Economy

Here’s how the latest US rate hike will impact Egypt’s economy

People walk past a currency exchange shop displaying a giant US dollars banknote in downtown Cairo on November 3, 2016. Egypt floated the country's pound as part of a raft of reforms, after a dollar crunch and exorbitant black market trade threatened to grind some imports to a halt. / AFP / KHALED DESOUKI (Photo credit should read KHALED DESOUKI/AFP via Getty Images)

Spearheaded by a hawkish Federal Reserve policy, the US dollar is rallying across the board versus world currencies. The greenback has posted gains against major currencies, including the euro, yuan and yen, since the Fed raised interest rates by 0.75% on July 27. The Egyptian pound has been no exception, with the US currency currently hovering above 19.15, the highest since December 2016.

However, the recent gains of the greenback are logical due to the demand/supply equation, as one economist told Al-Monitor.

“Demand for the dollar has increased, while supply declined on the back of falling revenues from tourism. However, the 0.19-pound increase in the dollar exchange rate is insignificant and is not a worrisome issue. As a percentage, it roughly stands at 0.8%,” Rashad Abdo, head of the Egyptian Forum for Economic and Strategic Studies, told Al-Monitor.

The dollar rose from 18.96 pounds on July 28 to 19.16 on Aug. 6, gaining roughly 0.19 pounds over a week. However, Abdo warned that the cost of imports would increase.

“One of the challenges resulting from the dollar hike is higher cost of imports. Importers will shift the burden to consumers by raising prices. Consequently, that would stoke inflationary pressures,” Abdo said.

He said the Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) might raise overnight interest rates in its next meeting, scheduled for Aug. 18.

“The MPC may either leave rates unchanged or raise them in the wake of the dollar gains. A rate hike is probable, hence local investment may decline due to higher funding cost,” he said.

The overnight deposit and lending rates currently stand at 11.25% and 12.25% respectively, according to CBE data. In its last meeting on June 23, the MPC kept interest rates on hold.

Abdo argued that carry trade might see a comeback if the MPC raised rates. “However, it should be noted that the economy can never capitalize on hot money for long,” he said, referring to a statement made in July by Minister of Finance Mohamed Maait.

Maait said on July 8 that hot money is available worldwide, but definitely, we (the government) should not rely on it. On June 22, Maait told Bloomberg that foreign outflows totaled $20 billion in 2022.

Egypt’s hard currency earners include tourism, remittances of Egyptian expats, the Suez Canal and exports.

Egypt’s nine-month tourism revenues in the fiscal year 2021/22 leaped by 164.5% to $8.2 billion between July 2021 and March 2022, from $3.1 billion in the same period a year earlier, according to CBE data. The country’s fiscal year begins on July 1.

Revenue from the Suez Canal and remittances of Egyptians abroad rose by 16.9% and 1.1% to $5.1 billion and $23.6 billion in the July-March period, against $4.3 billion and $23.4 billion in the same period a year earlier, respectively, according to CBE data.

However, a widening gap in the country’s balance of trade engulfed such increases. The non-oil trade balance deficit jumped by 22.5% to $37.7 billion between July 2021 and March 2022, up from $30.7 billion in the same period a year earlier, according to CBE data.

Despite the recent dollar gains, there may be a silver lining in the cloud as Alia El-Mahdi, professor of economics at Cairo University, put it.

“On the one hand, the dollar hike may affect the balance of trade positively. Imports may decrease due to higher cost, easing demand for the US dollar in the local market. In the same vein, a weaker pound may increase exports, as Egyptian-made products will be cheaper worldwide,” she told Al-Monitor.

However, the professor argued that an increase in exports would depend on the production sector’s flexibility.

“This flexibility is determined by the capability of local producers to meet increased demand from world markets. For instance, the producers of ready-made garments may benefit from such a situation if they can produce more,” she explained.

Egypt’s exports rose by 54.2% to $11.8 billion in the third quarter of the fiscal year 2021/22 (January-March), up from $7.65 billion in the same period a year earlier, according to CBE data.

As for the local exchange rate market, Mahdi warned against speculation on the greenback. “There is speculation outside the banking system that the dollar would make more gains. That may badly affect the pound,” she noted.

As for the impact on inflation and interest rates, Mahdi has pointed out that most of Egypt’s imports are intermediate and capital commodities. “So the dollar hike will raise production costs, hence lifting inflation rates. However, the dollar hike will slightly impact economic growth.”

According to Mahdi, the MPC will likely increase interest rates in its next meeting to contain inflation and strengthen the pound.

“However, higher rates would fuel burdens on the state budget due to increased yields on sovereign debt. Moreover, the private sector will be negatively impacted on escalating cost of finance. That will take a toll on direct investment,” she explained.

Answering whether higher interest rates would boost carry trade again, she has made it clear that the global financial situation has significantly changed.

“I don’t think higher interest rates in Egypt will lure hot money, as happened following the currency float in November 2016. The Fed has already increased rates, and many investors see the US market as heaven in terms of yields,” she added.

 

Read more: https://www.al-monitor.com/originals/2022/08/heres-how-latest-us-rate-hike-will-impact-egypts-economy#ixzz7bbx9Omdf