When an Economy Cannot Afford Lower Interest Rates

Whenever Egypt’s economy comes under renewed pressure, the Central Bank of Egypt (CBE) finds itself at the forefront of efforts to contain imbalances that monetary policy alone cannot resolve. Monetary policy has increasingly become the economy’s first, and sometimes last, line of defence against instability, shouldering the burden of problems it did not create while being expected to deliver solutions beyond its mandate.

This time, however, the challenge appears more complicated. Inflation is easing, while businesses and investors are waiting for interest rate cuts to bring down borrowing costs, encourage investment and support expansion. Instead, the CBE has moved in the opposite direction, raising interest rates and making credit more expensive in an economy crying out for cheaper financing, not another layer of financial strain.

What prompted the CBE to make a decision that could increase financing costs for businesses and the state budget, potentially weighing on investment and employment? Have the risk of foreign capital outflows, movements in the dollar, and the threat of renewed inflation left monetary policymakers with little room to manoeuvre?

The contradiction is clear: the central bank is expected to protect the Egyptian pound, contain inflation, and maintain investor confidence, yet it cannot independently boost exports, build factories, or secure sustainable foreign currency inflows. When other economic policy tools fail to move at the necessary pace, higher interest rates become one of the few available instruments for containing risks, even if the real economy bears the cost.

Why raise rates while inflation is falling?

Understanding the latest decision requires looking beyond the headline figures pointing to a slowdown in inflation and examining the wider range of economic indicators considered by the central bank.

At its 29 October meeting, the central bank raised its key interest rates by 100 basis points, taking the overnight deposit rate to 20% and the lending rate to 21%. The decision followed five consecutive meetings at which rates had remained unchanged, defying market expectations that the monetary easing cycle would resume.

The increase came despite a decline in annual headline inflation to 13.9% in September, while core inflation eased to 14.1%. On the surface, the figures appeared to support lower borrowing costs rather than another round of monetary tightening. But monthly inflation offered a less reassuring picture. Monthly headline inflation stood at 1.3% in September, while core inflation reached 0.8%, highlighting the persistence of underlying price pressures. Risks from higher global energy and food prices, alongside supply-chain disruptions, further complicate the inflation outlook.

The distinction between disinflation and deflation is critical. A lower inflation rate does not mean prices are falling; it means they are continuing to rise, albeit at a slower pace.

The CBE’s calculations, however, extend beyond the latest inflation readings. Monetary policy is inherently forward-looking, with interest-rate decisions shaped by expectations of future price movements rather than historical data alone. In its October statement, the central bank cited “more pronounced” risks and uncertainty, saying that preserving the disinflation path warrants “a more restrictive stance to converge towards the CBE target level of 7 percent (± 2 percentage points), on average, in Q4 2027.”

Against this backdrop, the rate increase can be viewed as a pre-emptive measure to protect the disinflation process rather than an indication that previous efforts to contain inflation have failed.

But this raises a more fundamental question: why does the interest rate remain the instrument of choice whenever inflationary pressures threaten to return? Should other areas of economic policy not be doing more to tackle those pressures at their source?

If higher energy, transport, and imported raw material costs are driving prices upwards, the response cannot be limited to curbing demand through interest rates. It must also involve lowering production costs, improving transport and distribution efficiency, removing supply-chain bottlenecks, and ensuring the timely availability of industrial inputs. These interventions fall largely within the government’s remit and can be pursued without waiting for another Monetary Policy Committee meeting.

Foreign capital and the dollar: the cost of relying on high yields

In the week ending 29 October, foreign investors recorded net sales of around 85.5 billion pounds ($1.5 billion) in Egypt’s secondary market for Treasury bills, following another week of substantial selling. The scale and frequency of these transactions raise questions about the sensitivity of Egypt’s debt market to shifts in international investor sentiment.

Net sales in the secondary market do not necessarily mean that all the proceeds leave the country. However, the scale of these transactions over a short period highlights the risks of relying heavily on investments that can move across borders at short notice, particularly when expectations about interest-rate returns, exchange-rate movements or geopolitical developments shift.

This exposes a potentially vicious circle. The CBE raises interest rates to attract foreign capital, then faces pressure to keep them elevated to discourage investors from leaving. The question is whether monetary stability has become increasingly dependent on offering foreign investors ever-higher returns.

