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March 23, 2022

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Is the Current Inflation Wave Leading to Another EGP Devaluation?

Markets globally, including in Egypt, are witnessing a rise in inflation rates, which were already on an upturn, due to the pandemic and the Russian-Ukrainian conflict. According to CAPMAS, the nationwide annual inflation rate recorded 10% for February 2022, compared to 4.9% for the same month last year. This is considered the highest in three years and exceeded the limit set by the Central Bank of Egypt at 7 percent (±2%) through the fourth quarter of 2022. JP Morgan predicted that Ukraine war and other ongoing challenges would extend the period of high inflation. Still, there is a bigger fear that is haunting Egyptian market– Are we going to witness another devaluation of the Egyptian Pound? The good news is that this might not be the only solution to control the current inflationary pressures.

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But First What are the Main Factors that are Feeding through Inflation Channel in Egypt in 2022?

I. Increase in Oil Prices:

Most forecasts predict that oil prices will keep rising for the time being with uncertainty over when they will stabilize, especially with geopolitical tensions running high. Oil price fluctuations may not be in Egypt’s interest given that it’s a net importer of crude oil and petroleum derivatives. Petrol prices generally move in sync with crude oil prices and the exchange rate of the pound against the US dollar. So, with brent crude oil rising to $130 a barrel on Mar. 8, we can see another rise in the price of gasoline by about 10%, which is the maximum allowed for a single increase in fuel prices. The higher global oil prices have already prompted Egypt’s government to increase petrol prices at the pump by LE0.25 per litre, marking the fourth hike in a year. Yet, some economists fear the possibility of raising diesel prices as it will certainly have a significant negative impact on the inflation index. Adding to this, housing and utility prices rose by 4.7% y-o-y, driven by higher energy costs, while transport costs rose by 4.9%. Also, the higher oil price would push food prices as the prices of food commodities move according to the movements of oil and petrol prices, given that food commodities represent 34% of the basket measured by the consumer price index.

II. Increase in Food Prices:

Last week, the global food price index reached an all-time high, soaring 24.1% above its level the year before. For Egypt, the increase in annual inflation was predominantly driven by 17.6% increase in food and beverage costs, especially with the increasingly complicated Russia-Ukraine crisis. According to Egypt’s Finance Minister, before the crisis in Ukraine, we used to buy a tonne of wheat for 226 euros, now it costs 363 euros. Given that Egypt is one of the largest wheat importers in the world, wheat prices worldwide could force the government to revise its bread subsidies to protect its finances. Yet, lifting bread subsidies will likely push Egypt’s inflation rate to 12%. While tackling the bread subsidy may not be considered in the short-term, the government has already raised the prices of other commodities such as sugar and cooking oil that many people receive as part of the food-subsidies program. The surge in food prices was also prompted by the government’s decision in December to raise the price of butane gas–used for cooking by most of Egypt’s poorest households along with the price of subsidized vegetable oil.

III. Growing Fiscal Deficit:

J.P. Morgan Commodities research team now see fiscal deficit wider at 6.6% of GDP in FY22 from 6.4% previously. This is attributed to the rising commodity prices and higher import costs. The rapid rise in wheat prices alone had an immediate impact on the government’s fiscal accounts as the finance minister recently announced that the state’s budget for wheat purchases would increase by EGP15bn. This has actually delayed state’s efforts to bring down the debt-to-GDP ratio, which is elevated in Egypt. The total debt-to-GDP ratio reached 90% in 2020, placing significant strains on the state budget, as the cost of interest on loans will consume 31.5% of state expenditure in 2021/2022. The situation is compounded by an underperforming non-oil private sector, which has been contracting for most of the past 5 years, due to weak local demand and export orders. This weakens the tax base of the state, further increasing the pressure on government to cut public spending in order to meet its debt commitments and maintain its creditworthiness. Before the crisis, Egypt had been working to sustain appetite for its treasury bills to finance current account and budget deficits. Yet, many investors are concerned that emerging markets, including Egypt, may be more susceptible to any disruptions resulting from Russia-Ukraine crisis. According to the bankers, who declined to be named, foreign investors had pulled about $3 billion out of Egypt since the beginning of March. Also, the Egyptian Stock Exchange revealed that foreign investors sold around $1.19 billion of Egyptian treasury bonds in just three days, according to the Reuters statement.

IV. A Sharp Rise in Input Costs:

According to the IHS report on Egypt, Egypt’s PMI dropped to its lowest reading since April 2021 at 47.9 but rose again in Feb to reach 48.1, which is still below the 50-threshold. This indicates a solid decline in overall business conditions and the sharpest decrease in non-oil activity in Egypt since June 2020. Sub-indexes showed a decline in output and new orders, as well as employment and purchasing activity, with firms struggling with another sharp rise in input costs. Input cost inflation was at its the second fastest in over 3 years in Dec. 2021. According to the IHS Markit report, raw material costs continued to climb, with some surveyed companies highlighted price mark-ups of over 10% to protect their profit margins. For example, according to Masrawy, Ezz Steel increases steel prices by EGP 2k/ton over the past month, while the Suez Steel Company hiked its prices by around EGP 1.5k. Also, increased shipping and energy prices continued to burden companies with rising input costs. So, it is not just food prices that are rising; other areas of the economy such as manufacturing and construction are facing higher input costs as the prices of raw materials rise. All these factors together are not only constraining activity over 2022 but have also led companies to reduce their staffing levels, resulting in a fourth successive monthly drop in employment.

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