Monetary Policy Report September 2017

Transcription

1 Central Bank of Egypt Monetary Policy Report September 217 Monetary Policy Committee Monetary Policy Report, September 217 Central Bank of Egypt

2 Table of Content THE INITIAL CONDITIONS PAGE 2 THE OUTLOOK... PAGE 15 APPENDIX: TABLES AND ABBREVIATIONS PAGE 17 This report was prepared by the staff of the Monetary Policy Sector and approved by the Monetary Policy Committee. Some of the data presented in the report are preliminary and subject to revisions. The cut-off date for the statistics included in this report is November 6, 217. Monetary Policy Report, September 217 Central Bank of Egypt 1

3 Mar-14 Jun-14 Sep-14 Dec-14 Mar-14 Jul-14 Nov-14 Jul-15 Nov-15 Jul-16 Nov-16 Jul-17 Mar-14 Jun-14 Sep-14 Dec-14 Figure 1 Trade-Weighted Economic Growth of Egypt s External Environment * (in %, y/y) Source: Bloomberg & Central Bank of Egypt calculations. *The series is weighted using Egypt s trade volume in 215/16. Figure 2 World Trade Growth (in %, y/y) Source: World Trade Organization. Emerging economies Advanced economies Figure 3 Trade-Weighted Headline Inflation of Egypt s External Environment * (in %, y/y) Advanced economies Emerging economies Source: Bloomberg & Central Bank of Egypt calculations. *The series is weighted using Egypt s trade volume in 215/16. The Initial Conditions a) Pressures from Egypt s external environment on domestic prices are mixed. Trade-weighted economic activity of Egypt's external environment continued to accelerate, growing by an annual rate of 2.9% during 217 Q2, the fastest pace since 211 Q3. Growth was primarily led by an improved performance of Russia and the Euro Area compared to the previous quarter. Meanwhile, output growth in the US continued to increase, while economic activity in the UK grew at the slowest pace since 212 Q4. Growth in China maintained its firm pace, while that of Brazil recorded its first expansion since 214 Q1. Looking ahead, economic activity of Egypt s main trading partners is expected to maintain its growth momentum. While the pace in advanced economies is expected to soften somewhat, that of emerging economies is projected to improve. 1 Meanwhile, the annual increase of global trade continued in 217. Nevertheless, it is expected to moderate in 218 for several reasons. 2 First, trade growth in 218 will not be measured against a weak base year as is the case in 217. Second, monetary policy is expected to tighten in advanced economies, which could result in changes in exchange rates that could influence international trade patterns. Third, fiscal expansion and easy credit in China are likely to be constrained to prevent the economy from overheating. Fourth, renegotiation of NAFTA and negotiation of post-brexit trade deals could also unsettle global and regional trade. Trade-weighted headline annual inflation of Egypt s external environment remained subdued at 1.9% in 217 Q3, before increasing slightly in August and September mainly due to the US and the UK. Inflation in Japan, Euro area, Brazil and India remained stable, while it declined modestly in China and Russia. Looking ahead, inflation is projected to increase slightly in emerging economies, 1 CBE calculations based on estimates by the International Monetary Fund s World Economic Outlook Database October 217, weighted by Egypt s trade values in FY 215/ Estimates by World Trade Organization in September 217. Monetary Policy Report, September 217 Central Bank of Egypt 2

4 Mar-14 Jul-14 Nov-14 Jul-15 Nov-15 Jul-16 Nov-16 Jul-17 Nov-17 Mar-14 Jun-14 Sep-14 Dec-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Figure 4 Developments of Oil Prices (USD per barrel) Source: Energy Information Agency Figure 5 Developments of Food Prices (in %, y/y, using domestic CPI basket weights) Source: Central Bank of Egypt calulations, World Bank, Food and Agriculture Organization, and United States Department of Agriculture. Figure 6 Policy Rates of Advanced Economies (in %) Source:. Bloomberg. Federal Reserve Bank of England European Central Bank while remaining broadly unchanged in advanced economies. 3 After averaging 52.1 USD/bbl in 217 Q3, oil prices increased considerably in October 217 and during the first week of November, averaging 57.5 USD/bbl and 61.9 USD/bbl, respectively, mainly due to geopolitical concerns. The instability in the oil-rich area of Kirkuk in Iraq and the diplomatic tensions with Qatar led to oil price increases in September and October. Thereafter, the anticorruption measures in the KSA added further pressure in the first week of November 217. Bloomberg composite forecasts for Brent oil prices in FY 217/18 and FY 218/19 were subsequently revised upwards to 59.9 USD/bbl and 6.3 USD/bbl at the end of the week compared to 57.6 USD/bbl and 57.8 USD/bbl, at the beginning of the week, respectively. The prospects of OPEC and allied nations continuing to curb oil output remains an important driver of oil prices. International food prices, weighted by Egypt s domestic food weights in the CPI basket, declined between August and October by a cumulative monthly rate of 6.8%, after increasing by 11.3% between May and July and registering 2.6% during the first four months of 217. This led annual increases in food prices to narrow to 8.6% in October after peaking at 24.5% in July. The recent drop in food prices occurred largely due to the drop in the prices of wheat and meat. The drop in wheat prices reflects higher supplies from the Black Sea and competition among exporters. The decline in meat prices was largely driven by poultry prices reflecting a seasonal pattern. Looking forward, food prices are expected to remain largely stable in Capital continued to flow into emerging market assets in 217, supported by favorable interest rate differentials. In their latest monetary policy meeting, the US Federal Reserve having previously hiked its policy rate in March and June 217 and the European Central Bank kept 3 CBE calculations based on estimates by the International Monetary Fund s World Economic Outlook Database October 217, weighted by Egypt s trade values in 215/ World Bank Commodity Markets Outlook, October 217. Monetary Policy Report, September 217 Central Bank of Egypt 3

