Abstract
This Selected Issues paper examines whether Egypt’s current account and exchange rate are in broad equilibrium. The paper analyzes areas of fiscal spending that have the biggest saving potential in a cross-country perspective. An assessment of Egypt’s real exchange rate is presented. The paper uses data envelopment analysis to analyze the efficiency in public spending on health, education, and social protection relative to comparable countries. The results suggest significant scope to improve efficiency in all three social areas, and that room for fiscal savings is particularly apparent in social protection and education.
IV. The Monetary Transmission Mechanism in Egypt48
Summary
The Central Bank of Egypt (CBE) has made important strides to upgrade Egypt’s monetary policy framework over the last few years. The development of monetary transmission channels, however, has been slow.
In line with evidence on countries at a similar stage of economic development, Egypt displays a pronounced exchange rate channel, whereas other channels (working through interest rates, bank lending, and asset prices) do not contribute significantly to the transmission of the monetary stance to macroeconomic variables.
With the recent introduction of the overnight interbank interest rate corridor, the interest rate channel appears to be strengthening—a development that would bode well for the CBE’s intention to adopt inflation targeting over the medium term.
A. Introduction
74. Conducting successful monetary policy hinges on a firm understanding of the timing and impact on monetary policy shocks on key economic variables. The monetary transmission mechanism (MTM) describes various channels through which these effects work. Gauging the effectiveness of the MTM is of key importance for any central bank in devising its monetary policy stance, strategy, and operations.
75. The Central Bank of Egypt (CBE) intends to adopt inflation targeting (IT) as a monetary policy framework over the medium term. Against this background, the CBE has introduced a number of reforms over the past decade that should strengthen the MTM in Egypt and enhance the macroeconomic impact of monetary policy decisions.
76. This chapter discusses the channels of monetary transmission in Egypt in light of the experience of the last decade. In light of rather limited research on the MTM in Egypt, the chapter provides some Egypt-specific background on the transmission channels, highlighting the frequent structural breaks, and provides some empirical results on the interaction (via selected channels) between the monetary stance and economic variables such as prices and output.
77. The following are the main findings:
The interest rate channel provides correct signs, but the significance and amplitude of the results are not satisfactory, in particular, in light of the planned move toward inflation targeting.
The exchange rate channel continues to play an important role in the transmission of the monetary stance and magnifies the impact of policy shocks drastically.
The role of the asset price channel is generally subdued, but explicit modeling of this channel indicates that it intensifies the response of prices to exchange rate shocks.
The bank lending channel points to a stronger transmission of the monetary policy stance on output through credit (loans and securities) to the public sector, with little transmission through private sector lending.
78. Several policy implications follow from the analysis. The set of recent reforms (see below) implemented by the CBE should enhance efficiency in the banking sector and contribute to a well-functioning monetary transmission mechanism over time. It will be important to follow through with plans to eliminate the legacy problem on nonperforming loans (NPLs) and enhance banking supervision to prevent it from re-emerging. Moreover, encouraging banking competition should lead to a more accentuated bank-lending channel. Additional exchange rate flexibility is an important precondition for successful IT. Finally, lowering the fiscal deficit over the next few years as planned should also strengthen several transmission mechanisms, especially the bank lending channel and the balance sheet channel (the latter is not explored in the present context due to data constraints).
79. The rest of the chapter is organized as follows: The next section summarizes the institutional background information on the MTM in Egypt, including on the different transmission channels at work. Section C provides selected empirical evidence highlighting the key findings in AMB. Section D concludes.
B. Background: Monetary Transmission Channels in Egypt
80. During much of the past decade, the CBE was concerned with simultaneously achieving multiple objectives, which were conflicting in several instances. These objectives included attaining high economic growth while maintaining low inflation and preserving a stable exchange rate. Between 1996 and 2005, the CBE’s operational target was excess reserves of banks, and given the strong link between monetary aggregates and inflation, growth in M2 was the intermediate target. In its toolkit, the CBE used various quantitative and price instruments at different points in time to achieve its multiple objectives, leading to a lack of consistency in monetary management.
