The Central Bank of Egypt (CBE) stressed that the policy of no intervention in the foreign exchange market preserved the CBE’s foreign assets, leading gross international reserves to record $44bn in April 2018, the highest on record. As a result, the ratio of gross international reserves to total external debt in the first quarter (Q1) of 2018 continued to improve and is estimated to record the highest in six years.
In a recent report on the monetary policy of the state, the CBE stressed that interest rate cuts on the pound supported the rise in real asset prices on the Egyptian Exchange (EGX).
It added that short-term and long-term public sector loans benefited more from interest rate cuts than retail loans.
The CBE also noted that the state’s tendency to borrow from overseas reduced its dependence on domestic borrowing, which dampened the return on debt instruments.
Moreover, the CBE highlighted that the tourism sector and natural gas output have contributed to the improvement in economic activity in 2017, projecting that the rate of recovery of private consumption will decelerate temporarily and that the gross domestic product (GDP) will continue to benefit from economic reform measures.
The CBE also predicted crude oil prices will rise to $76.7 per barrel in the fiscal year (FY) 2018/2019.
In the report, the CBE said that the real GDP growth is expected to continue benefiting from structural reform measures, while potential fiscal consolidation measures may briefly slow down the recovery of private consumption. Net exports and investments are expected to continue complementary consumption as growth engines.
The Monetary Policy Committee (MPC) decided in its recent meetings that current policy rates are appropriate to align the inflation outlook with the targeted disinflation path of 13% (± 3%) on average in Q4 2018 and single digits after the temporary effect of the anticipated supply shocks related to fiscal consolidation measures dissipates, and thus decided to keep key policy rates unchanged. This comes after the MPC determined to cut key policy rates by a cumulative 200 basis points (bps) in its February and March 2018 meetings.
The government is targeting to continue pursuing its comprehensive economic reform programme with the aim of achieving higher, more sustainable and inclusive growth.
The overall fiscal deficit is budgeted to decline by 8.4% of the GDP in 2018/19, compared to an expected 9.8% in 2017/18 and 10.9% in 2016/17, and is targeted to continue declining thereafter.
Meanwhile, the primary balance is budgeted to record a surplus of 2.0% of the GDP in 2018/19, compared to an expected surge of 0.2% of the GDP in 2017/18 and a deficit of 1.8% of the GDP in 2016/17, with the aim of maintaining this surplus thereafter.
The inflation outlook includes upward revisions to international commodity prices, according to the CBE.
Brent price projection was revised upward to $76.7 per barrel in FY 2018/19 4, compared to $67 per barrel previously.
This comes after its spot prices increased significantly in April and May 2018, leading to the materialisation of an upside risk to the domestic inflation outlook.
In response to international oil price developments, international food price forecasts, relevant to Egypt’s consumption basket, were also revised upwards. In addition to international commodity price developments, risks from the external economy continue to include a pace of tightening financial conditions.
Meanwhile, domestic risks surrounding the inflation outlook continue to include the timing and magnitude of potential fiscal reform measures, the evolution of inflation expectations, as well as demand-side pressures.
Annual inflation continued to decline
The CBE noted that annual headline inflation continued to decline, recording 13.1% in April 2018, after peaking in July 2017 at 33.0%.
Core inflation continued to decline until March 2018 and remained broadly unchanged in April at 11.6%, after peaking in July 2017 at 35.3%. The headline and core annual rates thereby registered the lowest rates since May and April 2016, respectively.
The decline of annual rates came despite the pick of monthly inflation during the first four months of 2018 in line with the historical seasonal pattern.
“Monthly inflation mainly reflected higher food inflation, while non-food inflation has been dramatically tame since December 2017 with few exceptions reflecting seasonality. Specifically, retail prices experienced vulnerability in February and April 2018 due to seasonal effects on clothing, and prices of services rose in March 2018 because of higher prices of Omra trips,” the CBE stated.
Meanwhile, prices of regulated items did not contribute to monthly headline inflation since December 2017, except marginally in January and April 2018.
