CAIRO: Egypt’s central bank unexpectedly raised interest rates on Thursday for the first time in more than two years, acting after depleting its foreign reserves trying to defend a local currency weakened by street violence and political chaos.
Investors have been rattled by violent clashes in Cairo and other cities between security forces and protesters demanding an immediate end to military rule, days before the scheduled start of a parliamentary election.
Some analysts said a rate hike had become more likely in recent weeks because the central bank was searching for ways to support the currency after drawing down $14 billion of foreign currency reserves since a popular uprising in January.
The Egyptian pound weakened to more than 6 to the dollar on Thursday for the first time since January 2005 after Standard & Poor’s lowered its credit rating on Egypt, saying a "weak political and economic profile" had worsened.
"The central bank is obviously very worried and they cannot carry on using reserves forever. They have reached a dangerous level in terms of import coverage," said Said Hirsch, Middle East economist at Capital Economics.
"If you look at foreign exchange reserves coupled with the escalation of political unrest, they had very little choice."
In the first change to benchmark rates since Sept. 17, 2009, the central bank raised its overnight deposit rate by 100 basis points to 9.25 percent and the overnight lending rate by 50 points to 10.25 percent.
The discount rate rose by 100 points to 9.5 percent.
In a statement explaining its decision, the central bank cited political changes sweeping the Arab world’s most populous country, as well as the euro zone debt crisis, as posing risks to consumption and investment.
It blamed upside inflation risk linked to supply bottlenecks and "distortions in the distribution channels" as the main reason for raising benchmark rates. There was no mention of the weakening currency or strains on banking sector liquidity.
"While the slowdown in economic growth should limit upside risks to the inflation outlook, there are possible upward pressures on inflation," the bank said.
Budget woes
Ten out of 11 economists in a Reuters survey had forecast that overnight rates would be unchanged at 9.75 percent for lending and 8.25 percent for deposits. One had predicted a hike of 50 basis points for both rates.
The fresh sell-off of Egyptian assets this week raised the heat on the country’s ruling generals as they tried to calm the mass protests that have left more than 40 people dead over five days.
Many of the demonstrators who have brought parts of central Cairo to a standstill say the army has failed to restore security to the streets since the January uprising, damaging the economy and worsening the plight of millions living in poverty.
The army-backed interim government, which resigned this week, was trying to draw foreign funds to bolster a budget that has swollen since the uprising. But it turned down $3 billion of support from the International Monetary Fund in June.
The worsening economic news badly undermines the army, said Raza Agha, RBS’s senior Middle East and North Africa economist.
"It makes the situation that much more unsustainable. Not only is the politics unsustainable, but at the pace at which the government’s borrowing costs are rising and the pace at which the central bank is losing reserves, it’s not sustainable from an economic perspective, either," he said.
The finance minister said last month that liquidity at domestic banks had almost been exhausted, and the government has faced soaring interest rates at recent domestic debt auctions.
The average yield on 182-day T-bills at a Thursday auction jumped to 14.648 percent from 13.978 percent a week earlier.
The central bank said it would offer $2 billion in 1-year US-dollar treasury bills at an auction next week.
"It’s a difficult time to be issuing new debt, particularly with the downgrade having just happened," said John Bates of Silk Invest. "It makes it a really tough sell, not only because of the turmoil but also because of the time of year."
Richard Segal, an analyst at Jefferies, said the dollar bond issue seemed to be aimed at satisfying local demand for the US currency, "thereby addressing capital flight tendencies" and he expected the sale would be only a partial success.
But Youssef Kamel, a Cairo-based fixed-income analyst at Rasmala, said the sale might not be so difficult to pull off.
"According to central bank data, foreign currency deposits in the Egyptian banking sector increased by 11.74 percent from December 2010 to August 2011, while local currency deposits were almost unchanged," he said.
