On March 9, 2023, official statistics on the level of inflation were published by the Egyptian government. These official figures reveal a sharp increase in inflation, which reached a record high of 31.9 percent for annual headline inflation, and a whopping 40.26 percent for core inflation. Most worryingly, the steepest increase stemmed from food products, where prices jumped by 14.4 percent month on month and 61.8 percent on an annual basis, causing severe stress on lower income households. The response of the Egyptian Central Bank (CBE) to the inflationary wave over the past year has followed the dictates of economic orthodoxy, namely increasing interest rates, which rose by 800 basis points last year in an effort to curb inflation.
The logic for this policy is rather simple: the increase in interest rates should soak up liquidity and lower demand, and thus, ease pressure on prices. In the Egyptian case, however, this logic reveals a fundamental misunderstanding of Egypt’s structural economic weakness and the root causes of inflation, which are the rapid devaluation of the Egyptian pound and a shortage of hard currency.
The basic assumption of the above-mentioned policy is that inflation is caused by increased local demand. In the case of Egypt, this is patently untrue; on the contrary, the local market has been shrinking. For example, as of December 2022, the Egyptian private sector had shown signs of contraction for 25 consecutive months, which is taken as an indication of lower demand, with November showing the worst private sector performance since the outbreak of the Covid-19 pandemic in March 2020. The lower demand was driven by rapid currency devaluation and import restriction imposed by the shortage of hard currency, which is the real cause of the inflationary wave gripping Egypt. (One needs to keep in mind that 47 percent of Egyptian imports are used as inputs for production.)
Moreover, this policy ignores the structure of the Egyptian banking sector. For example, based on 2021 data, the total number of adults that have a bank account is no more than 38 percent of the total population. This figure, a sign of the immaturity of the banking sector, casts doubt on the effectiveness of the new policy in dampening demand and soaking up liquidity. Hence, planned future increases in interest rates are unlikely to slow down inflation, but they will most certainly increase pressure on government finances and worsen the debt crisis. Indeed, a cursory look at the structure of banking credit reveals that the largest borrower is the Egyptian state, with private sector borrowing dropping from 42 percent of GDP in 2008 to 27 percent in 2020.
It is clear that an increase in interest rates will place additional pressure on an already-stressed government budget, where debt loan repayment constitutes 54 percent of government expenditures. This is compounded by the fact that the Egyptian taxation system is regressive, which means that it acts to funnel wealth to debt holders at the expense of the lower and middle classes. For example, in 2020, 45 percent of tax revenue was collected from VAT and other taxes on goods and services—all of which are regressive since they tax consumption rather than income. Placing this in context, the same ratio in the OECD countries stands at 32 percent.
Overall, monetary policy is not sufficient to solve Egypt’s inflation crisis, and there is no substitute for fundamental economic reform targeting the regime’s form of militarized capitalism. Indeed, increasing interest rates will only serve to deepen the crisis by placing additional pressure on government financing, while also failing to attract investments in Egyptian debt instruments. The extremely high rate of inflation is also a substantial barrier to a policy of offering high interest rates to attract investors, with real interest rates ranked the lowest among 50 developing economies. Hence, the old model of using inflation to attract capital inflows is no longer viable, and a radical shift in policy is required. Otherwise, grinding inflation will continue for the foreseeable future.
Maged Mandour is a political analyst who is a regular contributor to the Arab Digest, Middle East Eye, and Open Democracy. He is also the author of an upcoming book titled “Egypt Under Sisi.” Follow him on Twitter @MagedMandour.