5 Mar-14 Jun-14 Sep-14 Dec-14 Jan-17 Feb-17 Apr-17 May-17 Jul-17 Aug-17 Oct-17 Jan-17 Feb-17 Apr-17 May-17 Jul-17 Aug-17 Oct-17 Figure 7 Trading Partner Currencies against the USD 1/ (in %, m/m, +ve is depreciation) their respective policy rates unchanged, while the Bank of England raised its policy rate for the first time since 27. These decisions, as well as the start of the reduction of the Fed's asset purchasing program and the announcement of a similar reduction by the ECB starting January 218 were expected by markets and therefore did not affect the flow of capital into emerging economies. Looking ahead, interest rates in most emerging economies are expected to gradually decline, thereby narrowing interest rate differentials between advanced and emerging economies. Source: Bloomberg and Central Bank of Egypt calculations. 1/The series is weighted using Egypt s trade volume in 215/16. Figure 8 EGP against the USD (in %, m/m, +ve is depreciation) Figure 9 Egypt s Monthly Inflation Differential with its Main Trading Partners (in %, m/m) Source: Bloomberg and Central Bank of Egypt calculations. Since the beginning of 217 until October, currencies of Egypt s main trading partners appreciated against the USD on a monthly basis, mainly on anticipation of a more gradual policy tightening by the Fed. This trend reversed in October as a result of developments in the UK and Euro area, which account for a high share in Egypt s trade. Specifically, slower-than-expected policy normalization by the ECB and weakening growth prospects in the UK led the EUR and the GBP to depreciate against the USD. In the meantime, the EGP was relatively stable against the USD in May and June and appreciated slightly thereafter. This reduced the impact of the appreciation of trading partner currencies on the competitiveness of Egyptian goods and services as measured by the NEER. As a result, the annual NEER depreciation remained broadly unchanged. Meanwhile, the monthly inflation differential between Egypt and its main trading partners lessened between March and September 217 compared to between November 216 and February 217, with the exception of July due to domestic regulated price adjustments. This contained the increase in the annual inflation differential. Consequently, the REER has been slightly appreciating on a monthly basis since May given the combination of the broad stability of the NEER and an unfavorable inflation differential albeit moderating. The annual REER depreciation remained broadly unchanged since May, however by a weaker magnitude compared to 217 Q1. Monetary Policy Report, September 217 Central Bank of Egypt 4

6 Jun-7 Jun-8 Jun-9 Jun-1 Jun-11 Jun-12 Jun-13 Jun-14 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Figure 1 Contribution to the Current Account (in p.p. unless otherwise specified) 1% 5% % -5% -1% -15% -2% -25% Figure 11 Tourism Receipts and Payments (in USD billion) Figure 12 FDIs ability to Fund the Current Account Deficit excluding Grants (in USD billion) Services payments Transfers Hydrocarbons Services receipts Non-hydrocarbons Net inv. balance Current account (y/y %) Gross tourism payments Gross tourism receipts Net tourism revenues (RHS) b) The external balance continued to benefit from increased competitiveness gains and the liberalized exchange rate system, easing inflationary pressures. Egypt s current account deficit continued to narrow on an annual basis for the third consecutive quarter in 217 Q2, registering the highest annual USD improvement on record. This was supported by the increase in Egypt s competitiveness as measured by the REER as well as the ongoing recovery of Egypt's trading partners. The narrowing deficit was first driven by a higher contribution of remittances since 216 Q4, followed by higher contribution from NEGS since 217 Q1. The lower deficit of NEGS since 217 Q1 is attributed to a lower non-hydrocarbon trade deficit and a higher surplus of the services balance, while the hydrocarbon trade deficit deteriorated because of higher oil prices and natural gas imports. During 217 Q2, despite the stagnation of nonhydrocarbon exports, the NEGS deficit continued to narrow given lower non-hydrocarbon imports as well as the continued increase in the services balance, supported mainly by the recovery of tourism, as well as the slower pace of decline in the Suez Canal revenues since 217 Q1, in line with the pickup in global trade growth. Meanwhile, the increase in the hydrocarbon trade deficit lessened because of lower natural gas imports amid higher domestic production. Meanwhile, the new exchange rate regime continued to strengthen foreign investor appetite for Egyptian assets, supporting the financial account. Net FDIs recovered during 217 Q2, while net portfolio inflows continued to improve following its strong rebound in 217 Q1, supported by Eurobond issuances in January and May 217. Leading indicators confirm a continued recovery in foreign investment. Net FDIs have been increasingly covering the current account deficit (excluding grants) since 216 Q3, reducing Monetary Policy Report, September 217 Central Bank of Egypt 5

