Inflation in Egypt has fallen to some of its lowest levels in more than ten years, which may require consultations with the International Monetary Fund under the terms of a new loan of $5.2 billion.
Because of this, the dilemma faced by the central bank is also complicated: does it keep interest rates high to sell treasury bills and protect the currency, or does it reduce them to stimulate the growth of the economy affected by the Corona virus pandemic.
Under a one-year credit stand-by agreement signed with the IMF in June worth $5.2 billion, Egypt is obligated to consult with a technical team if inflation is about to drop below 6% by the end of September and with the Fund’s board of directors itself if annual inflation drops below 4 %.
Inflation slowed to 3.4% in August from 4.2% in July, close to its lowest level since 2005. Some economists are expecting a similar figure for September, the reading of which is expected on October 10th.
Some economists said that if inflation falls too quickly, the IMF may say the central bank’s monetary policy committee should consider cutting interest rates when it meets next on November 12.
They added that the Central Bank is reluctant to reduce interest rates until it is ascertained that stability is restored in sources of dollar flows, such as tourism, remittances from workers abroad and foreign purchases of Egyptian treasury bills.
“I don’t think they are ready to cut interest rates while external balances are still under pressure,” said Mohamed Abu Basha, an economist at EFG Hermes. The rise in real interest rates also keeps the profit transactions from interest rate differentials continuing.
An IMF staff report last month did not specify a time frame for measuring inflation, nor when any consultations would take place. Neither the fund nor the central bank has yet responded to two requests for clarification.
The decline in inflation in Egypt is due to reasons including the tightening of control over the money supply since the IMF program in 2016, a coordinated campaign to invest in agriculture and weak consumer demand due to the Corona pandemic.
Money supply growth (M2) slowed to 11.33% last year from a high of 25.4% following the three-year agreement with the IMF in 2016 for a $12 billion loan. Since the outbreak of the pandemic, the money supply is rising again.
According to central bank figures, investment in agriculture, mostly government, amounted to 0.92% of GDP in the 2018/2019 fiscal year, a significant level. Food products constitute an important part of the consumer price basket.
Inflation peaked at 33% in July 2017 after Egypt implemented IMF-backed austerity measures that included raising fuel prices and imposing value-added tax and other taxes on tobacco products, while devaluing the currency in half against the dollar.
It is an exceptional achievement to curb inflation to this degree in a low-income emerging market such as Egypt, said Charles Robertson, chief economist at Renaissance Capital.
“But I see a need to change the focus in 2021 and 2022 to support growth,” he said, adding that investment in manufacturing industries is stagnating, partly due to the coronavirus.
Central banks in developing countries have cut interest rates for 20 consecutive months, more than the easing cycles caused by the 2008 financial crisis and in the wake of the 2010 euro crisis, but the pace of cuts continued to slow in September.
On September 24, the Monetary Policy Committee in Egypt cut the overnight lending rate by 50 basis points to 9.75%, saying that key indicators during the summer are pointing to a gradual recovery in economic activity.
The central bank said it expects inflation to rise to the first of its target range, which ranges between 6 and 12%, in the fourth quarter of the year due to the effects of the base year.
Bank of America Global Research said the 50 basis point cut may have been to pre-empt IMF pressure to cut rates in November.