The Central Bank of Egypt (CBE) said that emerging markets (EMs) have slightly witnessed the recovery of capital inflows in January after a long period of absence since February 2018.
In its quarterly report on monetary policy, the CBE said that the capital flows in the coming period will be linked to three main factors: the tightening global financial conditions, the economic activity forecast, and prospects for more tension in international commercial policies.
It is expected for Egypt’s GDP to continue recovering, supported by ongoing structural reform, despite the possible impacts of such procedures to control the state’s general finances.
The CBE explained that the cut-off date for the data included in this report is 10 January 2019. Some of the presented data are preliminary or subject to revisions. There has been new incoming data since the cut-off date, including, but not limited to, the release of the inflation statistics for January and February 2019.
Furthermore, the CBE’s monetary policy committee decided to cut the CBE’s key policy rates by 100 basis points (bps) in its meeting held on 14 February, and kept policy rates unchanged in its meeting held on 28 March.
Initial Conditions
Global economic as well as trade growth continued to slow down, while international oil prices continued to decline, and EMs witnessed net capital inflows for the first time since January 2018.
Economic growth of Egypt’s external environment is estimated to have continued to soften for the second consecutive quarter during the fourth quarter (Q4) of 2018, registering 2.5% down from 2.7% in the previous quarter, and from 3.2% in Q4 of 2017, the highest pace since 2011.
Economic growth in advanced economies is estimated to continue its ease for the fourth consecutive quarter to register 1.5% in Q4 of 2018, compared to 1.8% in Q3 of 2018, as slower growth in the euro region, the United Kingdom, and Japan more than offset a stronger growth in the United States.
On the other hand, economic growth in emerging economies continued to inch up, registering 4.8% in Q4 of 2018, maintaining continuous improvement between Q4 of 2015 and Q2 of 2018.
Higher growth in Brazil and Russia more than offset slower growth in India and China, compared to the previous quarter.
The CBE noted that headline inflation of Egypt’s external environment declined slightly in Q4 of 2018 for the first time since Q1of 2018, registering 2.3%, compared to 2.5% in Q3 of 2018.
Inflation in several advanced economies declined to register 2.0% in Q4 of 2018, down from 2.2% in Q3 of 2018.
Meanwhile, inflation in emerging economies dropped slightly to register 2.9% in Q4 of 2018, after accelerating to 3.0% in Q3 of 2018.
The deceleration of the inflation rate in China, Brazil, and India more than offset the acceleration of the inflation rate in Russia, compared to the previous quarter.
Meanwhile, annual growth of global trade continued to slow down for the fourth consecutive quarter in Q3 of 2018 to register 3.6%, compared to 3.8% in the previous quarter, and down from a peak of 5.3% in Q3 of 2017.
Brent crude oil prices continued to decline to register an average of $7.4 per barrel in December 2018, after peaking at $86.1 a barrel in mid-October 2018 and before inching up slightly in January 2019.
Lower oil prices were mainly driven by a more favourable contribution from the supply side, which led major producers to agree on implementing a production cut of 1.2m barrels per day starting January 2019.
Meanwhile, a less favourable contribution from the demand side reflected concerns regarding global economic growth.
International food prices, using domestic consumer price index (CPI) basket weights of core food items, continued to decline on annual terms in December 2018 for the sixth consecutive month, however, by the weakest magnitude since July 2018 at negative 2.4%.
The CBE attributed the decline to dairy products, oils, and red meat as production conditions improved.
The Federal Reserve (Fed) raised its policy rate by 25 bps in December 2018, marking the fourth policy rate hike in 2018, and bringing the cumulative changes during 2018 to 1.0 percentage point.
This comes after raising policy rates by 1.25 percentage points during five meetings between December 2015 and December 2017.
The Bank of England kept its policy rates unchanged in November 2018, after raising it by 25 bps in August 2018 for the second time since November 2017.
The European Central Bank (ECB) also kept its policy stance unchanged.
The three central banks made no changes to their asset purchase programmes since the previous monetary policy report.
The Fed maintained its balance sheet unwinding plan which started in October 2017, slowing down the amount of government debt it reinvests. Meanwhile, the ECB maintained its plan for phasing out its asset purchase programme, halving monthly purchases since January 2018 to €15bn until the end of December 2018.
Capital flight from EMs, which started in February 2018, reversed slightly in January 2019.
The direction of net capital flows into EMs remains subject to the pace of tightening global financial conditions, the growth outlook, as well as the prospects of further escalation of trade tensions.