7 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Figure 13 FDIs by Sector Disaggregation (in USD billion) Figure 14 Real GDP Growth at Market Prices (in p.p., y/y) Gross outflows Non-residents purchases of real estate Oil & Gas Non-residents net purchase of companies Newly issued capital or capital increase FDIs net inflows 2.3 Source: Ministry of Planning, Follow-up and Administrative Reform. Figure 15 Labor Market Developments (in %, y/y, unless otherwise mentioned) Net Exports Gross fixed investments Private consumption 3/4-9/1 1/11-13/14 14/15-16/17 H1 Δ in Inventories Public consumption GDP (at Market Prices) Unemployment rate (% of total labor force) Labour Force (RHS) Employment (RHS) Source: Central Agency for Public Mobilization & Statistics and Ministry of Planning, Follow-up and Administrative Reform the gap to USD1.1 billion during 217 Q2, the lowest since 213 Q2. Meanwhile, the policy of no intervention in the foreign exchange market preserved the CBE s foreign assets under the current exchange rate regime, leading GIR to record USD36.7 billion in October 217, the highest on record. As a result, the ratio of GIR to total external debt continued to improve and is estimated to record the highest in five years. c) Real Gross Domestic Product (GDP) growth continued to strengthen, while the expend i- ture structure continued to rebalance. Real GDP growth at market prices continued to expand for the third consecutive quarter to record 5.% during 217 Q2, thereby averaging 4.6% during the second half of FY 216/17, the fastest pace since FY 29/21. In line with strengthening economic activity, the unemployment rate declined to 12.% in 217 Q2, registering the lowest since FY 211/12 after peaking at 13.4% in 213 Q4. The drop was recently supported by lower real wages and increasing productivity. The rebalancing of the expenditure structure started with weakening private consumption since 216 Q2, notwithstanding its increase during 216 Q4, followed by weakening public consumption since 216 Q3, and by the improvement of NEGS since 217 Q1. Public investment maintained its double digit growth rates in 216/17, albeit slowing compared to the previous two fiscal years. In the meantime, the expansion of private investment continued at an increasing pace for the third consecutive year, yet lower compared to its pre-28/9 performance. Real NEGS improved to register a positive contribution during 217 Q1 and Q2, after registering negative contributions during most of the period between FY 21/11 and the first half of FY 216/17. This improvement was due to the increase in exports that outweighed the increase in imports in both quarters. The contribution of private consumption weakened be- Monetary Policy Report, September 217 Central Bank of Egypt 6

8 21/2 22/3 23/4 24/5 25/6 26/7 27/8 28/9 29/1 21/11 211/12 212/13 213/14 214/15 215/16 216/17 Figure 16 L/C Claims on the Private Sector (in %., y/y) Figure 17 Growth in Investments by Sector (in %., y/y) Real growth Credit to Private Busines sector in L/C (yearly) Real growth Credit to Household sector in L/C (yearly) Source: Ministry of Planning, Follow-up and Administrative Reform. Figure 18 Contribution to Real GDP Growth by Sector (in p.p., y/y) Private investments Public investments 3/4-9/1 1/11-13/14 14/15-15/16 216/ General Government Trade Industry GDP (at Factor cost) /5-9/1 1/11-13/14 14/ H1 Suez Canal Services Agriculture Source: Ministry of Planning, Follow-up and Administrative Reform. tween 216 Q2 and 217 Q2, after being the main driver of growth historically. This coincided with the annual drop in real wages since 216 Q4, notwithstanding its slight recovery in 217 Q2, affecting consumer purchasing power. It also coincided with the annual decline of real claims to the household sector as well as imports of consumer goods. While the annual drop of real credit to the household sector and consumer imports continued in 217 Q3, recent monthly data of real credit to the household sector suggest its potential bottoming. While still recording double digits, public sector investment growth weakened in FY 216/17 vis-à-vis the previous two fiscal years mainly due to lower investment in Suez Canal and petroleum extractions that outweighed increased investment in electricity and natural gas extractions. 5 On the other hand, private sector investment growth continued to strengthen in FY 216/17 due to investment in real estate and natural gas extractions, while investment to trade and non-oil manufacturing weakened. Generally, strengthening private investment coincided with increasing real claims on the private business sector in L/C. In 217 Q2, the sectors driving economic activity shifted towards the services and other sectors vis-à-vis the industrial sector. Within the services sector, the contribution of real estate and construction improved vis-à-vis the previous quarter. The tourism sector s annual growth strengthened, however its relative contribution to growth weakened due to the stronger performance of the other sectors. On the other hand, the contribution of the industrial sector worsened as a result of the negative contribution of natural gas extractions and a weakening contribution of non-petroleum manufacturing, which was partially offset by the improvement in oil extractions during this quarter. Other sectors such as trade, Suez Canal and general government also improved in 217 Q2 compared to the previous quarter. Leading indicators during 217 Q3 generally suggest continuation of the positive growth momentum. 5 Using the same deflator of gross fixed investments. Monetary Policy Report, September 217 Central Bank of Egypt 7

