Rate Cuts: Good or bad?

As a resident of Egypt, you might have heard a lot of chatter about the cuts in interest rates that occurred in the last few months. You may have come across a few articles discussing the CBE’s decision and its implications on our overall economy. However, for most of us, without a background in finance and economics, these articles may be hard to comprehend. In this article, we will briefly explain the interest rate cuts and how they affect the overall Egyptian economy.

 

On Thursday, August 22nd, The Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) cut interest rates, for the first time since February, by 150 basis points (bps). The MPC decision matches forecasts of several economists shown in Bloomberg and Reuterspolls that predicted a cut of at least 100 bps. The interest rates cut are 14.25% for overnight deposit, 15.25% for the overnight lending, and 14.75% for the main operation.

Once again, on Thursday, September 26th, the MPC further cut interest rates by 100 bps. The interest rates have dropped down to 13.25% for overnight deposit rate, 14.25% for the overnight lending rate, and 13.75% for rate of the main operation.

 

 

Let us give some simple definitions for these financial terms!

 

What are Basis Points (BPS)?

 

Basis points are a common unit of measurement for the interest rates, as well as other percentages in finance. One basis point equals 0.01%, which is used to indicate the percentage change in any financial instrument. Simply put, 1% change = 100 bps.

 

 

What do those rates refer to?

 

The Overnight Rates are the interest rates set by MPC at which a bank lends/borrows (overnight lending rate) or deposits (overnight deposit rate) funds from another bank.

 

Basically, the amount of funds in a bank changes daily based on lending and withdrawal activities of its customers. Each day, banks can have either a surplus or shortage of funds. Banks that have a surplus often lend money overnight to other banks that have a shortage in funds.

 

The Main Operation Rate is also known as mid-corridor rate, which is the average between overnight deposit and lending rates.

 

What are the implications of these cuts in rates?

   

  1. Becoming the Fastest-Growing Economy in the Middle East

After the three years of grinding reforms that have been enacted to secure a $12 billion loan from the International Monetary Fund, that included devaluation of the EGP and subsidies on items like fuel by half, Egypt’s recovery has turned it into the Middle East’s fastest-growing economy.

 

  1. Drop in Inflation Rate:

As reported by the Central Agency for Public Mobilization and Statistics (CAMPAS), the inflation rate has declined to 6.7% in August, the lowest rate in the past 4 years. Moreover, the core inflation rate, which affects volatile items such as food, has also dropped to 4.9% in August. This decline in inflation rates is well below the 9% target that CBE had set for itself by 2020. That means that Egypt has reached its target one year ahead of schedule.

 

  1. Attracting More Foreign & Local Investors

Cutting rates helps existing private businesses that have been struggling with high borrowing costs in recent years. Moreover, according to Mohamed Abu Basha, head of macroeconomic analysis at EFG Hermes, Egypt is becoming more attractive to investors “given the positive reform story and the normalization of inflation”. Egypt is now offering the most profitable carry trades, which is a trading strategy that involves borrowing at a low interest rate and investing in an asset that provides a high rate in return, in emerging markets for investors.

 

 

In conclusion, the Egyptian economy is already blossoming after last month’s cuts in interest rates. Moreover, economists are expecting even greater reforms in the economic cycle for 2020.

 


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