81. Linking policy decisions to macroeconomic outcomes has been complicated by the structure of the banking sector. The dominance of the state in the banking sector until very recently tended to create rigidities in the interest rate structure, especially regarding lending rates. Distortions created by the existence of a substantial amount of NPLs compounded the disconnect between the monetary stance and macroeconomic outcomes.
82. In the context of the broader reform agenda initiated in 2004, the CBE launched a comprehensive and far-reaching banking sector reform program. The reform program contained important steps to help overcome the previous shortcomings in the banking sector and fulfill the prerequisites for inflation targeting, including the NPL-related restructuring and the privatization of banks with state participation, a new banking law and other regulatory reforms, the liberalization of the foreign exchange and money markets, and ongoing efforts to strengthen the supervision of banks.
83. Against this background and in light of the multiplicity of objectives and instruments over the whole 1996-2005 period, monetary policy making and the various transmission channels underwent a number of structural breaks. Therefore, for each transmission channel there are very specific constraints related to the identification of the proper transmission instruments as well as data availability issues. This chapter focuses on four transmission channels in Egypt: (i) the interest rate channel; (ii) the exchange rate channel; (iii) the bank lending channel; and (iv) the asset price channel.
The (direct) interest rate channel
84. This Keynesian view of monetary policy stresses the central bank’s capability to have an impact on the real cost of borrowing by changing nominal policy interest rates. A decrease of nominal interest rates lowers real interest rates due to price rigidities in the short term. This change would be transmitted through the banking system to longer-term lending rates and bolster expenditure on business investment, housing, and consumer goods, strengthening aggregate demand.
85. During the 1996-2005 period, the Central Bank of Egypt did not control a consistent interest rate-based indicator of the monetary stance. The overnight domestic currency interbank market was only introduced in 2001, and the overnight interest rate proved extremely volatile at the beginning, hardly a good measure of the monetary stance. Other interest rates—such as the bank lending rate and the deposit rate—have shown only limited response to business cycle conditions, indicating a similarly weak signaling function.
The exchange rate channel
86. A rise in domestic interest rates attracts foreign capital inflows and causes the domestic currency to appreciate in nominal and/or real terms.49 The nominal appreciation affects the cost of imported goods, potentially lowering overall inflation. A possible real appreciation, on the other hand, reduces competitiveness and can lead to a fall in net exports.
87. The Egyptian pound has been pegged more or less explicitly to the U.S. dollar during most of the past decade, and one can distinguish four distinct periods:
1997 to 2000 The pound was de jure and de facto pegged to the U.S. dollar. Balance of payments deficits led to a substantial loss of reserves. Cumulative devaluations of the pound by around 8 percent were intended to avert a dry-up of foreign reserves, but could not prevent the emergence of a parallel exchange market.
2001 to 2002 The exchange rate was set to crawl within horizontal bands, in an unsuccessful attempt to reduce continued shortages in foreign exchange. Activity in the parallel market expanded significantly to the extent of trading at a 15 percent premium over the official rate in 2002. Meanwhile, domestic prices remained surprisingly stable until the second half of 2002, reflecting a very slow pass-through from the series of step devaluations starting in April 1999.
2003 to 2004 The authorities decided to adopt a new exchange rate policy in January 2003 under which the exchange rate was allowed to float, entailing an immediate depreciation of 17 percent. However, the lack of credibility in this new system and public expectations of a further drastic depreciation led to the hoarding of foreign exchange receipts and speculative activities in the face of an inoperative interbank market. As a consequence, the pound continued to depreciate another 16 percent through end-2004. Finally, in December 2004, the CBE officially launched a new interbank foreign exchange market that accommodated all foreign exchange transactions between banks with the support of ample U.S. dollar liquidity related to an improved current account position after the substantial depreciation (32 percent against the U.S. dollar) in early 2003.