9 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct Oct-13 6-Jan Mar Jun Sep-14 8-Dec May Aug-15 9-Nov-15 1-Feb Apr Jul-16 1-Oct-16 2-Jan Oct-13 3-Feb May Sep-14 5-Jan Apr Aug Jul-16 7-Nov Feb Oct-17 Figure 19 O/N Interbank and CBE Policy Rates (in %, unless otherwise stated) Figure 2 Excess Liquidity 1/ (in EGP billion) / Excess liquidity is adjusted by O/N lending facility. Figure 21 Government's WACF (in %) O/N Interbank Volume (in EGP billion, RHS) O/N Lending Facility O/N Deposit Facility O/N Interbank Rate Average Variable-Rate Deposits Average Fixed-Rate Deposit Average O/N Deposit Facility Average Excess Liquidity WA T-bonds Yield WA T-bills Yield WACF (Tax adjusted) Source: Central Bank of Egypt calculations d) Monetary conditions continued to tighten. Real monetary conditions continued to tighten, supported by the combination of previous policy rate increases amounting to 7 bps since November 216, receding inflationary pressures, and the monthly appreciation of the REER. However, the O/N interbank rate has been hovering below the policy rate since mid-august 217 for the first time in six months, on average by 25 basis points. This was due to the combination of the shorter tenors of variable-rate deposit auctions and the continuous increase in liquidity except for the one-off drop due to higher reserve requirement ratio by 4 bps as of October 1, 217. Consistently, interbank activity weakened to the lowest level since January 217. The absorption of excess liquidity via 7-day deposit auctions and the O/N deposit facility remained at around EGP 25 billion (5% of liquidity,.6% of GDP) on average since the end of May 217. The maturity of liquiditywithdrawing operations averaged 41 days between September 217 and November 217 after averaging 56 days and 148 days between June-August 217 and February- May 217, respectively. Consequently, the maturity of absorbed liquidity greater than 7 days averaged 21 days as of November 6, 217. Meanwhile, yields of L/C denominated government securities continuously declined after peaking in July 217 and reflecting 63% of the CBE s policy rate increases since November 216. The suppressed transmission was supported by the diversification of financing sources of the fiscal deficit. Increasing demand for L/C denominated debt by domestic banks since August 217 complemented by the continuous net foreign portfolio inflows since February 217 supported the drop of the WACF (net of tax) by 2.6 p.p. to average 14.5% during October 217, the lowest level since November 216. The coverage ratio as well as the accepted-to-required ratio increased to 2.6x and 1.24x Monetary Policy Report, September 217 Central Bank of Egypt 8

10 Oct-13 Feb-14 Jun-14 Oct-14 Feb-15 Oct-15 Feb-16 Oct-16 Feb-17 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Figure 22 Local Debt Coverage Ratios (in (x), unless otherwise stated) Source: Central Bank of Egypt calculations. Figure 23 Spread between T-Bonds and T-Bills yields (in %, unless otherwise stated) 1 Source: Central Bank of Egypt calculations. Figure 24 Interest Rates (in %) Coverage Ratio for T-bills Coverage Ratio for T-bonds Coverage Ratio WACF (Tax adjusted, in %, RHS) Share of accepted bids for T-bills of total issuance Share of accepted bids for T-bonds of total issuance T-Bonds - T-Bills WAY differential, in bps (Tax Adjusted, RHS) O/N Interbank Rate Weighted Average Deposit Rate Policy Rate Weighted Average Lending Rate Weighted Average Cost of Finance (Tax adjusted) over the three months up to October compared to the 2.3x and 1.15x over the previous three months, respectively. In the banking sector, while the w.a. deposit rate reflected a 1% pass-through of the higher CBE policy rates since November 216, the w.a. lending rate reflected only a 69% pass-through, increasing to 16.3% and 19.2%, respectively. The strong response of the w.a. deposit rate was mainly due to saving certificate and time deposits rates as the increase in the rates of saving accounts was limited. On the other hand, the increase of the w.a. lending rate was across all maturities, especially longer-term business and retail loans. Nevertheless, the w.a. lending rate declined slightly in September 217 for the first time after continuously increasing since May 217. The drop in the w.a. lending rate was mainly due to the drop of the longer-term business lending rate and to a lesser extent the retail lending rate, while the short-term business lending rate continued to increase. Meanwhile, the efficiency of the foreign exchange market continued to improve reflected by increasing USD interbank activity as well as stable client bid-ask spreads, after declining between November 216 and February 217. The Egyptian stock market maintained its positive performance. The EGX3 benchmark index increased by 71% post the economic reform measures in November 216, registering all-time highs. This was supported by net foreign investment amounting to USD 1.18 billion since November 3, 216. Against this background, total market capitalization increased to average an estimated 16.6% of GDP during the first four months of FY 217/18, compared to 16.% in FY 216/17. Real asset prices, reflected by unit prices in the real estate sector, continued to increase on inflation adjusted basis in 217 Q3. Numerous developers managed to maintain demand on the wake of lower purchasing power and potential liquidity shortages by offering more flex- Monetary Policy Report, September 217 Central Bank of Egypt 9

