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Friday, 4 November 2016

The macro fallout

The economic impact: While praised generally, the move will require a very delicate balancing act to execute efficiently. The government will have to secure funding sources that work against its aim to narrow the budget deficit. A handy solution would be to reduce dependency on the domestic money market in the short term in favour of using the expected influx of foreign funding, including the IMF’s, as cash cover to increase the growth rate of M2.

Inflation will be a delicate dance, and the impact of yesterday’s moves — the float and fuel prices — will be a fine yardstick by which to measure how receptive the streets will be to the reforms. We await the government’s plan on how it will monitor the markets to ensure that prices are under control while balancing the requirements to subsidy reforms and cash transfer programmes.

Common wisdom now is that inflation is, for the most part, already priced in, as the businesses and individuals alike were resorted to the parallel market to source their FX needs. This is also CBE Governor Tarek Amer’s view: The spike in inflation, he said, “has already happened.” Any unjustified price increases will have to be scrutinised, but we have full faith in the vigilant watch of Mona El Garf (without reservation our favourite civil servant) and her Egyptian Competition Authority.

While it is designed to slow inflation down, the CBE’s step to add 300 bps to its interest rates would also have the challenging effect of slowing down the economy. The bet now must be that growth will primarily be driven by the external sector. Keep an eye on this: The gauge of economic growth in Egypt in the short run will be heavily skewed by the performance of the current account.

In fact, we’re not sold on the notion that raising rates will slow inflation, as we noted last week. The textbook says you raise rates to curb inflation. The catch: “The textbook doesn’t work in Egypt. Interest rates are not an effective means of transmission for monetary policy in a nation in which maybe one in 10 people have a bank account, the grey economy probably dwarfs the official economy, and SME credit is little more than a myth. Hiking interest rates will make borrowing more expensive for the government and push the very few SMEs able to access credit out of the marketplace. Worse, the state will likely pay more in debt service than it would have had it chosen to boost commodity subsidies or extend new cash benefits to the poor. As for corporations? Banks will still offer preferential borrowing rates to their largest clients — and those few SMEs able to borrow will face credit-card-like interest rates.</rant>

And all of this, of course, accounts only for the impact of the float. Rising fuel prices will also spur inflation in the short-term, making transportation more expensive for people (microbuses, buses, taxis, personal automobiles) and for goods such as food. Readers will remember that after President Abdel Fattah El Sisi’s July 2014 decision to cut fuel subsidies, there was a temporary Spike in food prices and widespread reports of disputes after microbus drivers raised prices. The impact of the fuel price hike is not “priced in,” and we have long held that it is impossible to overestimate the greed of the Egyptian trader: The rise in food prices in 2014 far outstripped the increase in fuel prices.

Our take-home message: The float will (by and large) not be an immediate issue for the poor provided the government can continue to make subsidized commodities available. It will squeeze the middle class, particularly on items such as tuitions at international schools. The more important things to watch for will likely be how (1) the fuel price hike affects all income levels, particularly lower-middle and lower-income earners; and (2) how the float impacts the middle class, who holding on by their fingertips right now.

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