Since 2005. The pound appreciated by about 7 percent within one quarter of the launch of the foreign exchange interbank market in December 2004, with a corresponding disinflationary impact on domestic prices. Between February 2005 and July 2007, however, the nominal exchange rate versus the U.S. dollar has been broadly stable, limiting exchange rate effects on domestic prices. Only very recently, against the background of the mid-2007 market jitters, has the bilateral exchange rate incurred some volatility, chiefly in the form of appreciation in the context of sizeable capital inflows and outflows.
The asset price channel
88. This channel is linked to the monetarist view of the MTM and stresses the importance of asset prices for the investment behavior of firms. Since investment decisions are taken in light of the relative value of the firm’s capital to the replacement value (Tobin’s q), lower asset prices—following a monetary tightening and a substitution of investors from equity into bonds—would reduce investment expenditures. Moreover, Mishkin (1995) underlines the associated wealth effect on household consumption, that also occurs through equity prices.
89. In Egypt, the stock market is the only well-documented asset market—although the effect may work well through other asset markets, e.g., real estate. After a period of subdued activity until 2003, the stock market—Cairo and Alexandria Stock Exchanges (CASE)—started to develop rapidly until 2006, when the regional stock market correction lead to a temporary sell-off.50 The rapid development that came before the correction and the swift recovery that took place since then could have contributed to the impact the monetary policy stance has on real activity and prices via a wealth effect on households and businesses.
The bank lending channel
90. This channel focuses on changes in the financial environment for a specific class of firms—small companies that are able (or not) to tap financial markets directly and the degree to which they depend largely on bank borrowing for investment financing. Contractionary monetary policy will exert a strong impact on this borrower class as they are directly affected by lower bank reserves and hence less loanable funds. Moreover, changes in the amount of credit available resulting from changes in the stance of monetary policy—for example, direct controls on the quantity and allocation of credit through changes in the reserve requirements and credit ceilings—have an impact on economic activity. This channel amplifies and propagates the effects of changes in policy instruments referred to in the (direct) interest rate channel.
91. In Egypt, the evidence of a relationship between bank lending and economic activity appears mixed. Total commercial bank lending to the private sector as a share of GDP increased until 2001 and has decreased since then. On the one hand, this boom-bust cycle in bank lending in the late 1990s and early 2000s is mirrored in the business cycle, implying that even in the case of a weak interest rate channel, the bank lending channel affects aggregate demand. On the other hand, the economic expansion since 2004 has not been accompanied (until recently) by a sizeable increase in commercial banks’ lending to the private sector. Moreover, low variability in lending rates and government ownership of a large share of bank assets contributed to a disconnect between borrowing decisions and prevailing interest rates.
92. The bank lending channel has also been hampered by a substantial stock of government debt held by public banks. Attracted by competitive yields in risk-adjusted terms, the commercial banking sector has, between 2000 and 2006, built up a sizeable position of government securities on its balance sheet, crowding out lending to the private sector. This stable flow of investment income—as opposed to risky lending—has formed the basis for a “quiet” recapitalization of the banking sector, helping banks address the NPL issue.
C. Empirical Evidence on the Monetary Transmission Mechanism in Egypt
Methodology and data
93. The transmission of monetary policy shocks is examined using a baseline vector autoregression (VAR) with extensions to inspect specific channels. A large amount of empirical literature has used VARs to investigate MTM issues as they provide a simple dynamic approach to modeling key variables.51 The VAR approach entails a simple graphical way to present empirical evidence in the form of impulse response functions (IRFs). These IRFs show the dynamic response of the endogenous variables in the system to an unanticipated change (shock) in one of the variables of interest. Additional times series are easily included in the baseline specification to investigate what effect specific channels have (compared to the baseline scenario).