11 1-Nov-16 2-Nov Jan-17 5-Feb Feb Apr May-17 3-May Jul Jul Aug Oct-17 6-Nov Nov Jan-17 1-Feb Feb Apr-17 2-May May Jul-17 1-Aug Aug Oct Oct-17 Figure 25 Foreign Exchange Market Characteristics (in USD millions, unless otherwise stated) Total Market Volume EGP/USD - Average Daily Price ible and longer-term payment plans. Demand was especially evident for residential vis-à-vis retail real estate. Meanwhile, external financing conditions continued to improve as investors confidence recovered and Eurobonds yields were between 86 and 135 bps lower compared to the issuance in January 217. In addition, Egypt's sovereign credit risk premium continued to remain well below October 216 levels and credit default swap spreads remained relatively low compared to the majority peers with similar rating. Figure 26 Stock Market Indices 1/ (Index, November 1, 216 = 1) Source: Egyptian Stock Exchange and Central Bank of Egypt calculations. 1/ Equity performance calculated on EGP basis. Figure 27 Contribution to M2 Growth (in p.p.) CBE NFA CBE NCG NCPEA CPSC Financial crisis Mar-8 Mar9 EGX3 Index EGX7 Index EGX1 Index Political instability Apr-9 Jan-11 Dec-1 Jun-13 Banks NFA Banks NCG CPS M2 growth (RHS) Financial liberalization Jul-13 Apr-14 July-15 Nov-16 Mar-14 Oct e) Broad money (M2) growth increased mainly due to the recovery of net foreign assets (NFA). 6 Annual M2 growth has been increasing since 216 Q4 to record 23.9% in 217 Q3. Growth was driven by the recovery of NFA of the banking system, mainly due to higher net external and foreign non-bank financing of the fiscal deficit. Meanwhile, the positive contribution of L/C components has been declining since 216 Q2. The decline was mainly driven by the lower positive contribution from net claims on government since 215 Q2, which turned negative in 217 Q3, as well as by the lower positive contribution from net claims on public economic authorities since 216 Q4. In the meantime, a slightly higher contribution from claims on the private sector and public sector companies partially offset the decline, however, they have recently showed signs of moderation. Following an interruption in FY 215/16, fiscal consolidation regained momentum in FY 216/17 with the government resuming its economic reform program. Indeed, preliminary estimates show a drop in the overall and primary deficit to 1.9% and 1.8% of GDP in FY 216/17 from 12.5% and 3.5% of GDP in the previous year, respectively. Furthermore, data for the first two months of 217 Q3 show a decline in the overall and primary deficit to 1.7% and.4% of GDP from 2.% and.8% of GDP in the previous year, respectively. This was driven by the combination of higher revenues, mainly from taxes, and a 6 All F/C components were recalculated excluding foreign exchange rate revaluation. Monetary Policy Report, September 217 Central Bank of Egypt 1

12 Sep-2 Jun-3 Mar-4 Dec-4 Sep-5 Jun-6 Mar-7 Dec-7 Sep-8 Jun-9 Mar-1 Dec-1 Sep-11 Jun-12 Mar-13 Dec-13 Sep-14 Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Figure 28 Contribution to M2 Growth from L/C components of NDA (in p.p.) Net Other Items Claims on Private Sector Claims on Public sector companies Net claims on public economic authorities Net claims on General Government Broad money (RHS) contained increase in expenditures supported by subsidy reforms. Nonetheless, despite the fiscal consolidation in percent of GDP, the fiscal deficit increased in EGP billions and its contribution to money growth also increased during FY 216/17 compared to a year earlier. As a result, the drop in contribution of net claims on the government, which reflects the shift in the financing structure of the fiscal deficit, did not offset the increase in NFA, contributing to higher money growth. Figure 29 Contribution to M2 Growth from NFA and F/C components of NDA (in p.p.) Figure 3 Growth of L/C Real Claims on the Private Sector (in %) Net Foreign Assets Other Broad money (RHS) Private Busines sector Household sector In the meantime, the moderation of L/C claims on the private sector in real terms began since 216 Q2, with real growth turning negative since 217 Q1. Real claims on the household sector have been declining since 216 Q2 and registered a contraction since 216 Q4. Meanwhile, real claims on the private business sector has been generally increasing between 215 Q3 and 217 Q2, before slowing down in 217 Q3. The recent slowdown was entirely driven by lower loans to the industrial sector, mainly to electrical industries and electronics, food and beverage as well as oil and gas, while lending to the pharmaceutical sector rose. In the meantime, lending to the services, trade and agricultural sectors increased, partially offsetting the overall decline of loans to the industrial sector. Within the services sector loans to the non-oil logistics, real estate and oil logistics sub- sector rose, while loans to the transportation and storage, communication and tourism sub-sectors declined. Regarding components of M2, CIC gradually declined to an average of 11.1% of GDP between 216 Q4 and 217 Q2, supported by the unification of the foreign exchange market. This ratio had increased between 213 Q1 and 216 Q3 following the CBE s rationing of F/C provisions to banks and the introduction of foreign exchange controls, which led to the emergence of parallel foreign exchange markets that required higher CIC. Leading indicators using CIC as percent of L/C deposits in M2 during 217 Q3 suggest continued normalization of money holding behavior. Monetary Policy Report, September 217 Central Bank of Egypt 11