Regulation items contributed significantly to headline inflation between July and November 2017, mainly due to subsidy reform measures, as well as upward adjustments of other regulated items.
The report stated that food inflation was the main driver of monthly headline inflation since February 2018. This comes after resuming its downward path between August 2017 and October 2017 and recording consecutive negative rates between November 2017 and January 2018 for the first time since January 2016.
Despite reliably higher inflation of core food prices, food inflation was mainly driven by higher volatile food prices since August 2017 with the exception of November 2017, January and February 2018 where core food inflation took the lead, stated the CBE. Seasonally higher prices of fresh vegetables were the main driver, while prices of fresh fruits have generally been stable since July 2017.
Relatively higher core food inflation was due to higher prices of poultry, rice, fish, and seafood, while prices of other core food items were mostly stabilized.
Since January 2018, higher core food inflation domestically have coincided with higher international food prices.
This comes after core food inflation registered negative rates on average both domestically and internationally between August and December 2017.
Real monetary conditions remain tight
The report pointed out that real monetary conditions remained tight despite being impacted by potential future inflationary pressures from fiscal consolidation measures.
This was backed by previous policy rate increases, notwithstanding the cumulative 200 bps policy rate cuts since the beginning of 2018. Receding under inflationary pressures and the appreciation of the Real Effective Exchange Rate (REER) on average further supported tightening monetary conditions. Meanwhile, the transmission of the nominal policy rate cuts continued to be strong to nominal interest rates in the economy, except for rates of government securities which were further impacted by weaker demand.
After declining in December 2017, excess liquidity continued to increase since January 2018 to record on average EGP 679.3bn (15.4% of the GDP) during the maintenance period ending 7 May 2018.
The absorption of excess liquidity over the short term rose primarily due to higher volumes in seven-day deposit auctions to record on average EGP 52.1bn (1.2% of the GDP and 8.0% of excess liquidity) since mid-February 2018, compared to EGP 27.5bn (0.6% of the GDP and 4.9% of excess liquidity) on average between July 2017 and mid-February 2018.
Meanwhile, the effective maturity of liquidity-withdrawal operations greater than seven days continued to increase since March 2018 to average 49 days at the end of the first maintenance period in May, after stabilising at around 18 days between October 2017 and February 2018.
In addition, the interbank market yield curve shifted downwards, reflecting 100% transmission of the 200 bps policy rate cuts on 15 February 2018 and 29 March 2018.
The effect of higher short-term excess liquidity offset the effect of higher liquidity absorption tenors, leading to the stability of interbank rate spreads against the policy rate at around 30 bps, thereby maintaining the spread since mid-August 2017. Nevertheless, activity in the interbank market rose significantly since April 2018.
During the first three issuances in May 2018, yields for letters of credit (L/C) government securities recorded 13.9% net of tax, relatively unchanged since February 2018, after being affected by the CBE’s 100 bps policy rate cut on 15 February 2018. Lower demand for L/C government securities grossly offset the impact of the CBE’s 100 bps policy rate cut on 30 March 2018.
The coverage ratio declined 1.8 times on average during the issuances in April and the first three issuances in May 2018, compared to 2.3 times on average during Q1 2018 and Q4 2017.
Furthermore, the increase in net external financing of the fiscal deficit contained the need for domestic financing, further supporting the stability of the weighted average rate of L/C government securities.
Meanwhile, the yield curve remained inverted, slightly steepening in May after gradually flattening since November 2017. The recent minor widening of the negative spread between Treasury Bonds (T-bond) and Treasury Bills (T-bill) yields was driven by lower demand for T-Bills, while the demand for T-Bonds remained broadly unchanged.
The CBE stated that Eurobond yields continued to increase since March 2018, in line with increasing risk premiums of emerging market economies and higher Credit Default Swap (CDS) spreads. Nevertheless, Egypt’s CDS spreads remained relatively low compared to the majority of peers with similar sovereign credit ratings. Furthermore, Egypt’s credit rating was upgraded by Standard and Poor’s (S&P) in May 2018.