Improvement of the current account continued to slowdown
The CBE explained that after improving for seven consecutive quarters, the current account deficit stabilised in Q3 of 2018, compared to Q3 of the previous year. A less favourable contribution from the hydrocarbon trade deficit, remittances, and net income payments have more than offset the more favourable contribution from net services receipts and the non-hydrocarbon trade deficit.
Nevertheless, the negative net exports of goods and services continued to narrow in Q3 of 2018 on annual terms for the seventh consecutive quarter.
This was due to a more favourable contribution from exports of goods and services, which more than offset the less favourable contribution from imports.
However, the pace of annual improvement in net exports of goods and services continued to slowdown for the fourth consecutive quarter.
The hydrocarbon trade deficit continued to improve on annual terms in Q3 of 2018 for the third consecutive quarter, however at a slower pace compared to the previous quarter.
The improvement was mainly driven by higher exports, which more than offset the increase in imports.
The non-hydrocarbon trade deficit continued to widen on annual terms in Q3 of 2018 for the fourth consecutive quarter, however, at a slower pace compared to the previous quarter.
It explained that this was mainly due to slower growth of imports, which more than offset the annual decline in exports for the first time since Q2 of 2017.
The services surplus continued to increase in Q3 of 2018 on annual terms and its contribution to the improvement of the current account deficit rose, yet its pace of growth stabilised in Q3 of 2018.
A more favourable contribution from transportation excluding Suez Canal tolls, net government services as well as net receipts from tourism have offset the less favourable contribution from Suez Canal tolls and net other services.
Meanwhile, the annual improvement of remittances declined in Q3 of 2018 to its slowest pace since Q3 of 2016.
After witnessing an annual increase in Q2 of 2018 for the first quarter since Q2 of 2017, the growth of net Foreign Direct Investment (FDI) inflows resumed its decline in Q3 of 2018.ss
The CBE attributed that to lower gross inflows and stronger gross outflows. The decline in gross inflows was due to a less favourable contribution from newly-issued capital and the oil and gas sector, which more than offset the more favourable contribution from non-residents’ purchases of real estate and net purchases of companies and assets by non-residents.
Portfolio flows, excluding bonds, continued to register a net outflow in Q3 of 2018 for the second consecutive quarter amid unfavourable global conditions for EMs.
This, however, was more than offset by net inflows from net foreign assets of commercial banks.
Gross international reserves declined to $42.6bn in December 2018 from the historic peak of $44.5bn which was registered in the previous month.
Annual real GDP growth softened slightly to 5.3% in Q3 of 2018, while the unemployment rate inched up slightly to 10.0%
After increasing for six consecutive quarters and stabilising in Q2 of 2018 at 5.4%, real GDP growth softened slightly to 5.3%.
The decline in the contribution of investments to the GDP has more than offset the improvement in that of net exports and, by a lesser extent, consumption.
Meanwhile, the unemployment rate inched up slightly to 10.0% in Q3 of 2018, after declining for seven consecutive quarters.
The drop in the contribution of investment was mainly driven by the public sector, while investments by the private sector contributed positively.
The improvement in the contribution of net exports was mainly driven by the decrease in real imports, as growth of real exports continued to weaken since Q4 of 2017.
At the sectorial level, the CBE added, growth softened mainly due to the construction and the non-petroleum manufacturing sectors, in addition to small weaknesses in other sectors.
This has more than offset the improvement in tourism, communication, and natural gas extractions.
Available leading indicators for the non-hydrocarbon sector mostly point to weakening activity in Q4 of 2018. The Purchasing Managers’ Index (PMI) weakened compared to its average level in Q3 of 2018.
Industrial production contracted on annual terms in October and November 2018, compared to an average expansion in Q3 of 2018. Suez Canal net tonnage grew on annual terms at a slower pace in Q4 of 2018 compared to Q3 of 2018.
On the other hand, total car sales grew on average at a faster pace in October and November, compared to the average pace registered in Q3 of 2018.
Meanwhile, natural gas production increased on annual terms at faster pace during October 2018, compared to the average pace in Q3 of 2018.
Broad money growth continued to decline supported by fiscal consolidation
Following the fading of the exchange rate revaluation effect in Q4 of 2017, annual M2 growth continued to decline to average 14.2% in Q4 of 2018, supported by fiscal consolidation, according to the CBE.
In Q4 of 2018, the contribution of foreign non-bank and external financing continued to decline, in line with the reversal of net portfolio inflows, due to global factors as well as the absence of Eurobond issuances. Together they have more than offset the increase in domestic bank financing.
In addition to the decline in M2 growth, inflationary pressures were further dampened by the drop of broad money velocity in Q3 of 2018, after having increased between Q3 of 2017 and Q2 of 2018, albeit by a weaker momentum since Q1 of 2018.