13 Sep-2 Sep-3 Sep-4 Sep-5 Sep-6 Sep-7 Sep-8 Sep-9 Sep-1 Sep-11 Sep-12 Sep-13 Sep-14 Jun-2 Jun-3 Jun-4 Jun-5 Jun-6 Jun-7 Jun-8 Jun-9 Jun-1 Jun-11 Jun-12 Jun-13 Jun-14 Figure 31 Developments of CIC Outside the Banking System 1/ (in %) 3.% 28.% 26.% 24.% 22.% 2.% 18.% 16.% 14.% 12.% 1.% CIC to M2 CIC to LC deposits in M2 CIC to GDP (RHS) 12.5% 12.% 11.5% 11.% 1.5% 1.% Meanwhile, the dollarization ratio resumed its downward trend in 217 Q3 following an interruption in 217 Q2. Since 24, the composition of deposits has been increasingly leaning towards L/C vis-à-vis F/C deposits with few exceptions during the periods of dollarization. Moreover, the introduction of 1.5-year certificates at a higher rate compared to longer-term certificates led to a shift in the structure of private sector L/C deposits to be dominated by deposits less than 3 years since November 216, after being dominated by deposits more than 3 years up to October / Average CIC, LC deposits and M2, four quarters rolling sum of GDP. Figure 32 Structure of L/C Private Sector Deposits (in % of total private sector deposits) Figure 33 Developments in F/C Deposits (in %, y/y, unless otherwise stated) Earmarked deposits Deposits less than 3 years Deposits more than 3 years Current deposits Dollarization ratio (F/C deposits to deposits in M2) F/C deposits (RHS) Despite the recent increase in M2 growth, inflationary pressures were dampened by the drop in velocity as defined by the frequency with which a unit of currency is used to purchase domestically produced goods and services. Historically, velocity has been declining between 213 Q2 and 217 Q2, nevertheless its magnitude has been lessening markedly since 217 Q1. Moreover, annual growth of M adjusted by the CBE's O/N deposit facility and fixed rate deposit auctions dropped sharply since 216 Q4, recording a contraction in 217 Q3 for the second consecutive quarter. This was mainly driven by the absorption of excess liquidity via maturities greater than 7-days. In October, growth in M, as defined above, is expected to increase due to the higher reserve requirement ratio by 4bps. The money multiplier measured as the ratio between M2D and M as defined above continued to increase since between 216 Q4 and 217 Q3. This was mainly driven by the continued absorption of excess liquidity via deposit auctions with maturities greater than 7 days and the narrowing of CIC as percent of L/C deposits in M2 as a result of the gradual normalization of money holding behavior. Nonetheless, the increase in reserve requirement ratio effective 1 October 217 is expected to lower the money multiplier as defined above, more than offsetting the effect of lower CIC as percent of L/C deposits. Monetary Policy Report, September 217 Central Bank of Egypt 12

14 Sep-14 Dec-14 Sep-14 Dec-14 Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Figure 34 Contribution to Adjusted M 1/ (M in %, y/y, otherwise in p.p.) Dep. Auc. 7 days O/N Deposits L/C Deposits of Banks Currency in circulation outside banks Adjusted M (y/y, RHS) 1/ M adjusted by standing facilities and fixed rate deposit auctions. Figure 35 Headline and Core Inflation 1/ (in %, y/y, weights in parenthesis) Headline Inflation (1%) Core Inflation (74.43%) f) Inflationary pressures are receding. Annual headline and core inflation declined for the second consecutive month in September 217 to record 31.6% and 33.3%, after peaking in July 217 at 33.% and 35.3%, respectively. Monthly headline and core inflation declined in August and September to average of 1.1% and.3%, lower than the average of 1.6% and 1.% in the corresponding months in 216, respectively. This came despite headline inflation being affected by higher electricity prices in August and higher water supply prices in September 217. Monthly headline and core inflation had picked up in July 217 to 3.2% and 2.8%, respectively as the government implemented another round of regulated price adjustments and increased the VAT-rate. Tightening monetary conditions, aimed at containing underlying inflation including potential second-round effects of supply shocks, supported the drop of the annual inflation rates. The inflationary impact of the domestic currency depreciation has largely receded, except for items that witness delayed or seasonal consumption such as pilgrimage in May and clothing in June Source: Central Agency for Public Mobilization and Statistics and Central Bank of Egypt. 1/Core inflation is headline inflation excluding regulated and volatile food items. Figure 36 Monthly Contribution to Headline Inflation (in p.p.) Regulated Items Fresh Fruits & Vegetables Core Food Items Retail Items Services The number of items that experienced price increases narrowed on average to 7.2% in August and September, compared to an average of 13.3% between 29 and 215. This comes after the generalized price increase between November 216 and January 217 affected about half of the items in the CPI basket. Prices of regulated items contributed significantly to headline inflation in the periods between November 216 and March 217 and between July and September 217. This was mainly due to subsidy reforms related to hydrocarbons, electricity and water supply as well as other regulated items such as tobacco and medical products. Source: Central Agency for Public Mobilization and Statistics and Central Bank of Egypt. The gradual decline of monthly inflation was broad- 7 Seasonality patterns of monthly headline inflation indicate that the period July-October witnesses the highest increases, followed by the period of January-April, then May-June, then November-December. Monetary Policy Report, September 217 Central Bank of Egypt 13

15 Sep-14 Dec-14 Sep-14 Dec-14 Figure 37 Diffusion Index: Headline Inflation by Number of Items that Experienced Price Changes (in %) Price increases Price decreases Net Source: Central Agency for Public Mobilization and Statistics and Central Bank of Egypt. Figure 38 Timing of Regulated Price Adjustments as Reflected in CPI 1/ Source: Central Agency for Public Mobilization and Statistics and Central Bank of Egypt. 1/ In addition to higher VAT rate since July 217. Figure 39 International vs. Domestic Core Food Prices (in %, m/m, using domestic CPI basket weights) July 217 August Hydrocarbons - Butane Gas Cylinders - Landline Telephones - Medicines - Public Hospitals - Tobacco - Inland transportation - Electricity - Inland transportation September Water supply - Natural Gas for Housing International Food Prices (based on domestic weights) Domestic Core Food Prices based, especially in core inflation items. Services and retail items have been only contributing marginally to headline inflation since January and March 217, respectively. Exceptions in services were in May and July due to higher prices of pilgrimage and the indirect and second round effects of subsidy-reform measures, respectively. Exceptions in retail items were in June, July and September due to clothing, higher VAT-rate, and household cleaning products, respectively. Meanwhile, food inflation narrowed in August and September 217 and was mainly driven by higher prices of fresh vegetables. The contribution of core food inflation narrowed markedly in August and recorded in September its first negative contribution since July 216, coinciding with international food price developments. Poultry as well as fish and seafood prices declined, while prices of other core food items have generally stabilized. The stability of red meat prices was witnessed for the first time since April 216. Before dropping in August and September 217, pressures from international food prices, using domestic CPI basket weights, have been relatively tame in the first four months of 217 while domestic core food prices have been relatively elevated due to the economic reform measures. Nevertheless, in the period between May and July 217, domestic core food inflation witnessed relatively lower magnitude of price increases, despite being affected by seasonal effects and indirect effects of subsidy reform measures as well as elevated international food prices Source: Central Agency for Public Mobilization and Statistics, Central Bank of Egypt, World Bank, Food and Agriculture Organization and United States Department of Agriculture. Monetary Policy Report, September 217 Central Bank of Egypt 14