In the banking sector, both the rates for new deposits and new loans declined to record 12.3% and 18.0% in April 2018, respectively. Compared to the cumulative 200 bps policy rate cut in February and March 2018, the pricing of new deposits declined by 1.5 times, while the pricing of new loans declined by 0.6 times, leading interest margins to widen to 5.8 promises to purchase (pp), compared to 3.7 pp in Q4 2017.
“The strong response of deposit rates was mainly driven by public banks due to the shift of new deposits towards deposit schemes that are at a lower rates compared to the cancelled saving certificates less than three years in mid-April 2018, mainly saving certificates greater than three years. On the other hand, private banks’ pricing of new deposits declined by 2.0 pp (1.0 times of the policy rate cuts),” the report read.
Meanwhile, the weak response to new lending rates was also due to the weak reaction by public banks (0.2 times the cumulative 200 bps policy rate cuts), whereas the pricing of private banks declined by 1.6 pp (0.8 times the cumulative 200 bps policy rate cuts).
The decline in new lending rates was primarily due to the drop in short-term business lending rates, followed by long-term business lending rates, while the transmission to the pricing of retail lending was weak.
In equity markets, real prices were supported by the CBE’s policy rate cut before being affected by the global emerging market sell-off in May 2018. In USD terms, the EGX benchmark index rose by a cumulative 17.3% during March and April 2018 and declined by 2.9% during the first two weeks of May 2018.
Meanwhile, unit prices in the real estate sector continued to increase in real terms during Q1 2018, however, at a slower pace due to increasing competition, while numerous developers continued to offer more flexible payment plans.
Broad money growth continued to ease supported by fiscal consolidation
The CBE explained that annual money supply (M2) growth continued to decline in Q1 2018 for the second consecutive quarter to average 22.6% or 22.5% excluding revaluation, supported by fiscal consolidation. The contribution of foreign non-bank and external financing increased in Q1 2018 in line with higher net portfolio inflows and the Eurobond issue, after declining in the previous quarter, partially offsetting the drop in the contribution of bank financing. Declining M2 growth also favourably coincided with annual changes of broad money velocity, which turned positive since Q3 2017 after contracting between Q2 2013 and Q2 2017, suggesting lower room for non-inflationary money growth.
Meanwhile, the contribution of claims on the private sector to M2 growth has been generally declining since Q2 2017.
However, inflation-adjusted L/C claims on the private sector, which began to witness annual increases during Q1 2018, after recording annual contracts in 2017.
This recovery was especially evident for claims on the private business sector, while claims on the household sector reclaimed by a relatively weaker magnitude. Over and above, the contribution from net claims on public economic authorities continued to increase in Q1 2018 while the contribution from claims on public sector companies continued to decline.
Within the components of M2, CIC declined as a percent of the GDP since the liberalisation of the foreign exchange market and is expected to record 9.4% in Q1 2018, the lowest on record.
Similarly, the decline of Central Information Commission (CIC) as a share of L/C deposits in M2 accelerated post the liberalisation of the foreign exchange market to record in March 2018 the lowest on record. This suggests continued normalisation of currency holding behaviour.
While the annual growth of F/C deposits in USD has been reliably stable, the composition of private sector deposits continued to increasingly lean toward L/C.
Moreover, the structure of private sector L/C deposits, specifically household deposits, continued to be dominated by deposits less than three years since November 2016, after being dominated by deposits more than three years mainly due to the introduction of 1.5-year saving certificates at a higher rate compared to longer-term certificates.
In March 2018, however, the monthly growth of deposits in longer-term certificates began to outpace the growth of deposits in certificates less than three years, given the relatively higher drop in rates of short-term certificates compared to rates of longer-term certificates following the CBE policy rate cut.
