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Egypt’s economy shows signs of vigour: BNP Paribas  - Daily News Egypt

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Egypt’s economy shows signs of vigour: BNP Paribas 

Inflation isn’t the only reason behind the soaring inflation

The economic situation in Egypt has improved significantly since the flotation of the Egyptian pound in November 2016 and is showing signs of vigour. The most significant improvement was witnessed in external accounts and foreign currency liquidity. Currency reserves at the Central Bank of Egypt (CBE) have increased by 60%, reaching $31.3bn in June 2017, equivalent to covering nearly six months of importing goods and services, according to BNP Paribas’ report.

On the other hand, 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.

“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,” the report said.

The report cites that one of the inflation drivers are the indirect effects due to an increase in the prices of semi-finished goods and commodities, which feeds production prices and, consequently, consumer prices, as a result of the lack of many sizeable domestic manufacturers across consumer goods segments.

Furthermore, another factor is the reaction of companies to the currency depreciation. Following the flotation, an increase in prices for imported factors of production and the fact that most private corporations in the formal sector raised their salaries by 10-20% made increasing selling prices necessary.

The report indicates that structural factors, such as the level of competition in the consumer goods sector, is a major driver of inflation, especially in the food retail segment, as many producers set their pricing strategy based on the control over distribution channels.

Companies may have direct control over part of their distribution channels by distributing through traditional circuits (local shops), in which they have higher control over selling prices. Despite the fact that the modern retail sector is expanding rapidly, producers tend to favour traditional distribution channels in order to protect pricing power.

According to the report, there is anecdotal evidence that shows that, after the pound flotation, some price hikes in certain consumer good categories may have gone beyond covering the rising cost of intermediate imported goods, allowing producers to make up lost ground after several years of relative price stability.

Moreover, the existence of limited competition in the consumer retail market may also explain the persistence of high inflation over a long period, even when production capacity is not fully utilised. The expansion of modern supermarkets in Egypt may, therefore, promote competition and relieve inflation, but also threaten producer margins.

According to the report, the reduction of energy subsidies was an another important factor behind inflation, since fuel prices have witnessed more than a 100% increase compared to 2014, while electricity witnessed an increase of 29-124%, depending on the consumption tier.

In the short term, consumer price inflation is likely to remain elevated. BNP Paribas forecasts that CPI inflation will reach 25% in fiscal year (FY) 2017/18. Further subsidy cuts, the persistence of imported inflation, and a possible upturn in domestic demand are all likely to continue driving inflation. The effectiveness of the interest rate lever is limited by the low adult bankability ratio, which is lower than 15%, the report concludes.

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