16 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 The Outlook The outlook for average annual headline inflation remains consistent with achieving the CBE's target of 13% (±3%) in 218 Q4 and single digits thereafter. Figure 4 Inflation Forecast 1/ (in %, y/y) % 7% 5% 3% confidence interval 1/ The chart captures uncertainty regarding the inflation forecast with its most likely evolution, given the risks. The band around the center of the forecast shows the range of inflation outcomes that can occur with 3% probability, while the widening bands represent a gradually increasing probability of 5%, 7% and 9%. After tighter real monetary conditions supported the decline of annual headline inflation in August and September 217, strong favorable base effects are expected to accelerate disinflation, especially between November 217 and February 218. Tighter real monetary conditions reflected the combination of previous policy rate increases and receding inflationary pressures that lead to positive real interest rates, as well as the appreciation of the real exchange rate due to the stability of the nominal exchange rate and the positive, yet declining, inflation differential between Egypt and its trading partners. Underpinning this outlook are global assumptions. Brent oil prices are projected to average 6 USD/bbl in 217/18, up from the previous assumption of 55 USD/bbl mainly because of recent geopolitical developments. On the other hand, international food prices relevant to Egypt's consumption basket are forecasted to be stable in 218. Meanwhile, the recovery of global inflation and economic activity is expected to continue maintaining weak pressures on domestic prices, while supporting the gradual normalization of global monetary policy. At the same time, Egypt s real GDP growth is expected to continue recovering, supported by the recovery of NEGS as well as domestic and foreign investments, which are expected to complement consumption as growth engines. The recovery of tourism, construction, nonpetroleum manufacturing as well as extractions, particularly natural gas, are expected to support economic activity by sector. Monetary Policy Report, September 217 Central Bank of Egypt 15

17 Furthermore, the government is expected to continue pursuing its comprehensive economic reform program with the aim of achieving higher, more sustainable and inclusive growth. The overall fiscal deficit in 217/18 is targeted to decline to 9.% of GDP, while the primary balance is targeted to record a surplus of.2% of GDP for the first time since 22/23 and to increase thereafter. Nevertheless, there are several risks surrounding the baseline inflation outlook, notably the evolution of inflation expectations, demand-side pressures as well as the timing and/or magnitude of any fiscal consolidation measures. Monetary Policy Report, September 217 Central Bank of Egypt 16

18 Appendix: Tables and Abbreviations Monetary Policy Report, September 217 Central Bank of Egypt 17

19 Table A1: CPI Contribution Weig hts Sep- 16 Oct- 16 Nov- 16 Dec- 16 Jan- 17 Feb- 17 Mar- 17 Apr- 17 May- 17 Jun- 17 Jul- 17 Aug- 17 Sep- 17 Monthly Contributions to Headline CPI Inflation (in pp) Headline Regulated Items Fresh Fruits & Vege tables Core CPI Food Prices of which Poultry & Red Meat Food excl. Poultry & Red Meat Retail Prices Services Annual Contributions to Headline CPI Inflation (in pp) Headline Regulated Items Fresh Fruits & Vege tables Core CPI Food Prices of which Poultry & Red Meat Food excl. Poultry & Red Meat Retail Prices Services Source: Central Agency for Public Mobilization and Statistics and Central Bank of Egypt calculations. Monetary Policy Report, September 217 Central Bank of Egypt 18

20 Date 212/ / 214 Table A2: Egypt's Balance of Payments (USD billion) 214/ /216*(1) 216/217* 215/2 216/2 Q1 Q2 Q3 Q1 Q1 Q2 Q3 Q4 16* (1) 17* (1) Trade Balance Export proceeds ** Petroleum exports Other exports Import payments** Petroleum imports Other imports Services Balance Receipts Transportation Of which: Suez Canal dues Travel ( tourism revenues ) Payments Travel Investment Income Balance Receipts Payments Of which: Interest paid Current Transfers Private (net), Official (net) Balance of Current Account Capital & Financial Account Capital Account Financial Account Direct investment abroad Direct investment in Egypt (net) Portfolio investment abroad Portfolio investment in Egypt (Net) # Of which: Bonds Other Investments (Net) Net Borrowing Medium- and Long- Term Loans (net) Medium- and Long- Term Suppliers' Credit Short term Suppliers Credit (net) Other Assets Other Liabilities Net Errors & Omissions Overall Balance Change in CBE Reserve Assets (Increase -) * Provisional. ** Including exports and imports of free zones. # Including net transactions on Egyptian TBs, as well as Egyptian government bonds issued for the Saudi Fund for Development in the amount of USD 5 million in FY 211/212, Q4. It also includes foreigners' net transactions on medium- term USD bonds issued by the Egyptian government in the amount of USD 2.5 billion in the fourth quarter of 212/213, and of USD 1. billion in the first quarter of 213/214, in addition to USD bonds issued in the amount of USD 135. million in the fourth quarter of 214/215. (1) The data were adjusted according to the latest update. Monetary Policy Report, September 217 Central Bank of Egypt 19

