections indicate that Egypt has already entered a “hyper-inflation” phase, i.e. the inflation, which cannot be controlled, with expectations for continuous and high rises.
And what can push the depositor to put his money in the bank in front of these opportunities of speculation in the stock market, or on the dollar in the black market, or at least to follow the trend for dollarization, or in speculating on real estate?
The dollar black market in Egypt has become a haven for speculation, despite the restrictions and legislation adopted by the government to increase sanctions on the currency trading. However, the tricks of the traders in the light of modern technology encouraged them to overcome these sanctions, and the dollar has become active again in the black market in Egypt, surpassing the barrier of 11 pounds against the dollar after remaining at 10.8 pounds for about two weeks.
The Public Debt:
The economic problems in Egypt have become complicated, and the economic policy makers are now in a dilemma. The decision that was made by the Monetary Policy Committee of raising the interest rate by 1%, will make Finance Ministry suffer from the high domestic debt service rates as a result of this increase, which would cost it more than 50 billion pounds ($ 5.6 billion), as the borrowing requirements of the 2016-2017 fiscal year, starting from the first July, are estimated at 576 billion pounds (64.9 billion dollars).
This means that the debt service will jump to go beyond the sums that were allocated for it in the budget rising from 295 billion pounds to about 350 billion pounds, and the budget deficit is expected to exceed 319 billion pounds to be at least up to 360 billion pounds.
Because the Egyptian government does not have a program to address the issue of the public debt in a real way and to get out of the mechanism of repayment of the old debts through getting new loans, the burden of inflation will be greater on the economy in light of the growing burden of the public debt.
We do not forget that the government during the past three years over-printed money without providing a cover of foreign exchange or gold, thereby exacerbating the problem of inflation significantly. We daresay that the government in the current economic performance will continue to print money and cause more inflationary pressures.
Apparently, the issue of the debt is no longer on the agenda of the government’s concerns, as evidenced by its trend to over-borrow from abroad, even after the public debt reached about 3.1 trillion pounds, including 2.4 trillion pounds of domestic debt, and 53.4 billion dollars of external debt. It is feared that this conduct of the government may lead Egypt to descend into the spiral of the foreign debt crisis once again, in a similar manner to what the country experienced at the end of the eighties of the twentieth century.
The Miraculous Solution:
The complementary and necessary procedure to meet the inflation rates in Egypt represents a miraculous solution for the post-military coup governments, namely to build a strong production base in the sectors of industry and agriculture. It is noticeable that the governments of the post-coup governments focus – typically as the case was with the Mubarak era governments – on rentier activities, or the real estate and tourism sectors, or the economic activities that lead to greater dependence of the Egyptian economy on the outside activities.
The proof for this is that the government has paid no heed to its decisions concerning failing to supply power to the industrial sector at low prices to sustain the local or the global competition. The government did not even search for the reasons behind the closure of many factories. It also does not adopt a policy of “displacement of imports” so that their decisions related to the lifting of customs duties or limiting the imports could have a positive impact on the gross domestic product, to mitigate the demand for the dollar, or improve the gross domestic product performance in terms of the production of goods and services and thus reducing the inflation rates.
The decision to raise the interest rate will have negative effects on the productive sectors, especially in industry and agriculture sectors, due to the high cost of funding that the product will not find a way to avoid its effects except through loading it on the consumer, which makes the Egyptian products lose their competitive advantage in front of the foreign products, both in the domestic or the foreign market.
The sums allocated for the export support, which are estimated at 4.6 billion pounds in the draft budget of 2016-2017, will then be useless. Prior to raising the cost of funding, the year 2015 and early 2016 have witnessed a significant decline in the performance of merchandise exports of Egypt, which was estimated at 10% during 2015, let alone the possibility of rises in the cost of funding the Egyptian product. Undoubtedly the Egyptian exports would expect a further decline in the coming period.
The government should not have let the CBE handle a problem that requires all economic policy components to solve, not just the monetary policy. There is no cure for the issue of inflation in Egypt without handling it from its various aspects, especially the aspects relating to the production and investment, and to spare the external impact on the high rate of inflation, especially given the decline in the value of the Egyptian pound.
We, therefore, believe that the proper solution of the issue, from our point of view, is a solution that the current government is unable to possess its tools and policies of implementation. It is a miraculous solution for it.
The practices of the government of Sharif Ismail – as well as its precedent governments – of freeing the hands of the CBE to make decisions, without taking into account the negative effects on the rest of the economic policy components, suggest that the isolated islands policy is what controls the actions of the government. Perhaps the negative repercussions of the economic problem in Egypt have become too big for the government to overcome; so they let every official do what he likes!
*Abdel-Hafez Al-Sawy is an Egyptian economist. He has many economic writings, including: The Post-Revolution Balance, the Employment of Zakat Funds in the Muslim World, A Development Vision, and the Egyptian Economy between the Taxes and the Zakat.
(Published in Al-Jazeera on June 22, 2016, and translated for MEO)