Thursday, March 01, 2018/ 01.10 PM / Fitch Ratings
Egypt's first interest rate cut since exchange rate liberalisation has been made possible by an improvement in macro-economic stability, underpinned by more orthodox policy settings under the country's IMF programme, Fitch Ratings says. These factors were reflected in our revision of the Outlook on Egypt's 'B' sovereign rating to Positive last month.
The Central Bank of Egypt (CBE) on 15 February cut its overnight deposit and lending rates by 100bp to 17.75% and 18.75%, respectively. Its main operation and discount rates were also cut by 100bp, to 18.25%. The CBE had increased rates by 700bp since devaluing the Egyptian pound in November 2016.
Headline and core inflation have fallen in recent months as the spike caused by currency depreciation and fiscal reforms subsides. Annual headline inflation dropped to 17.1% in January, down from its July peak of 33.0%. Food price inflation, which carries a large weighting and has significant import dependence, has declined sharply from more than 40% to 16.6% yoy. Nevertheless, inflation is well above peers and remains a sovereign rating weakness.
We think inflation will fall further this year but remain in double digits, averaging around 13%. This assumes that further subsidy reform in July leads to energy price increases, especially given higher oil prices. Even so, we expect the CBE to cut rates further this year (another 200-300bps) even as global rates rise, while maintaining positive real interest rates. Since exchange rate reform, the CBE has set out to control inflation expectations. In delivering the rate cut, it said that it would "not hesitate to adjust its stance to achieve its mandate of price stability over the medium term."
The IMF indicated in December that it was broadly satisfied with the transition to a floating exchange rate regime and the CBE's efforts to contain inflation, when it completed the second review of Egypt's USD12 billion, three-year programme. Exchange rate reform has proved a turning point for Egypt's external finances and the economy, with growth of around 5% in the first half of the current fiscal year, notwithstanding the tight monetary and fiscal stance. Reserves have risen and the current account deficit has started to narrow. Growth and the current account will both benefit increasingly from rising domestic gas production.
High rates and the reform programme have attracted a surge of foreign participation in the local debt market (non-residents held USD19 billion of domestic government debt at end-2017). Interest rates on domestic government debt started to fall before February's rate cut, with the 91-day T bill rate 450bps lower than its July peak and the one-year T bill rate close to its pre-devaluation rate of around 16.5%. With rates falling, we think the CBE will be mindful of the risk of some outflows, even though its stock of FX reserves has risen to USD38 billion and it has other reserve assets linked to its portfolio repatriation scheme.
Progress on macro-economic adjustment was reflected in January's Outlook revision, but the process is not risk free. Reforming subsidies and bringing down the government debt ratio is a multi-year process. Reforms have not prompted a visible social backlash, and the authorities have minimised the potential for opposition figures to build political momentum ahead of next month's presidential elections. Relatively weak governance, security and political risks continue to weigh on the rating.