Meanwhile, following its decline between Q2 of 2017 and Q1 of 2018, the contribution of claims on the private sector to M2 growth continued to increase in Q4 of 2018 for the third consecutive quarter, supported by initiatives at preferential interest rates.
Similarly, inflation adjusted letters of credit L/C claims on the private sector began to witness annual increases since Q1 of 2018, after recording annual contractions in 2017.
The recovery was especially evident for claims on the private business sector, while claims on the household sector recovered by a relatively weaker magnitude.
Furthermore, the negative contribution of net foreign assets that are not related to fiscal deficit financing continued to ease since the fading of the exchange rate revaluation effect.
On the other hand, the contribution of net claims on public economic authorities declined slightly and claims on public sector companies roughly stabilised in Q4 of 2018.
Within the components of M2, the currency in circulation (CIC) as a percent of L/C deposits in M2 declined slightly in Q4 of 2018 for the second consecutive quarter, recording a ratio below its long term historical average, suggesting lessening currency holding behaviour.
Furthermore, despite the slight increase in the annual growth of foreign currency (F/C) deposits in US dollar in Q4 of 2018, the composition of private sector deposits continued to be increasingly leaning towards L/C, leading the dollarization ratio of F/C deposits to total deposits in M2 to continue falling.
Moreover, the structure of household deposits in L/C continued to be dominated by deposits more than three years since May 2018, following one and a half years of dominance by deposits less than three years amid the introduction of one and a half year saving certificates at a higher rate compared to longer term saving certificate rates.
The reversal of the structure of household deposits is consistent with redemptions of these certificates since May 2018, given their cancellation by public banks in late April 2018.
Annual growth of the monetary base (M0), adjusted by total excess liquidity, continued to decline in Q4 of 2018 for the fifth consecutive quarter due to the CBE balance sheet operations which lowered excess liquidity growth.
The money multiplier, measured as the ratio between local currency components of broad money and M0 as defined above, remained broadly stable for the fifth consecutive quarter in Q4 of 2018, following its decline between Q3 of 2016 and Q3 of 2017.
Real monetary conditions remained tight
Real monetary conditions remained tight, backed by receding inflationary pressures as well as previous policy rate increases, notwithstanding the cumulative 200 bps policy rate cuts in the beginning of 2018.
Excess liquidity declined in December 2018 for the first time since December 2017 to record an average of EGP 717.3bn (13.5% of the GDP) during the maintenance period ending in 31 December 2018.
However, the absorption of excess liquidity over the short term via the seven-day deposit auction and overnight deposit facility remained relatively stable, recording EGP 63.6bn (1.3% of the GDP and 8.9% of excess liquidity) since mid-February 2018.
The effective maturity of liquidity-withdrawing operations greater than seven days continued to range between 38 and 69 days since April 2018, compared to 21 days on average between October 2017 and March 2018.
Thus, interbank activity and the interbank yield curve remained relatively stable since April 2018, with interbank rates continuing below the policy rate by around 30 bps.
Yields for L/C government securities stayed stable at 15.8% net of tax since October 2018, after continuously rising between May and September 2018.
This compares to 13.7% in April 2018 and 14.6% on average in Q4 of 2017, before the policy rate cuts by the CBE. The impact of rising risk aversion toward demand for EM assets has more than offset the impact of the cumulative 200 bps policy rate cuts in February and March 2018.
Notwithstanding the recovery of demand for L/C government securities in January 2019, the weighted average cost of finance remained relatively stable during the first two issuances due to a higher acceptance-to-required ratio.
Meanwhile, Egyptian Eurobond yields declined somewhat in January 2019, in line with the improvement in the risk premium for EMs, after it has been increasing during most of 2018. Moreover, Egypt’s CDS spreads remained relatively low compared to most peers with similar sovereign credit rating. Furthermore, Egypt’s outlook was raised to positive in August 2018 by Moody’s, while S&P upgraded Egypt’s credit rating in May 2018.
In the banking sector, rates for new deposits remained relatively stable to record 12.8% on average since April 2018, after declining in response to the cumulative 200 bps cut in February and March 2018.
Concurrently, rates for new loans inched up slightly to 17.3% on average during October and November 2018, after receding to 17.0% in Q3 of 2018.
The pricing of new deposits declined by 1.3x compared to the cumulative 200 bps policy rate cut, mainly driven by strong drops of deposit rates in public sector banks, while the pricing of new loans decreased by 0.9x.
In equity markets, real prices continued to be affected by the negative sentiment on EMs.