21 21/ 11 Table A3: GDP contribution (at factor costs) 211/ / / 14 GDP (at Market Prices) GDP (at Factor cost) Public GDP (at Factor Cost) Private GDP (at Factor Cost) Agriculture, forestry, fishing and hunting Industry Extractions Oil Natural gas Other Manufacturing Petroleum Non-Petroleum Services (excluding construction) Construction Real Estate Rental and Services Transportation and Warehousing Finance Insurance 1/ Communication Tourism Educational, Health Care, and Other Services Utilities 2/ Information Trade Suez Canal General Government Source: Ministry of Planning. 1/ Includes Social Insurance. 2/ Includes Electricity, Water, and Sewage. 214/ / 16 Mar- 16 Jun -16 Sep -16 Dec -16 Mar- 17 Jun -17 Monetary Policy Report, September 217 Central Bank of Egypt 2

22 Table A4: Market Developments (aop) Oct-16 Nov-16 Jul-17 Aug-17 Oct-17 Latest Vs. Oct. 216, in bps 1/ Policy Rates Mid-Corridor rate, % Money Market Interbank WAR,% W.A. O/N Interbank rate, % Interbank O/N average volume, EGP million 1,67 1,799 2,49 4,16 5,978 6,15 4,118 4,768 2,866 Interbank O/N share of total interbank volume, % Banking Sector W.A. Deposits Rate, % n/a 7 Time Deposits, % n/a 663 Short-term Deposits, % (< 1Y) n/a 677 Other Deposits, % n/a 41 Saving Certificates % n/a 68 < 3 years, % n/a 828 > 3 years, % n/a 31 Saving Accounts, % n/a 16 W.A. Lending Rate, % n/a 479 Business Lending Rates, % n/a 428 Short term Loans, % n/a 397 Long term Loans, % n/a 485 Retail Lending, % n/a 57 Local Debt Market W.A. T-Bill yield 1Y, % W.A. T-bill yield, % W.A. T-bond yield, % WACF, % 2/ Spreads 2/ W.A. O/N Interbank - Mid Corridor rate, % W.A. Lending rate - Mid Corridor rate, % n/a -221 Mid Corridor - W. A Deposit Rate, % n/a -1 WACF - Mid Corridor rate, % W.A. Yield Curve, % W.A. Lending rate - WACF, % n/a 217 W.A. Lending rate - T-bill yield, % n/a 241 W.A. Lending rate - W.A. Deposit rate, % n/a -221 W.A. Long term Business W.A. Short term Business loans, % n/a 88 1/ All changes are in basis points with the exception of Interbank o/n volume, the changes are in EGP million. 2/ Government securities' yields are adjusted for tax. Monetary Policy Report, September 217 Central Bank of Egypt 21

23 Monetary Survey Table A5: Monetary Survey and Central Bank Balance sheet (eop, in EGP billion) June 212 June 213 June 214 June 215 June 216 Net Foreign Assets (NFA) June 217 Central Bank Commercial Banks Net Domestic Assets (NDA) Sept. 217 Net Claims on Government Net Claims on Public Economic Authorities Claims on Public Sector Companies Claims on Private Sector Net Other Items Broad Money (M2) Domestic Currency Component (M2D) Currency Outside Banks Domestic Currency Deposits F/C Deposits Central Bank Balance sheet Net foreign assets (NFA) Foreign assets Foreign liabilities Net domestic assets (NDA) Net claims on government Net claims on public economic authorities Claims on Banks Bank's Deposits in F/C Open Market Operations / Other items net Reserve money (M) / Currency Outside Banks Reserves of banks Cash at vaults L/C Deposits Source: Central Bank of Egypt 1/ Deposit auctions and deposit facility. 2/ M at end of June 215 was affected by cancellation of deposit renewals at CBE due to unexpected announcement of national holiday on June 3,215. Monetary Policy Report, September 217 Central Bank of Egypt 22

24 Abbreviations bps bbl CBE CIC CPI EGP EGX3 eop EUR FDI FY GBP GDP GIR L/C F/C m/m M M2 M2D NAFTA NDA NEGS NEER NFA O/N OPEC p.p. Q REER UK US USD w.a. WACF y/y Basis points Barrel of oil Central Bank of Egypt Currency in circulation outside the banking system Consumer price index Egypt pound The Egyptian exchange benchmark index End of period Euro Foreign direct investment Fiscal year Great Britain pound Gross domestic product Gross international reserves Local currency Foreign currency Month on month Reserve money Broad money Local currency component of broad money North American Free Trade Agreement Net domestic assets Net exports of goods and services Nominal effective exchange rate Net foreign assets Overnight Organization of Petroleum Exporting Countries Percentage points Quarter Real effective exchange rate United Kingdom United States United States dollars Weighted average Weighted average cost of finance Year on year Monetary Policy Report, September 217 Central Bank of Egypt 23

25 Monetary Policy Report, September 217 Central Bank of Egypt 24