94. The baseline specification of the VAR uses monthly observations, running from January 1996 to June 2005.52 The choice of sample span is driven by the regime change in monetary policy implementation, related to the successful introduction of the overnight interest rate target corridor. The variables contained in the VAR consist of a measure of economic activity, the price level (WPI), a measure of the monetary policy stance and of the nominal effective exchange rate.53 Most models are estimated with three lags (except for the cases when more lags are needed to satisfy specification tests). Identification is achieved using a Choleski decomposition, with the variables ordered as indicated. Unless noted otherwise, the data are sourced from the CBE, the Egyptian statistical agency (CAPMAS), and the IMF database. Although most of the variables are not stationary, we refrain from exploring long-run cointegrating relationships more thoroughly in light of the rather short time span covered by the data. Consistent with the literature, the analysis is conducted in levels as the transmission mechanism is primarily a short-run phenomenon (Favero, 2001).
Baseline model
95. In the baseline model, the price level displays a strongly significant response to exchange rate shocks but not a quite significant response to the monetary stance measure developed in MMZ (Figure IV.1). The response of prices to an increase in the monetary policy measure (easing) is closer to significance if we extend the sample until end-2005. While not significant, the response of output to shocks to the monetary policy stance is in line with expectations—after about a year or so, output starts rising in response to an easing monetary stance. The significant, positive response of the output to a nominal appreciation shock, however, is somewhat counterintuitive and warrants further attention.54 The strong deflationary impact of a tightening on the WPI is intuitive and consistent with earlier findings (Rabanal, 2005).
Selected Impulse Responses, Baseline VAR
(One standard deviation innovations ± 2 standard errors)
Citation: IMF Staff Country Reports 2007, 381; 10.5089/9781451811896.002.A004
Note: The impulse reponses are shown for a positive shock (corresponding to monetary easing and an appreciation of the nominal effective exchange rate).96. The variance decomposition (not shown) for the baseline VAR indicates that most variables are highly idiosyncratic: even after five years, the variation of three out of four variables is explained by their own innovations. The exception is the WPI, whose variation after barely one year is mainly explained by the NEER—consistent with a strong exchange rate pass through to the WPI.
97. These baseline results are robust to (i) a different measure of the monetary stance (reserve money); and (ii) a different variable ordering, inverting the positions of the exchange rate and the monetary stance variables. While the former check is driven by the attempt to identify a quantity measure of the monetary stance, the latter check is motivated by the fact that the exchange rate may be considered, at least occasionally, a policy target, and hence exogenous to the monetary stance in the short run. Substituting reserve money for MMZ’s monetary policy stance measure does not change the key results from the baseline specification. After expansionary shocks to reserve money, the output continues to respond positively but insignificantly, whereas the WPI no longer shows the initial (insignificant) increase from the baseline scenario. The output has the same unexpectedly positive reaction to an appreciation, and prices respond negatively and significantly to an appreciation. The inversion of the exchange rate variable and the monetary stance variable has no effect on the results, indicating that the baseline specification is rather robust.55
The interest rate channel
98. Without a functioning interest rate channel, the capacity of the central bank to influence real activity is limited. In the absence of a representative short-term policy on interest rates, pair wise Granger causality tests have been conducted between a number of interest rate series and the monetary policy stance measure included in the baseline VAR to examine the interest rate channel more closely. Table IV.1 shows that interest rates in Egypt are rather unrelated to each other, as the null hypothesis of a non-causal relationship can only be rejected in three cases at the 10-percent level. In particular, the monetary policy stance measure appears to Granger-cause the 3-month deposit rate but not vice versa, and the 3-month deposit rate has some impact on the lending rate in turn.
Pair Wise Interest Rate Granger Causality Tests, 1995–2005 1/
*, ** Imply signficance at the 10, 5 percent level. Lag length is three.
