A tale of two rates: how an Egyptian central bank instrument has backfired
On October 21, the Egyptian president issued a decree appointing Tarek Amer as the new governor of the Central Bank of Egypt (CBE), in succession to Hisham Ramez. Since then, the country has witnessed an apparent shift in its monetary policy regime based on three main pillars. Firstly, creating a fundamental decrease in the demand on U.S. dollars through setting strict restrictions on imports, in cooperation with the Ministry of Trade and Industry, as well as lifting dollar deposit and withdrawal caps. Secondly, preserving the Egyptian pound’s exchange rate; in other words decreasing the appetite for dollars through raising interest rates. Finally, adopting new banking policies that aim to diversify loan portfolios to cover a wider range of companies, including small and medium-sized enterprises.
In a short period of time, Amer managed to expand the range of financial instruments used by the CBE, which is quite impressive. The effort that has been exerted throughout the past six months prompts one to salute the current CBE management.
However, one can also objectively question the effectiveness of some of the recent CBE monetary decisions. On March 14, Egypt’s three giant public banks – National Bank of Egypt, Bank Misr and Banque Du Caire – issued three-year certificates of deposit (CD). The certificates offer a 15% annual interest rate on Egyptian pounds and are conditioned on selling U.S. dollars or any foreign currency to the bank at the official price. The fundamental reason behind the introduction of this instrument is to encourage foreign currency holders to migrate their U.S. dollars to the “official banking system”, which would enhance dollar liquidity. Ideally, this should have decreased the demand for foreign currency on the parallel market and curbed the continuous rise in the dollar exchange rate against the Egyptian pound.
But this did not materialise in reality and the results have been disappointing. The three banks announced the collection of a few hundred million dollars instead of the billions set as a target, and the unofficial rates reached a record high of 10.10 (up to 10.20) pounds per dollar.
So why did not the strategy work? The gap between the official rates and the parallel market rates exceeds 6.6 per cent.
Let’s go back in time to October 2015, before the official announcement of Amer’s appointment as CBE governor, at a time when steps were being taken to prepare for the upcoming phase. Amer worked closely with the banking sector, particularly with public banks, to find solutions to the economic obstacles the country was (and still is) facing. The issuance of a three-year deposit certificate with an annual rate of 12.5 per cent was one of the results of this collaboration. Unlike the more recent certificates that have a 15 per cent interest rate, this one does not require selling U.S. dollars to banks as a condition. In fact, anyone can purchase them. And if you possess U.S. dollars, you can simply sell your dollars at the parallel market and then invest the equivalent in Egyptian pounds in the 12.5 per cent certificates of deposit.
As we speak, two CDs are available: the first with a 12.5 per cent interest, the second with a 15 per cent interest rate. The question is, if I possess U.S. dollars and I would like to capture the opportunity of high interest rates on Egyptian pounds, which CDs should I put my money into?
You now have two options, either to invest in the more recent 15 per cent CD (conditioned on selling dollars to the bank) or invest in the 12.5 percent CD. Assume you have a $1000, originally purchased at 7.83, and you want to make use of the high interest rates offered on EGP CDs: You will generate two types of gains. On the one hand, you will receive the interest on the CD, either 15 or 12.5 per cent. On the other, you will also benefit from the foreign exchange rate by selling your dollars in exchange for pounds.
Since the 15 per cent CD is conditioned on selling your dollars on the official market, where the rate is 8.88, your foreign exchange returns will be limited to the differential between 7.83 and 8.88. Since the 12.5 per cent CD is not conditioned, you will more likely sell your dollars on the parallel market where the exchange rate can go up to 10.20 pounds per dollar, which will offer you a higher differential as a result of the higher exchange rate. To know your overall gain, add your returns from the parallel-market currency exchange rate and your return from the CD interest rate in Egyptian pounds.
At a 6.6 per cent differential between the official and parallel market rates, the two instruments yield the same return. If it surpasses 6.6%, a rational decision maker would rather sell dollars on the parallel market and invest in the CD that has 12.5 per cent yield. With the current gap between the official and parallel market rates equal to 14 per cent, the CD with the lower interest rate actually gives a premium of 9.4 per cent above the CD with the higher interest rate. So, effectively, those who possess dollars will continue to sell their foreign currency on the parallel market and maximise profit from an older tool (the 12.5 per cent CD).
The newly-introduced instrument, which was originally established to attract foreign currency into the official banking system, has backfired. It caused movement of the USD liquidity from households as well as bank accounts straight to the parallel market.
This article might be perceived like an advice for people on where to put their money, but in fact it is directed more to policy makers.
In an economic environment where high interest rates are mixed with a wide gap between official and unofficial foreign exchange rates, the process of “letting go of dollars” is actually directing the supply of the foreign currency to the black market, something that every central banker has been trying to fight since 2011.
The question remains, has the central bank's management created so many financial incentives that it disturbed the very plan it seeks to achieve, which is retail-selling dollars to banks?
(Noaman Khalid is an economist at CI-Capital Asset Management, the largest bank-based asset manager in Egypt, and a regular news commentator in Egypt’s Al-Mal and AlBorsa, two of the largest economic newspapers in Egypt. He also writes for a number of media outlets such as OpenDemocracy.)