Egypt’s central bank raised its key interest rate by the most since at least 2006, the latest in a series of measures to tackle the black market for dollars and to attract more foreign investors to Egyptian assets.
The Monetary Policy Committee, headed by Governor Tarek Amer, raised the benchmark overnight deposit rate by 150 basis points to 10.75 percent on Thursday, the highest level since December 2008. The median estimate of eight economists in a Bloomberg survey was for an increase to 9.75 percent. The overnight lending rate was lifted by the same amount to 11.75 percent.
Egypt has been suffering from a dollar crunch that has slowed economic growth, hindered investment and made it difficult for foreigners to expatriate funds, as well as driving down the value of the local currency to record levels on the black market. Authorities promised to adopt more flexible exchange rate policies to boost debt and equity markets following the biggest one-time devaluation of the pound since 2003 on Monday.
“The decision fits the bill 100 percent,” said Ziad Waleed, an economist at Cairo-based Beltone Financial, who predicted an increase of at least 1 percentage point. “It eases the pressure on the pound, and more importantly, presents an attractive yield to portfolio investors” targeted by the central bank to help ease the foreign currency shortage, he said.
Raising interest rates will also help to limit the inflationary impact from weakening the pound this week, he said.
Adopting a flexible exchange rate has restored confidence in the Egyptian pound, and authorities will aim to keep inflation at no more than 10 percent in the medium-term, the central bank said in a statement after the decision. Inflation in urban areas, the measure that bank monitors, eased to 9.1 percent in February, the lowest level in six months.
“The Monetary Policy Committee judges that a rate hike is warranted to anchor inflation expectations,” it said.
Yields on Egyptian debt rose in a 9.25 billion pound auction today, with rates on 1-year securities rising to 13.589 percent from 12.514 percent a week ago.
The bank has also injected hard currency worth about $2.4 billion into the market this month, including a $1.5 billion exceptional sale on Wednesday, about five times the central bank usually offers to banks monthly.
Egypt’s two largest state-run banks have started offering pound-denominated certificates of deposits that paid 15 percent — on condition that buyers exchange dollars to invest in them. They are also offering a call option product that allows foreign investors buying T-bills to hedge against currency risk.
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Package of Measures
Raising borrowing costs was the logical next step, Hany Farahat, senior economist at Cairo-based CI Capital Holding, said before the rate decision. A higher interest rate will increase the opportunity cost of holding dollars in favor of the local currency, he said.
“The devaluation step was taken in the hope that it would result in a pick up in portfolio inflows,” he said. “For that to happen, interest rates have to increase to stimulate demand for the the Egyptian pound, to stabilize speculation and to curb inflation after the pound was devalued.”
The most-populous Arab country has struggled to attract investments since the 2011 uprising that ousted Hosni Mubarak, while aid from Gulf Arab allies is drying up and the tourism industry was dealt a new blow after the downing of a Russian passenger plane last year over Sinai.
The main disadvantage of raising rates is the potential for the budget deficit to increase, Waleed at Beltone Financial said.
Interest payments already account for nearly 30 percent of state spending this fiscal year. The government has taken measures to cut energy subsidies, and plans a value-added tax to boost revenues.
“It’s a trade-off, you either fix the currency shortage or look at the budget deficit,” he said. “And I think the former should be the priority right now.”
(Updates with analyst comment in fourth paragraph.)
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