Egypt's interest rate hike to curb growth but not inflation, critics say

CAIRO (Reuters) - Egypt’s financial community says Sunday’s 2 percent interest rate hike, in line with calls from the International Monetary Fund (IMF), will do little to curb rampant inflation and will harm investment at a time when the country needs it most.

People walk in front of the Central Bank of Egypt's headquarters at downtown Cairo, Egypt, November 3, 2016. Picture taken Egypt, November 3, 2016. REUTERS/Mohamed Abd El Ghany

The central bank’s first hike since a 3 percent rate rise in November is aimed at dealing with inflation - now above 30 percent - as well as demand-side pressures, after the IMF said action on those two factors was vital to keeping Egypt’s economic reform program on track.

But economists, businessmen and bankers say that inflation in Egypt, where only 10 percent of the population have bank accounts, is due to rising raw materials costs and a hike in rates will not produce the desired effect.

The business community blames IMF pressure for what it says is a wrong decision and says that Egypt’s specific business and monetary environment has not been taken into account and requires a different approach.

“It is clear that the IMF is going by the book while Egypt is different to other countries ... so what works elsewhere does not necessarily work here. There are different dynamics, such as that less than 10 percent of the population is banked,” a Cairo-based banker, who declined to be named, said.

Thirteen of 14 respondents polled by Reuters had expected the central bank to keep interest rates on hold.

“We don’t understand the logic of this decision,” Prime Holding economist Eman Negm said, noting that the rate hike may have the opposite effect of worsening inflation levels by raising borrowing costs for companies.

“The central bank said they are targeting inflation but that is wrong because inflation here is cost-push inflation. They are clearly influenced by the IMF pressures,” she said.

Egypt, which has been struggling to revive growth since an uprising six years ago, floated its currency, as well as raising rates, in November. The pound has halved in value since then.

Those moves helped it clinch a three-year $12 billion IMF loan program tied to ambitious reforms such as tax hikes and subsidy cuts which saw inflation jump to a three-decade high at 31.5 percent in April.

“I don’t understand how they can take such a step, how do they comply with all the IMF’s demands? The economy can halt,” Cairo Chamber of Commerce board member Alaa El-Saba said, referring to Sunday’s rate hike.

“Borrowing now will cost me (interest of) more than 18 percent. This is a ridiculous figure which will be added to the price of goods,” he said.

Egypt's stock market had fallen 2.5 percent by 1155 GMT on Monday .EGX30, while average yields jumped at an auction of five-year and 10-year treasury bonds, central bank data showed.

Head of public debt at Egypt’s Finance Ministry, Sami Khallaf, said Monday’s treasury bond sale was sold mostly to foreign investors. Egypt-based bankers said their bids were higher than the accepted bids by the Finance Ministry.

Increased inflows from foreign investors could eventually lead to lower inflation in the future as the Egyptian pound strengthens against the dollar, some analysts say. Banks were selling dollars at around 18 pounds on Monday. EGP1=

“We expect the rate hike to support the Egyptian pound and continue to attract foreign inflows,” said Salah Shamma, head of Investment, MENA Equity, Franklin Templeton Investments (ME).

“The expected inflows should replenish the country’s foreign reserves and find its way to the local banking sector. We see any appreciation in the Egyptian pound as a catalyst for lower inflation.”

Additional reporting by Ehab Farouk; Editing by Louise Ireland and Toby Chopra