Egypt: Lifting the economy

These may be tough times for the Egyptian economy, but healthy long-term fundamentals and sound monetary policy bode well for the future. Indeed, the decision by Egypt’s central bank to keep rates on hold is a clear sign of its policy of prioritising growth in 2012.

Egypt’s economy has a very strong long-term outlook, thanks in part to its massive domestic population and sizable secondary and tertiary sectors, but the recent political uncertainty and global economic slowdown have certainly had an impact, contributing to currency volatility, capital outflows and a worsening fiscus. As a result, the new government is keen to reinvigorate the economy, while the Central Bank of Egypt (CBE) is looking to prevent the Egyptian pound from sliding.

On July 26, the CBE opted to keep its overnight deposit rate at 9.25%, its overnight lending rate at 10.25% and its discount rate at 9.5%, the international press reported. This was the bank’s first meeting since the election of Mohammad Morsi as president.

A number of factors seem likely to have influenced the CBE’s decision. Low growth, concerns about depreciation and diminishing inflationary risk are all at play.

The Egyptian pound has performed remarkably well since the beginning of the revolution in early 2011, losing only 4% of its value to late July. However, some analysts suggest that investors may be waiting for the currency to fall, making their cash in Egypt go further. Were it not for the CBE’s attempts to protect the Egyptian pound, it may have fallen further, allowing the economy to achieve a more advantageous competitive equilibrium, but also increasing the cost of imports, which could stoke inflation further.

The CBE’s cautious position is understandable, as Egypt faces a number of short-term challenges, mostly related to its handover of power. Foreign currency reserves have fallen by more than half since the beginning of the revolution, to $14.42bn at the end of July from $36bn in December 2010. The country also faces controversial negotiations for $3.2bn of funding from the IMF, plus finding other sources for gaps in its budget. Fiscal pressure has caused the government to borrow from the CBE, as rates elsewhere have proved unfavourable given the political situation.

Unlike many countries in difficult fiscal positions, Egypt can count on its “solid and sound fundamentals”, as the IMF put it in a January 2012 report. Egypt remains the largest market in the Middle East and North Africa, with a youthful and growing population, an important geographical location for trade and communications, natural resources, and the institutional underpinning of sound macroeconomic policy. The government is shooting for 4-4.5% growth in fiscal year 2012/13, which began on July 1, partly through boosting investments.

According to international press reports, Morsi’s team are confident that the IMF deal can be sealed as the new government is now in place. The cash will help fill the gap in the budget, unlock other funding deals, and potentially hold off a devaluation of the Egyptian pound. The signs are that the new administration will be willing to implement a reform programme to secure the loan, and that Morsi will make efforts to build a bipartisan cabinet, moving towards the “broad political consensus” the IMF is seeking. On July 30, Momtaz Al Saieed, the minister of finance, was quoted as saying that talks would resume in September or October. While the funds on offer from the IMF would cover only around one quarter of Egypt’s deficit, the deal is considered important to underline confidence in the new political and economic direction.

“The key moving forward will be the loan from the IMF,” Jean-Phillipe Coulier, the managing director of National Société Générale Bank, the fourth-largest bank in Egypt, told OBG. “Even though it is only $3bn, it will shore up confidence for foreign investors and will set a benchmark in terms of country risk. Although some strings will be attached as to where the money will be allocated, it will surely spark future investment in the country.”

The inauguration of Egypt’s first-ever democratically elected president is a major historical milestone for the country. While there are serious immediate and long-term challenges, it should also pave the way for the reinvigoration of the economy, and the first steps to it realising its growth potential.