The challenge, however, extends beyond nominal interest rates. Investors assess the returns they can ultimately retain after accounting for exchange-rate movements. A high yield offers limited protection if depreciation of the Egyptian pound erodes a substantial portion of an investment’s value when converted back into dollars.

Selling government debt instruments and converting the proceeds into dollars can increase demand for foreign currency. However, not every sale automatically results in a conversion into dollars, and exchange-rate movements cannot be attributed solely to foreign portfolio outflows. Higher interest rates may make pound-denominated assets more attractive, but they cannot independently generate the foreign currency supply needed to stabilise the market.

The solution, therefore, is not to abandon portfolio investment, which remains a normal component of financial markets, but to reduce excessive reliance on it.

The Ministry of Finance could begin by gradually extending the average maturity of government debt, diversifying its investor base, and reducing its exposure to concentrated short-term refinancing needs.

More substantial progress, however, must come from productive investments that can generate export revenues in the near term, alongside projects that replace costly imports with locally manufactured goods.

The government could also accelerate the implementation of foreign direct investment projects rather than relying solely on announcing investment commitments.

Over the next six months, authorities could identify factories that have halted operations or are running below capacity, assess their financing needs, raw-material shortages, and licensing constraints, and then measure actual increases in production and exports.

Every dollar generated through sustained productive activity reduces the need to attract another dollar in search of the highest available financial return, one that could leave at the first sign of turbulence.

Who pays the price, and what should the government do?

How can the private sector be expected to lead economic growth while the cost of financing that growth continues to rise? A company with 100 million pounds in variable-rate borrowing, for instance, could face an additional 1 million pounds in annual costs if the full one-percentage-point rate increase were reflected in its borrowing costs. For a factory operating on narrow profit margins, that amount could be enough to postpone expansion, equipment purchases, or new hiring.

The burden does not stop with businesses. The government, too, faces higher costs when issuing new debt or refinancing maturing obligations. A one-percentage-point increase in the cost of 1 trillion pounds in newly issued or repriced debt could add around 10 billion pounds to annual financing costs. In effect, the economy pays twice for the same pressure: first through weaker private investment, and then through the reduced fiscal space available for public services and investment.

This does not mean the central bank should overlook inflation to protect investment. Rather, the government must address the other pressures driving up production costs.

Rather than offsetting every interest-rate increase through broad-based financing initiatives that could add to inflationary pressures, the government could focus on streamlining licensing procedures, reducing logistics costs, speeding up payments owed to exporters, and providing targeted credit guarantees to sectors with clear productive returns, supported by transparent and clearly budgeted funding.

Public debt also requires better management, rather than relying on monetary policy to absorb the consequences of rising borrowing costs. This means extending debt maturities whenever market conditions allow, reducing financing needs, improving the efficiency of public spending, and directing government investment towards projects with higher returns.

Additional revenue, meanwhile, should come from expanding economic activity, broadening the tax base and bringing more of the informal economy into the formal system — not from imposing heavier burdens on businesses that are already meeting their obligations.

Perhaps this is the central paradox: monetary policy takes one step forward, only for structural economic imbalances to push it several steps back. The central bank tries to contain inflation, only to face another shock in energy or import prices. It seeks to preserve the pound’s attractiveness, only to see foreign investors reverse course. It prepares the ground for rate cuts, only for sluggish growth in production and exports to narrow its room for manoeuvre.

The objective cannot be to eliminate the impact of external shocks; that would be impossible. It must be to build an economy that is less exposed to them and better equipped to absorb their effects.

When markets reopen on Sunday, 1 November, investors will be watching exchange-rate movements and foreign activity in government debt instruments for an early indication of the market’s response to the rate increase.

A single trading session, however, cannot provide a definitive verdict on the success or failure of monetary policy. The real test will be whether the economy is less dependent on high interest rates six months from now.

The government’s performance should instead be measured by the number of factories that have resumed operations, actual growth in exports, shorter customs-clearance times, improvements in the public debt maturity profile, and the volume of foreign direct investment projects that have moved from announcement to implementation.

The CBE can influence the cost of money, liquidity conditions, and inflation expectations. It cannot, on its own, build a factory, boost exports, or reorder public spending priorities. The problem, then, is not that the central bank is raising interest rates. It is that the economy has yet to give it enough room to bring them down.