The CBE might lower interest rates by as much as 400 basis points throughout 2018, which would preserve the attractiveness of local currency domestic debt while leaving real interest rates in positive territory at 3.6%, according to BNP Paribas estimates in a report issued on Sunday.
Moreover, the bank forecasted that the spread between real interest rates and the expected growth rate in 2018/19 (5.5%) should gradually contribute to a reduction in the public debt as a percentage of GDP. Given the limited risk of overheating due to domestic factors such as limited loan penetration, diminishing household purchasing, and the expected appreciation of the Egyptian pound, monetary policy could be eased even further if external constraints were to be reduced.
However, BNP Paribas forecast that inflationary risks cannot be completely neglected. The CBE ’s target of average inflation equivalent to 13% (±3%) in December 2018 seems reasonable, despite further cuts in energy subsidies in H2 2018. A higher than expected increase in oil prices is the main factor that could jeopardise this target.
According to the report, the Egyptian pound floatation in November 2016 had two consequences at the monetary level: leading to a sharp increase in inflation as well as acceleration in money supply growth. The average annual inflation rate more than doubled in the fiscal year (FY) 2016/17 to 23% from 10% the previous year.
However, monetary factors also contributed to inflation; the increase in “hot money” foreign currency inflows in the economy. This was particularly witnessed in portfolio investment inflows, which rose from virtually non-existent levels to $16bn in FY 2016/17, and $8bn in H1 FY 2017/18, along with the return of foreign currency liquidity into the banking system. Both factors contributed to the acceleration in the M2 money supply (taking into consideration cash, checking deposits, savings deposits, money market securities, mutual funds, and other time deposits.)
Despite the easing of inflationary pressures, control of money supply remains a challenge.
The decline in consumer price inflation began in late 2017. Following a peak of 33% in July 2017, the year-over-year CPI rate dropped to 13% in March 2017 (although the average annual rate was 26%). Open market operations currently make up around 20% of the M2 money supply, compared to 7.8% in FY 2015/16.
Moreover, government debt has fallen significantly since mid-2017, due to fiscal deficit reduction, and a eurobonds issuance. Meanwhile, the improvement in foreign currency liquidity in the banking system continues to contribute to M2 money supply growth to account for an average of 1.7% in the past three months compared to 1.8% in 2017.
The report forecasted that in the medium term, the current account balance will remain negative and portfolio investment should stabilise at best, given the expected decline in returns in the local currency. Direct investment, in contrast, should continue going strong, buoyed by bright prospects in the energy sector. Lastly, Egypt will continue to benefit from abundant multi and bilateral financial support.
It added that limiting currency appreciation in the short term would be beneficial to maintaining the country ’s attractiveness to international investors.