Pair Wise Interest Rate Granger Causality Tests, 1995–2005 1/
| Null Hypothesis | Observations | F-Statistic | Probability | |
|---|---|---|---|---|
| Six-month t-bill rate does not Granger-cause lending rate | 123 | 0.23 | 0.87 | |
| Lending rate does not Granger-cause 6-month t-bill rate | 0.35 | 0.79 | ||
| Three-month deposit rate does not Granger-cause lending rate | 128 | 3.48 | 0.02 | ** |
| Lending rate does not Granger-cause 3-month deposit rate | 1.30 | 0.28 | ||
| MP measure does not Granger-cause lending rate | 117 | 0.01 | 1.00 | |
| Lending rate does not Granger-cause MP measure | 0.52 | 0.67 | ||
| Three-month deposit rate does not Granger-cause 6-month t-bill rate | 123 | 0.69 | 0.56 | |
| Six-month t-bill rate does not Granger-cause 3-month deposit rate | 3.62 | 0.02 | ** | |
| Mp measure does not Granger-cause 6-month t-bill rate | 112 | 0.29 | 0.83 | |
| Six-month t-bill rate does not Granger-cause MP measure | 0.36 | 0.78 | ||
| MP measure does not Granger-cause 3-month deposit rate | 117 | 2.38 | 0.07 | * |
| Three-month deposit rate does not Granger-cause MP measure | 0.99 | 0.40 |
*, ** Imply signficance at the 10, 5 percent level. Lag length is three.
Pair Wise Interest Rate Granger Causality Tests, 1995–2005 1/
| Null Hypothesis | Observations | F-Statistic | Probability | |
|---|---|---|---|---|
| Six-month t-bill rate does not Granger-cause lending rate | 123 | 0.23 | 0.87 | |
| Lending rate does not Granger-cause 6-month t-bill rate | 0.35 | 0.79 | ||
| Three-month deposit rate does not Granger-cause lending rate | 128 | 3.48 | 0.02 | ** |
| Lending rate does not Granger-cause 3-month deposit rate | 1.30 | 0.28 | ||
| MP measure does not Granger-cause lending rate | 117 | 0.01 | 1.00 | |
| Lending rate does not Granger-cause MP measure | 0.52 | 0.67 | ||
| Three-month deposit rate does not Granger-cause 6-month t-bill rate | 123 | 0.69 | 0.56 | |
| Six-month t-bill rate does not Granger-cause 3-month deposit rate | 3.62 | 0.02 | ** | |
| Mp measure does not Granger-cause 6-month t-bill rate | 112 | 0.29 | 0.83 | |
| Six-month t-bill rate does not Granger-cause MP measure | 0.36 | 0.78 | ||
| MP measure does not Granger-cause 3-month deposit rate | 117 | 2.38 | 0.07 | * |
| Three-month deposit rate does not Granger-cause MP measure | 0.99 | 0.40 |
*, ** Imply signficance at the 10, 5 percent level. Lag length is three.
99. To corroborate this preliminary evidence, the baseline VAR was re-estimated with (in this order) the lending rate, the 3-month deposit rate, and the monetary policy stance measure between the price measure and the exchange rate. Figure IV.2 presents selected impulse responses. The significant reduction of the 3-month deposit rate after an expansionary shock to the monetary policy measure is consistent with the Granger causality results above. The almost-significant response of the lending rate to the shock in the policy stance, however, is not mirrored in the Granger test statistics above. The absence of an effective policy interest rate before the introduction of the overnight corridor clearly indicates that the transmission mechanism is hampered at the short end—especially as far as the signaling of the monetary stance is concerned. Nevertheless, the results in Figure IV.2 (left panels) and Table IV.1 provide some limited evidence of an interest rate mechanism beyond the very short end.
