Monetary Policy Dilemma – Medhat Nafie

The Central Bank of Egypt decided for the second time in a row to fix the interest rate at 27.25%, despite the relative decline in annual inflation in June 2024 compared to June 2023 (27.5% for headline inflation and 26.6% for aggregate inflation). I consider this a confirmation of the monetary tightening policy, through which the Central Bank is trying to control the runaway inflation rate, which is still far from the target inflation (+7% or -2 percentage points).
The stabilization decision was in line with expectations, but it was accompanied by ambiguous signals, with some calling for the start of monetary easing (lowering of interest rates) and others advocating the continuation of tightening. As for the strengthening of easing policies, as mentioned earlier, it is associated with a decline in the annual inflation rate, and the Fed has almost decided to start a wave of monetary easing in September next year, taking into account the encouraging inflation data, growth and employment. On the contrary, political indicators point to a victory of the Republican candidate Trump in the upcoming presidential elections, which includes a high probability of intervention or a little influence on monetary policy, thus quickly embarking on a path of interest rate cuts for the benefit of the stock market and general investment activity.
On the other hand, the rise in monthly inflation to 1.8% in June 2024, after a slowing pace of monthly inflation since the March 6 decision, has stimulated the trend of further monetary tightening in Egypt, as reflected in the (minus) 0.8% inflation rate in May. The rise in monthly inflation reflects the rapid absorption of the gains of the Ras Hekma agreement by the market, and new factors are needed to curb the inflationary wave caused by the depreciation of the national currency by about 38% following the above decision. It is also obvious that any improvement in the annual inflation rate is justified by the base effect. This means that inflation rates in the same period last year were very high, close to 40% in the summer months, and core inflation exceeded 41% in August 2023.
There are also signs that the IMF Executive Board was scheduled to meet on July 10 to discuss the new trend in fuel prices, discuss the third review of the Egyptian loan agreement, and then release a new tranche of about $820 million. Postponing the meeting to July 29 could give Egypt an opportunity to adjust fuel prices, which, as previously stated in the IMF report, is one of the most important outstanding items in the third review.
So my preference for the decision of the central bank to stabilize interest rates is to be cautious with all the previous ambiguous signals, but also to support the continuation of austerity, since the current level of interest rates is already high, which has a negative impact on investment and the cost of public debt, which is currently the biggest burden of the government. If the decision of the central bank is consistent with this weight, then it puts a heavy burden on financial policy, which needs to be combined with monetary policy to besiege the first enemy of the economy, namely inflation, through austerity, especially in investment spending. I think that the Egyptian government insisted on postponing the decision to adjust fuel prices so as not to add fuel to the inflation fire, which is why the name of Egypt was removed from the agenda of the July 10 meeting of the Executive Board of the International Monetary Fund. The postponement to July 29 gave the Egyptian negotiators the opportunity to negotiate a direct decision to adjust fuel prices, especially since this move was made under the name of phasing out subsidies, which itself needs to be redefined in order to be able to achieve this goal. Distinguishing from the reasons for the increase in fuel costs, which include waste, losses, poor contract management and lack of energy planning, all of which must be considered. The newly formed government has a deadline to remedy it.
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But the IMF removed Egypt’s name from the agenda again on July 19, 2024 (the date of the last modification of the agenda after its removal), and did not return it until around 4 pm (Cairo time) on July 21 (the last update. There is no date mentioned on the website! ), provided that Egypt is back on the agenda. It is not only titled with the discussion of the expert report on the third review of the loan, but also includes detailed information about Egypt’s request. To postpone some obligations, to re-discuss some performance indicators, and something related to monetary policy! This alone is enough to put pressure on the Egyptian side to adjust the fuel price a few days before the meeting on July 29, so that it does not end with the refusal or postponement of the third payment of the audit work to Egypt, knowing that Egypt has already paid more than $3 billion of the outstanding debt owed to the Fund in the first half of this year.
The country will pay $10.3 billion to the IMF in 2024 and 2025 at unfair interest rates. The IMF director himself announced the need to review the most indebted countries such as Egypt, Ukraine and Argentina. In the face of local and regional urgency, the pressure to spend no more than $820 million must not be tolerated. Especially since failure to pay (by both parties) threatens the IMF itself with the possibility of default by its second largest borrower.
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Besides what was approved at the July 29 meeting (unknown at the time of writing) and whether it included the disbursement of the third tranche, I think the IMF has been somewhat cynical in its approach to the Egyptian economy, by subjecting the disbursement of the loan component to strict compliance with performance standards! This is despite a general consensus on the general standards, to which Egypt also made commitments. The IMF’s tendency to remove and then re-include Egypt on the agenda of its Executive Board meetings sends negative signals to investors and stakeholders, and even makes fuel prices (despite the sensitivity of dealing with these issues) a subject of market bets, which could create unhealthy consumption patterns (e.g. crowded gas stations). As we all know, delays in loan disbursement put the entire reform program at risk! It has a negative impact on other documents and commitments that Egypt has successfully complied with and agreed to.
All this confirms the importance of what I have often called for, namely, the need for a national non-governmental committee to follow up and evaluate the economic reform program signed with the IMF, which is the direction that Sri Lanka wants. As some IMF officials themselves assured me, the program is a success. This committee saves government members a lot of embarrassment and reflects the pulse of the street and the opinions of experts fairly and impartially.
The immediate impact of the wave of inflation that will (inevitably) result from the rise in fuel prices will not only be on living standards, poverty rates or the continuation of monetary and financial tightening, with its negative impact on growth and investment rates… On the contrary, there is a crisis associated with hot money flows, which to date have exceeded $35 billion. The owners of these flows will not hesitate to exit (as they have repeatedly done) if the “real” interest on Egyptian government debt instruments falls. Real interest is nominal interest minus the inflation rate. If the nominal interest rate is fixed, high inflation erodes the real interest and induces foreign investors to move their funds to the nearest country with higher interest rates.
The fall in real interest due to rising inflation affects the real effective exchange rate, making it more likely that the pound will fall against the dollar, and therefore the value of the money transferred to the dollar when the bill matures. The “ideal” investor who intends to reinvest the proceeds of the Treasury bill in pounds will not be tempted by the depreciation of the pound when it matures. If the way to prevent all these negative consequences is to stabilize the exchange rate, then we have the double reward of more serious violations of the IMF agreement and hot money that drains our foreign exchange reserves to support the value of the pound. Granted, we don’t like or rely on hot money, but we don’t have the luxury of giving it up in the short term, especially when international debt has increased to about $37 billion in just one year.

Writer and economic analyst