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FEATURE

higher standards

by ahmad aboul wafa and nazly shamel

mounting interest rates show no sign of cooling off, but they certainly could put the chill on inflation. investors wonder if they’re here to stay and what it all means

rising interest rates have created a flurry of activity at banks in recent months as customers queue up to lock away their pounds. the excitement started in august when national bank of egypt (nbe) and banque misr simultaneously issued what they called “advantage certificates” – savings deposit certificates offering 12-percent annual interest, a full two points higher than the going rate on savings instruments. word soon got out and by late august, people were flocking to the main branches of the two banks to get their share of the pie.

the two banks have collected billions of pounds since issuing the three-year savings deposit certificates. nbe alone reported selling £e 3 billion in certificates in the initial three weeks.

some customers pulled their deposits out of other banks to use the cash to buy the certificates, while others exchanged their dollar savings into pounds to purchase additional ones. misr international bank (mibank) client khaled hisham said he was tempted to put all his savings in nbe after he learned about the bank’s new platinum certificate. “twelve percent interest makes it tempting for anyone to change his bank or even borrow money to buy the new certificates,” said the 37-year-old, who has a daughter in primary school. “we are in dire need of any extra money, especially as prices jump every day and our salaries remain the same.”

raising the stakes
to avoid losing their clients, smaller banks such as suez canal bank and bnp paribas le caire offered their own 12-percent savings deposit certificates. delta international bank raised the stakes in september by offering interest rates up to 12.25 percent.

ali negm, chairman of delta bank and former governor of the central bank of egypt (cbe), told business monthly he was forced to offer higher interest rates to prevent his depositors from transferring their savings to other banks. “the rate hikes happened without a prior warning from the cbe,” he said. “we waited for the cbe to explain what happened or for the two public sector banks to justify their decision, but the reasons we were given were neither logical nor acceptable. there was no transparency.”

the central bank of egypt, which charts egypt’s monetary policy and must approve all interest rates, has reportedly been leaning on local banks to raise interest rates. cbe governor farouk el okdah said in an interview with state-run daily al-ahram that nbe and banque misr were the first to respond to the cbe’s signals because they have 40 percent of the total savings deposits in egyptian banks. officials at the two public banks, however, denied they were pressured into raising their rates, though they confirmed that the cbe approved their decision.

“the central bank’s tentacles in the market are the public sector banks. i imagine that the central bank chose these two banks and asked them to issue the certificates, in effect sending a clear signal to the market indicating an upward trend for interest rates,” said mohamed taha, executive vice president of egyptian american bank (eab). “if these certificates had offered a floating interest rate — a rate that changes periodically — there might have been doubts about the trend. yet the fact that they’re fixed for the entire three-year period leaves no doubt.”

interest rates have been creeping up across the board.treasury bills have seen a significant rise in recent months. interest rates on 91-day t-bills rose to 11.04 percent in late august, up from just 6.77 percent at the start of the year. bankers expect their rates to climb even further to stay competitive with other short-term investment instruments.

raising interest rates on savings deposits means a bank must pay more to its depositors, squeezing its profit margin until the lending rate is adjusted. khaled el-mehdy, head of research at hsbc securities, noted that, to date, only banks suffering liquidity shortages have attempted to match the rates offered by the two public banks. “so far, none of the ‘tier a’ banks have moved their interest rates north because they already have excess liquidity and don’t need to offer higher rates to draw even more funds,” he said.

the invisible hand
el okdah confirmed in remarks to the press that he favors higher interest rates to counter the effect of inflation, which has grown to 11 percent since the cbe floated the egyptian pound in january 2003. “there was a defect in the lending and savings structure as people were paying 14-percent interest rates on loans while the interest rates on savings remained at about 7.5 percent,” he said. “there was about a 7-percent difference... and eventually we had to catch up with the market and make up for the price increase.”

with the consumer price index (cpi) hovering around 5 percent and average returns on savings deposits at around 8 percent, the real inflation rate is closer to 3 percent. economists, however, caution that the cpi is a deceptive measure of inflation because it is calculated using a basket of mostly subsidized goods. measuring real inflation using the wholesale price index (wpi) would suggest a real rate of inflation of around 10 percent.

taha, a proponent of higher interest rates, says warming interest rates could help reduce the sting of inflation. “i’d proposed setting interest rates at 17 percent to offset inflation,” he said. “we’re not perfect, but at least we’re getting there.”

el-mehdy agrees. he said higher interest rates are necessary to achieve positive real interest rates, but stressed that the wpi was decelerating. “even though inflation may still be on the rise, it is increasing in lower increments, which is a reassuring sign that price levels may be stabilizing in the near future,” he told business monthly.

on the downside, higher interest rates would increase the public debt service bill, which already accounts for some 25 percent of government expenditure. it is estimated that each one-percent rise in interest rates will mean an extra £e 2.1 billion in debt service. “this is not necessarily bad if we can increase gdp growth,” said one financial expert.

much depends on the cbe’s ability to curtail dollarization, the psychological reliance on foreign currencies for savings and transactions. by signaling for higher interest rates, the cbe hopes to halt the downward march of the egyptian pound, which has shed 38 percent of its value since it was floated in january 2003. if real, long-term domestic interest rates prove more attractive than interest rates on foreign-currency deposits, it could create higher demand for the pound and bolster its value.