Impulse Responses, Interest Rate Channel
(One standard deviation innovations ± 2 standard errors)
Citation: IMF Staff Country Reports 2007, 381; 10.5089/9781451811896.002.A004
Note: The impulse reponses are shown for a positive shock (corresponding to higher interest rates (left) and an easing of the monetary policy measure (right)).The exchange rate channel
100. In light of Egypt’s recent exchange rate experience, this channel warrants particular attention. A simple way to discern the importance of the exchange rate channel is to shut down the transmission by including the exchange rate in the set of exogenous variables, as opposed to the endogenous ones.56 By doing so, we avoid the transmission of the initial monetary shock to the exchange rate.57
101. Figure IV.3 displays the impulse responses for two different monetary shocks—the monetary policy measure and the interest rate on 3-month deposits—with the NEER channel active/inactive. The responses are consistent in shape—a positive shock in the monetary policy measure corresponds to an easing of the monetary stance.58 In both cases, the exchange rate channel plays an important role. After a monetary easing, an active exchange rate channel doubles or even triples (in response to a deposit rate shock, bottom left panel) the magnitude of the price response due to the additional effect stemming from the depreciation of the price of imported goods.59 With regard to the response of output to an unexpected easing in the monetary stance, an active exchange rate channel appears to delay the expansionary reaction for both monetary policy measures stemming from depreciation-induced expenditure switching toward domestic goods (right panels). In our sample, this effect could be driven by the monetary easing in the late 1990s, which coincided with a drop in investment and intermediate imports. This somewhat counterintuitive result could be explained by rising import prices, which—by reducing the availability of imports that are critical inputs for production—hamper productive activity.
The asset price channel
102. Assessing this channel relies on a good measure of asset prices—in this case the stock market index. Egypt’s official stock exchange offers a stock price index, CASE 30, that covers the 30 major stocks quoted with a minimum free float of 15 percent. As stock market index data is available since January 1998, we have re-estimated the baseline VAR for this limited period, ordering the (log) stock price after the output and the WPI but before the monetary policy stance, assuming that monetary policy could react within the same observations period to movements in the stock market.60
Impulse Responses With and Without NEER Channel
(Cholesky decomposition, one standard deviation innovations)
Citation: IMF Staff Country Reports 2007, 381; 10.5089/9781451811896.002.A004
Note: In the top part, the impulse reponses are shown for a positive shock to the monetary policy measure (corresponding to a monetary easing). In the lower part the inverse impulse responses to a positive interest rate shock are shown shock (also corresponding to a monetary easing).103. A functioning asset price channel intensifies the price response to an exchange rate shock (not shown). Compared to the baseline, it increases the amplitude but shortens the time during which the response is significant by about one year. This result could be explained in two ways: First, it may be evidence of an additional wealth effect on private consumption. As investments in the pound-based stock market become more expensive with an appreciation, foreign investors are likely to reduce their positions (and local investors would tend to shift their investments abroad), and the stock market index decreases significantly (see text chart). Investors—both retail and institutional—experience a decrease in their net worth and adjust their consumption and investment behavior accordingly. Second, the appreciation could deteriorate the outlook for export-oriented sectors (tourism and non-oil goods exports). Lower profit expectations could exert pressure on stock market quotations, reinforcing the wealth effect.
CASE 30 Response to NEER Appreciation
Citation: IMF Staff Country Reports 2007, 381; 10.5089/9781451811896.002.A004
The bank lending channel
104. To explore the bank lending channel, a real credit aggregate is included in the baseline VAR.61 First, we include total private domestic and public credit—except for the government proper credit, but including state-owned enterprises and public economic authorities—consisting of both lending and securities held by banks. For identification purposes, the variable is ordered between the price index and the monetary policy measure.
105. Explicitly modeling the credit channel does not change the baseline results. Although domestic credit expands significantly after shocks from monetary easing and after an appreciation of the nominal effective exchange rate (Figure IV.4), the impulse responses of outputs and prices to these shocks (not shown) are very similar to the baseline scenario.