Nevertheless, the EGX 30 USD index continued to outperform the MSCI EMs index since March 2018, despite its drop since June 2018.
At the same time, real unit prices remained relatively stable in Q4 of 2018, after declining in select districts of Cairo’s residential real estate sector during Q3 of 2018 for the first time since Q4 of 2016.
The demand continued to shift from the secondary market toward the primary market, given more flexible payment plans offered by numerous developers.
Headline inflation target for Q4 of 2018 has been achieved
Annual core inflation continued to record single digits for sixth consecutive month.
Annual headline inflation declined to 12.0% in December 2018 from 15.7% in November 2018, thereby leading average inflation during Q4 of 2018 to record 15.1%.
As a result, the inflation target of 13% (±3 percentage points) for Q4 of 2018, which was announced in May 2017, has been achieved.
The deviation from the target mid-point was due to supply-side factors that are outside the scope of monetary policy.
Annual headline inflation has been affected by fiscal consolidation measures, which were impacted by a higher-than-expected increase of international oil prices. Furthermore, headline inflation was affected by temporary supply shocks in select fresh vegetables in September and October 2018.
These factors led inflation to rise to 17.7% in October 2018 from the 25-month low of 11.4% in May 2018.
The decline of annual inflation in November and December 2018 reflected the reversal of the temporary supply shocks in select fresh vegetables as well as the containment of underlying inflationary pressures.
In the meantime, annual core inflation continued to register single digits for the sixth consecutive month, averaging 8.5% between July and December 2018, the lowest rate in over two years.
This, combined with the decline of annual headline inflation in November and December 2018, led the spread between annual headline and core inflation to narrow significantly after peaking in October 2018.
Monthly headline inflation was mainly driven by food inflation since August 2018, while non-food inflation has been contained, reflecting only expected seasonal increase in clothing prices in November 2018.
Inflation of fresh vegetables was the main contributor to food inflation. It was elevated between June and October 2018 due to seasonal effects which were heightened by the indirect effects of the fiscal consolidation measures, as well as transitory supply shocks related to potatoes and tomatoes, which reversed in November and by a larger extent in December 2018.
Prices of tomatoes declined for the second consecutive month in December 2018, after recording price increases for four consecutive months. Also, prices of potatoes declined, after recording price increases for nine consecutive months.
Simultaneously, prices of core food items were largely stable, except for poultry and eggs, which experienced volatility since July 2018, as well as rice, which increased in December 2018 for the third consecutive month.
The largely stable core food inflation witnessed domestically since August 2018 led to divergence between domestic and international core food price developments.
International core food inflation recorded its first positive monthly rate in December 2018, after consistently recording negative monthly rates since June 2018, driven mainly by prices of poultry, red meat, and dairy products.
This comes after domestic and international core food price developments have been largely consistent in the first half of the year, except in June 2018 due to domestic fiscal consolidation measures.
Outlook
The CBE stated that policy rates and the inflation outlook remain consistent with achieving the targeted disinflation path.
“This includes achieving the 9% (±3 percentage points) inflation target for Q4 of 2020-which was announced in December 2018-down from the 13% (±3 percentage points) inflation target for Q4 of 2018, announced in May 2017, which has been successfully achieved,” declared the CBE.
“Real GDP growth is expected to continue recovering, benefiting from continued structural reforms, despite being affected by potential fiscal consolidation measures,” it added.
The CBE explained that the primary fiscal balance is targeted to record a surplus of 2.0% of the GDP in 2018/19, compared to an estimated surplus of 0.1% of the GDP in 2017/18, and a deficit of 1.8% of the GDP in 2016/17, and is targeted to maintain this surplus thereafter.
Meanwhile, the overall fiscal deficit is targeted to decline to 8.4% and 7.2% of the GDP in 2018/19 and 2019/20, respectively, compared to an expected 9.8% in 2017/18 and 10.9% in 2016/17, and is targeted to continue declining subsequently.
The outlook for Brent crude oil prices incorporated in the domestic inflation outlook remained broadly unchanged following its downward revision, yet spot prices remained subject to volatility due to potential supply-side factors. Cost recovery for most fuel products is expected to be reached by mid-2019, and automatic fuel price indexation is expected to be implemented.
Meanwhile, international food price forecasts, relevant to Egypt’s consumption basket, are expected to be stable during 2019 before increasing in 2020.
In addition to international commodity price developments, risks surrounding the inflation outlook from the global economy continue to include trade tensions, economic growth developments, as well as the pace of tightening financial conditions.
Meanwhile, domestic risks continue to include the timing and magnitude of potential fiscal consolidation measures and the evolution of inflation expectations, it concluded.
