Inflation: EGP depreciation does not explain everything
The floatation of the Egyptian pound since November 2016 and the introduction of fiscal reforms have significantly improved the macroeconomic situation, in particular forex reserves. The sharp EGP depreciation has pushed inflation to 30-year high, highlighting the sensitivity of consumer prices to currency fluctuations. However, other factors have also had a key role such as strong corporate pricing power in the consumer goods sector, particularly due to supply chain inefficiencies. Fiscal policy is also contributing to rising prices, but to a more limited extent. Getting inflation down could take some time, and in the short term, the authorities have limited resources to tackle it.
The economic situation in Egypt has improved significantly since the Egyptian pound was allowed to float in November 2016. To no great surprise, the most significant improvement has come in external accounts and foreign currency liquidity. Currency reserves at the Central Bank of Egypt (CBE) have increased by 60%, reaching USD 31.3 billion in June 2017, equivalent to nearly six month cover of goods and services imports. The credibility of the new exchange rate regime and substantial increase in yields on government securities have attracted more than USD 10 billion in foreign portfolio investment as of July 2017, compared to virtually zero up until mid-2016. It should be noted that this figure, relating to carrytrades, is not included in official currency reserves as it is based on inflows prudently considered by the CBE as volatile. The improvement in public finances has been lower, but the trend is positive for the moment. The gradual reduction in energy subsidies and the increase in certain fiscal receipts (VAT) should help reduce the primary budget deficit for the fiscal year (FY) 2016/17 by more than half (to 1.9% vs estimated 4.5% of GDP in FY 2015/16). However, the debt servicing cost remains very high, at more than 8% of GDP, or around 45% of total fiscal receipts, meaning that the overall budget deficit will remain above 10% of GDP in FY 2016/17.
Economic activity is showing signs of vigour, but that remains to be confirmed. Household consumption, one of the main drivers of economic activity, is severely constrained by rising prices. Annual consumer price inflation has been running at an average of over 30% since January. This rate of inflation is partly due to the sharp EGP depreciation since November 2016 (-50% against the USD).
However, we believe that other elements are important explanatory factors in Egypt's structurally high inflation and the magnitude of price rises over the last six months.
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by Pascal DEVAUX