Impulse Responses Baseline VAR and Domestic Credit
(One standard deviation innovations ± 2 standard errors)
Citation: IMF Staff Country Reports 2007, 381; 10.5089/9781451811896.002.A004
Note: The impulse reponses are shown for a positive shock (corresponding to monetary easing and an appreciation of the nominal effective exchange rate).106. To discern better the growth impact of various types of credit, total domestic credit was substituted by disaggregate data, distinguishing first between private and public credit (to state-owned enterprises and public economic authorities) and second between lending to the household sector and the corporate sector.62 In all cases, an active credit channel increases the positive response of the output to a monetary easing. The bank lending channel points to a stronger transmission of the monetary policy stance on output through credit to the public sector compared to private sector lending. The response of the output is broadly twice as large if we model the transmission via the public sector explicitly compared to the private sector. Similarly, the transmission via corporate lending is quantitatively more important for the output than lending to households.
The Impact of the Target Corridor for the CBE’s Overnight Standing Facilities
107. Within the newly adopted monetary framework, the CBE launched the overnight corridor system in June 2005, shifting its monetary operations from a quantity-based target (excess reserves of banks) to a price-based one, the overnight interbank rate. The overnight deposit rate and the overnight lending rate are effectively the floor and the ceiling of the corridor, respectively. Steering the domestic currency overnight interbank rate in the middle of the corridor is the CBE’s operational target. The CBE manages market liquidity through its open market operations. Overnight Interbank Interest Rate (In percent)
108. Since the introduction of the corridor, the domestic currency overnight interbank interest rate has become substantially less volatile, and potentially a better indicator of the monetary policy stance (see text chart). To investigate whether this fundamental change has had any effect on the interest rate channel over the last 1½ years, Granger causality tests similar to the ones above (Table IV.1) were carried out with a different set of interest rates for this very short sample (Table IV.2).63 The results indicate that the overnight interbank rate has started to assume a strong role in the interest rate channel. It Granger-causes both the interest rates on 3-month deposits and new bank borrowing (the lending rate). This bodes well for the CBE’s monetary policy strategy going forward if it maintains the clear signaling function that the overnight rate appears to have assumed in a rather short period of time. Moreover, the banking sector’s decreasing spread between cost of funding and investment return on government securities caused by stronger competition for lending opportunities to the private corporate and household sector should reinforce the empirical link going forward
Pair Wise Interest Rate Granger Causality Tests, 2005–06 1/
*, ** Imply signficance at the 10, 5 percent level. Lag length is three.
Pair Wise Interest Rate Granger Causality Tests, 2005–06 1/
| Null Hypothesis | Observations | F-Statistic | Probability | |
|---|---|---|---|---|
| Lending rate does not Granger-cause 3-month deposit rate | 16 | 1.19 | 0.37 | |
| Three-month deposit rate does not Granger-cause lending rate | 1.28 | 0.35 | ||
| Overnight interbank rate does not Granger-cause 3-month deposit rate | 16 | 10.15 | 0.00 | *** |
| Three-month deposit rate does not Granger-cause Overnight interbank rate | 0.97 | 0.45 | *** | |
| Six-month t-bill rate does not Granger-cause 3-month deposit rate | 16 | 2.42 | 0.14 | |
| Three-month deposit rate does not Granger-cause 6-month t-bill rate | 1.23 | 0.36 | ||
| Overnight interbank rate does not Granger-cause lending rate | 16 | 5.60 | 0.02 | ** |
| Lending rate does not Granger-cause Overnight interbank rate | 1.68 | 0.24 | ||
| Six-month t-bill rate does not Granger-cause lending rate | 16 | 3.94 | 0.05 | * |
| Lending rate does not Granger-cause 6-month t-bill rate | 1.38 | 0.32 | ||
| Six-month t-bill rate does not Granger-cause Overnight interbank rate | 16 | 1.18 | 0.38 | |
| Overnight interbank rate does not Granger-cause 6-month t-bill rate | 2.18 | 0.17 |
*, ** Imply signficance at the 10, 5 percent level. Lag length is three.
