Egypt's Economy: A Cautious Road Ahead

Growth in oil-importers in the Middle East, North Africa, Afghanistan and Pakistan (MENAP) region, including Egypt, is continuing at a moderate pace, reflecting ongoing reforms and continued external demand, the newly-released Regional Economic Outlook (REO) report said, an annual report issued by the International Monetary Fund (IMF) discussing economic prospects for countries in various regions.

The report projected growth in the region to reach 4.5 per cent in 2018, up from 4.1 per cent in 2017, before moderating to four per cent in 2019. It said that continued strong growth in Egypt and Pakistan in 2018 was driving regional aggregate growth higher, masking weaker and more fragile growth in other countries, particularly those affected by conflict. It added that higher oil prices were also offsetting underlying improvements in external and fiscal balances.

The report anticipated GDP growth in Egypt to stand at 5.3 per cent in 2018 and 5.5 per cent in 2019. It projected the region’s annual export growth in 2018 to be more than double last year’s to reach 15.4 per cent, outpacing import growth of 10.1 per cent, up from eight per cent.

“This surge is largely driven by Egypt, reflecting base effects from receding macroeconomic imbalances during 2016-17 and an improved business environment,” the report said.

It added that tourist arrivals in Egypt had risen following improvements in security, a weaker exchange rate, and the resumption of direct flights from Russia.

It said that Egypt, along with Jordan and Tunisia, had maintained a neutral or tightening monetary policy stance that remained broadly appropriate to reining in inflation.

However, these countries would need to remain vigilant against a rise in inflation and stand ready to anchor inflation expectations should second-round effects from higher energy and food prices materialise, it said, projecting inflation in Egypt to reach 13.9 per cent in 2018 and 12.6 per cent in 2019.

Egypt’s annual headline inflation increased to 17.5 per cent in October, up from 16 per cent in September, according to figures from the Central Agency for Public Mobilisation and Statistics (CAPMAS). The agency attributed the rise in inflation to increases in vegetable prices and school fees.

The figure is above the upper boundary of the Central Bank of Egypt’s (CBE) end-year target range of 13 per cent (+/- three per cent) inflation. Monthly headline inflation also rose last month, coming in at 2.8 per cent against 2.5 per cent in September.

The rise in inflation means that the CBE’s Monetary Policy Committee (MPC) will most likely leave interest rates unchanged in this week’s meeting.

London-based research firm Capital Economics said in a report that the acceleration in inflation raised the risk that policy-makers would hike interest rates in this week’s MPC meeting. But with underlying price pressures still subdued, it said it was more likely that interest rates would be left unchanged.

The firm said that the rise in inflation in October was almost entirely due to a sharp pick-up in food inflation. Food prices, which account for 40 per cent of the basket of goods by which rates are calculated, had increased by 20.2 per cent year-on-year in October, up from a three-year low of 8.6 per cent in May.

“Given that the rise in inflation has been almost entirely due to higher food inflation rather than a broader strengthening of price pressures, we think that the CBE will decide to keep the overnight deposit rate unchanged at 16.75 per cent,” Capital Economics said.

The CBE left its policy rate unchanged at its last meeting in late September, leaving overnight deposit and lending rates on hold at 16.75 per cent and 17.75 per cent, respectively, while the main operation and discount rates were also maintained at 17.25 per cent.

This was the fourth consecutive meeting at which rates were left on hold, having been lowered by a cumulative 200 base points earlier in the year. Mahmoud Al-Masry, an economist at local investment bank Pharos Holding, said the CBE would likely leave interest rates unchanged in this week’s meeting because a hike in inflation made it difficult to cut rates.

He said the spike in inflation could be attributed to “unexpected seasonal factors” related to vegetable prices, meaning that the spike in inflation was not alarming.

He expected inflation to decline starting in December with the new harvest. It could end the year within the CBE’s target, but on the upper boundary, ending at around 15.8 per cent, he said.

The CBE would likely keep rates unchanged in its next two meetings until inflation rates were clear, Al-Masry said. Should it continue to rise, the CBE could hike interest rates, he added.

Keeping rates unchanged is not only about inflation, Al-Masry said. The CBE wanted to maintain investor appetite to invest in Egyptian debt instruments and prevent “hot money” from exiting the Egyptian market, especially since these investments have been on the slide, he said. The percentage of foreign holdings in Egypt’s treasuries declined to 18 per cent in September 2018, from a high of 32 per cent in October 2017, on the back of the world emerging markets crisis.

Another factor that could drive the CBE to keep rates unchanged was the fact that yields on treasury bills in other emerging markets were high, Al-Masry said.

In Turkey, yields on one-year treasury bills are 23.97 per cent, while they stand at 17.44 per cent in Argentina and 16.5 per cent in Nigeria. Egypt’s yields are currently 15.78 per cent, after deducting taxes, Al-Masry said. “Our rates are in the middle compared with other emerging markets, so we cannot cut them now,” Al-Masry told Al-Ahram Weekly, adding that Egypt had a competitive edge compared to other emerging markets as it had lower risks and cutting interest rates and resuming the easing cycle would likely not take place before the second quarter of 2019.

Besides inflation, the REO report referred to Egypt’s debt levels, saying that the country would remain above the 60 per cent vulnerability threshold for emerging market economies and that significant fiscal adjustment was still needed.

Although Egypt’s foreign debt has increased recently, the country’s public debt-to-GDP ratio is starting to decline for the first time in nearly a decade, in a positive sign that partly prompted international ratings agency Standard & Poor’s (S&P) to affirm Egypt’s sovereign credit rating at B and its outlook at stable.

The agency said last week that the move came on the back of a “more competitive exchange rate, improving macro fundamentals and rising domestic gas production.”

S&P expects fiscal challenges to remain under control and sees government debt gradually declining. “The stable outlook balances our expectation that Egypt’s current account deficits will now stay as a smaller percentage of GDP and that growth prospects will remain strong, against risks of fiscal slippages and an increase in the high stock of relatively short-dated government debt issued at high interest rates,” the agency said in a statement.

It added that it could raise the rating to positive if the country’s economic growth exceeded its expectations or if Egypt worked out a way to reduce its financing needs or government debt.

Nonetheless, the agency said that Egypt’s rating could risk a downwards revision if plans to reduce the debt-to-GDP ratio were “derailed by fiscal slippages, higher borrowing costs, more pronounced currency depreciation than expected, or if foreign exchange reserve levels were to fall significantly.”

Finance Minister Mohamed Maait said in August that Egypt targeted reducing its public debt to 92 per cent of the GDP in the 2018/2019 budget, down from 98 per cent the previous year. He said this would happen by increasing state revenues and controlling government expenditure.

The REO report said that in addition to continued fiscal consolidation, complementary structural reforms were needed to raise the region’s economic potential, create jobs, and enhance inclusion.

These reforms include improving the business environment, with the report adding that Egypt has sought to facilitate the restructuring of failing firms and is taking steps to make it easier to improve access to industrial land for businesses.

It will sell minority shares in five state-owned firms this year to reduce the role of the state in the economy.

Other reforms include strengthening governance and institutions, enacting labour-market reforms, reducing the size of the informal sector, and enacting productivity-enhancing reforms.