One Interest Rate Cut at a Time

Digging ourselves out of the weeds, one interest rate cut at a time.

Central banks, the “lender of the last resort” and the banks’ bank, implementer of each country’s monetary policy, have at their disposal certain tools they can use to stimulate the economy at what they’ve determined are strategic entry points. These tools include discount lending, interest rate cuts, and open market operations, to name a few, and to avoid getting too technical.

The United States, the most prominent user of such tools as of late, implemented what it dubbed a “Quantitative Easing” initiative to combat the aftermath of the financial crisis.

Quantitative Easing is simply a fancy phrase for an economy stimulating program of cutting interest rates (down to zero!) and simultaneously buying up bonds, mortgage backed securities (which caused their financial crisis in the first place), and other securities circulating in the market to increase cash held by individuals and businesses.

This specific monetary tool is meant to encourage spending (low interest rates deter saving, and government buying bonds pushes cash to investors) to start a cycle of pulling people out of their risk averse mindsets of saving every penny they make.

Explaining the cycle isn’t the sexiest thing, but I’ll be brief so as not to bore you out of your minds. The program is meant to signal an improving macroeconomic and risk environment, stimulating spending by individuals, which increases demand for goods and services, which increases employment as producers need to hire more to meet demand, which increases cash held by individuals, which increases their individual spending patterns, which again increases demand for goods and services… and the cycle grows with a multiplier effect.

In parallel unemployment is expected to fall, currency strengthens as demand for EGP increases, equity and debt markets (stock market and corporate lending through issuance of long term debt directly or by issuing bonds) strengthen as fresh cash from investors pours into the market.

Long story short, interest rate cuts signal that the government believes the time is right to get people spending again, and that risk is fading. Over the weekend, in an unexpected turn of events, the Central Bank of Egypt cut interest rates 50bps or 0.5%.

Let’s look at latest developments: there is a new government in place, crucially needed aid of USD12bn has been pledged with USD5bn already received, and a clear map for transition of power is in place. Post the 2011 Revolution; the CBE had introduced interest rate hikes despite slowing GDP growth and rising inflation, in an effort to maintain price stability.

Coupled with the political turmoil that ensued since and with foreign investors fleeing their Egyptian holdings, the recipe spelled disaster, where production was down, prices up, and the USD was being sold for as high as 8 EGP on the black market.

While these latest interest rate cuts do not reverse the hikes from 2011 onwards, they come as a sign of hope from the policy-makers behind Egypt’s helm. Is the move politicized and meant to send a message? I’d be naïve if I didn’t think so. Is it better than doing nothing as stock prices plummet, unemployment rises, and foreign investors avoid Egypt like the plague while the government is a not-so-innocent bystander?

Definitely. I’ll take the lesser of two evils any day, pray that the economy listens to the market’s signals, and that one day Egypt can have a rich man’s problem.