The annual growth of M0, adjusted by total excess liquidity, has been declining since Q4 2017. This was supported by lower excess liquidity growth as defined above, driven by a drop in L/C government securities along with other CBE balance sheet items. Higher reserve requirements effective October 10, 2017 due to the 400 bps increase of the required reserve ratio had a neutral effect on M0 as defined.
The money multiplier, measured as the ratio between the local currency component of broad money and the M0, remained broadly stable for the second consecutive quarter in Q1 2018, following its decline between Q3 2016 and Q3 2017, as the narrowing of the CIC, as well as excess liquidity as a share of L/ deposits, offset the effect of the higher required reserve ratio.
Economic activity continued to strengthen
The CBE added that the real GDP growth at market prices continued to increase for the fifth executive quarter during Q4 2017 to record 5.3% and an average of 5.0% during 2017, the fastest pace since 2010. The real GDP growth further increased during Q1 2018, registering a preliminary estimate of 5.4%. Strengthening economic activity coincided with the drop in the unemployment rate to 10.6% in Q1 2018, the lowest rate since Q4 2010.
The pick-up of net external demand due to more competitive exchange rates followed by higher public domestic demand, primarily arising from public investments, were the main drivers of the strengthening economic activity in 2017 compared to 2016. This improvement has more than offset the winning private domestic demand.
According to the CBE, the key sectors which contributed to the strengthening of economic activity are tourism and natural gas extractions. In 2017, tourism and natural gas extractions grew by 66.0% and 12.0% respectively, compared to negative 36.8% and negative 5.3% in 2016, respectively.
The improvement in the petroleum manufacturing sector, as well as the Suez Canal, further supported the real GDP growth in 2017.
However, the contribution to the real GDP growth remained relatively diversified across all sectors, and the private sector accounted for 79% of the real GDP growth at factor cost during 2017.
The external balance continued to benefit from increased competitiveness and the liberalised exchange rate system.
Increased competitiveness as measured by the annual REER depreciation and the recovery of economic activity of Egypt’s trading partners supported the reduction of the current account deficit in 2017 by $11bn (55% compared to the previous year). The net exports of goods and services deficiency narrowed, remittances rose, while the net income deficit widened.
The increase in exports of goods and services was higher than the increase in imports. The non-hydrocarbon trade deficit declined due to higher exports and lower imports by roughly the same magnitude. The services surplus rose on account of higher tourist receipts, while the hydrocarbon trade deficit widened in line with higher oil prices, which led to a higher defect in petroleum products trade.
Nevertheless, the annual pace of improvement of the current account declined slightly in Q4 2017 after continuously accelerating for four consecutive quarters.
This occurred despite strengthening contribution from net services receipts and remittances due to the weaker contribution from the hydrocarbon and non-hydrocarbon trade deficiencies, as well as from the net income deficiency.
The non-hydrocarbon trade deficit increased compared to the previous year, after witnessing a gradual slow-down in its annual improvement since Q2 2017 in line with the slower annual REER depreciation. Imports rose mainly of intermediate goods, more than offsetting the continued strengthening of exports. Meanwhile, the hydrocarbon trade deficit stabilised in annual terms during Q4 2017 after narrowing during the previous quarter, as the annual increase in crude trade surplus and the decline in natural gas imports offset the higher deficit of petroleum products trade in line with international oil price developments.
On the other hand, the pace of annual improvement in the services balance continued to increase in Q4 2017 for the fifth executive quarter, despite some weaker momentum in the tourism sector. This was mainly driven by a lower other services deficiency and higher net receipts from the Suez Canal and other transportation services.
Despite the annual drop in net foreign direct investment (FDI) inflows during Q4 2017, net FDIs have been increasingly covering the current account deficit excluding awards since Q3 2016, turning the difference into a surplus for the second consecutive quarter in Q4 2017, after recording deficiencies since Q2 2013.
Meanwhile, net portfolio inflows weakened during Q4 2017 before regaining momentum in Q1 2018, supported by net portfolio inflows excluding bonds as well as the issuance of $4bn Eurobonds in February 2018.