“to attract investors to hold and invest in the egyptian currency, the domestic interest rate must be higher than the foreign interest rate,” said taha. “if domestic interest rates increase to reach 12 percent versus 2 percent on the us dollar, that makes a difference of 10 percent.”

he explained that a 10-percent difference offers bank customers the equivalent of the us dollar trading at £e 9 in three years’ time. “if you believe the us dollar will reach or surpass £e 9 in three years, you’re better off holding us dollars,” said taha. “on the other hand, if you think that in three years the us dollar will be valued at less than that, you’re better off holding egyptian currency.”
the pound’s fall against the us dollar in recent years prompted speculators to transfer their savings into dollars to keep ahead of inflation. foreign currency deposits in banks amounted to the equivalent of £e 150 billion in may 2004, up from £e 123 billion the year before. more telling, however, is the growing ratio of foreign deposits, which accounted for 32 percent of total bank deposits in may 2004, up from 21 percent in mid-2000.

cbe officials claim the higher interest rates on savings deposit certificates have helped reverse this trend. “banks saw an 80-percent increase in their hard currency liquidity, partially due to the exchange to the new certificates,” el okdah told reporters during a recent interview.

the pound’s black market rate has strengthened in recent months, almost converging with the official rate of approximately £e 6.22 per dollar. some suspect the new interest rates could eliminate the gap altogether, a feat that would send a positive message to both local and foreign investors.
ahmed arafa, board member of the investment committee of the federation of egyptian chambers of commerce, said rising interest rates would help draw liquidity from people and bring more investment opportunities to the local market. “we are a cash-based society and we need something to convince people to invest their money in banks,” he said. “the value of investments in egypt does not exceed £e 5 billion and we need at least £e 15 billion to attract more investment.”

mixed messages
some experts, however, believe the cbe is sending the wrong message. “banks that were not prepared for the rate increase and had to follow the same path will later have to decrease their lending rates in order to keep their clients and investments,” said mohamed hassan, an assistant economics professor at cairo university. “of course this system will be completely wrong economically and will harm small banks which cannot afford financial problems.”

negm echoed his sentiment, arguing that those banks that rushed to match interest rates on savings deposits would inevitably have to adjust their lending rates to cut losses. “banks that followed suit will have to increase their lending rates and consequently the costs of production and investment will jump again,” he said.

higher interest rates imply higher lending rates, thus increasing the cost of borrowing and discouraging investment. investors often weigh nominal interest rates against nominal gdp growth in deciding whether or not to borrow money to make an investment. if interest rates exceed gdp growth then the incentive to invest is small. the latest ministry of planning figures put nominal gdp growth at 9.6 percent.

yet financial consultant raed allam argues that even if lending rates rise another 4 percent it would not necessarily hamper investment. “a decade ago, people borrowed at interest rates ranging from 18 to 20 percent – it was hardly an issue,” he said. “making an investment is a decision that’s based on many factors, and interest rates is only one of them.”

economists generally agree that economic stability, market transparency and steady exchange rates are the most important lures for investors. “higher interest rates and investment are not mutually exclusive,” said one economist speaking on the condition of anonymity. “looking at the bigger picture, attracting investments requires a stable economic environment. higher interest rates in the short to medium term help achieve that. it’s not a trade-off.”

staying power
are higher interest rates here to stay? bankers think not. “i personally see higher rates for a year or a year and a half maximum; any longer would be unsustainable,” said taha. “there are a number of new projects under way such as mortgages, which will never be able to take off in such a high-interest-rate environment. who could possibly borrow for 10 or 20 years at rates between 15 and 20 percent?”

interest rates are the main tool of monetary policy and, as us federal reserve chairman alan greenspan is aware, any hints of a policy change can have a major impact on economic performance and investor optimism. while some economists have argued that egypt’s current fiscal and monetary policies are in opposition, taha commended the cbe for offering a coherent strategy.

“previously, monetary policy – if in fact it did exist – was incomprehensible. the discount rate, t-bill rate and the central bank deposits rate were all at variable often conflicting levels and there was no direction,” he said. “at least now there’s a vision and a trend that i can base my plans upon.”
some bank customers are less impressed. “what is happening at the moment is a sign of the instability of bank policy,” said souad amin, a 42-year-old teacher. “one day they increase the rate, maybe tomorrow they will come up with a new decision.”

amin said she would continue to keep her savings in a foreign currency savings account despite the low interest rate it offers. “it is true that the interest rate on dollars is only one percent, but hard currency is always stable and more trusted than the local currency,” she said.

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