Pair Wise Interest Rate Granger Causality Tests, 2005–06 1/
| Null Hypothesis | Observations | F-Statistic | Probability | |
|---|---|---|---|---|
| Lending rate does not Granger-cause 3-month deposit rate | 16 | 1.19 | 0.37 | |
| Three-month deposit rate does not Granger-cause lending rate | 1.28 | 0.35 | ||
| Overnight interbank rate does not Granger-cause 3-month deposit rate | 16 | 10.15 | 0.00 | *** |
| Three-month deposit rate does not Granger-cause Overnight interbank rate | 0.97 | 0.45 | *** | |
| Six-month t-bill rate does not Granger-cause 3-month deposit rate | 16 | 2.42 | 0.14 | |
| Three-month deposit rate does not Granger-cause 6-month t-bill rate | 1.23 | 0.36 | ||
| Overnight interbank rate does not Granger-cause lending rate | 16 | 5.60 | 0.02 | ** |
| Lending rate does not Granger-cause Overnight interbank rate | 1.68 | 0.24 | ||
| Six-month t-bill rate does not Granger-cause lending rate | 16 | 3.94 | 0.05 | * |
| Lending rate does not Granger-cause 6-month t-bill rate | 1.38 | 0.32 | ||
| Six-month t-bill rate does not Granger-cause Overnight interbank rate | 16 | 1.18 | 0.38 | |
| Overnight interbank rate does not Granger-cause 6-month t-bill rate | 2.18 | 0.17 |
*, ** Imply signficance at the 10, 5 percent level. Lag length is three.
Overnight Interbank Interest Rate
(In percent)
Citation: IMF Staff Country Reports 2007, 381; 10.5089/9781451811896.002.A004
D. Conclusions and Outlook
109. The CBE has made many important strides to upgrade Egypt’s monetary policy framework over the last few years with a view to adopt inflation targeting as a monetary policy framework once the prerequisites are fulfilled. Summarizing, it appears that some of the preconditions for a successful implementation of IT (not discussed in detail here)—including a competitive banking system and a fully consistent monetary policy framework—are not yet fulfilled. However, certain aspects of the monetary transmission mechanism, another plank of successful IT, appear to work, especially the exchange rate channel. Moreover, since the launch of the corridor in June 2005 for the overnight interbank rate, this rate has been less volatile and—although empirical evidence is slow to emerge—has proven to be a better indicator of the monetary policy stance in the context of the interest rate channel. Finally, not discussed in this chapter is the fact that continuous improvement of the CBE’s communication strategy has helped to strengthen the monetary policy framework and enhance the expectations channel.
110. Despite the shift away from the exchange rate as the nominal anchor and the growing importance of the interest rate channel, the ER channel will continue to play an important role as a large share of the consumer goods basket used in the CPI is tradable. In fact, several countries have moved toward inflation targeting while paying particular attention to the exchange rate; for example, Turkey and Chile. In the Egyptian context, however, allowing further exchange rate flexibility is an important precondition for successful IT.
111. Going forward, other transmission channels should become more significant. The bank-lending channel should become stronger as competition between banks enhances the sector’s effectiveness in intermediating financial flows and translating the central bank’s monetary stance into market rates. Especially, the relative strength of transmission via public sector credit should lessen as private sector lending re-emerges as a plank of economic development in Egypt. The role of the asset price channel will be enhanced over time as per capita incomes grow and consumption becomes less dependent on current income.
112. Two priorities adopted by the government—cleaning up the remaining NPLs in the banking sector and lowering the fiscal deficit over the next few years—should also strengthen several transmission mechanisms, especially the bank lending channel and the—not explored in the present context—balance sheet channel as financing for smaller corporates becomes more easily available and firms are in a better position to respond to changes in the interest rate, since their balance sheets are no longer burdened by NPLs.
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Billmeier, A. and I. Massa, 2007a, “Go Long or Short In Pyramids—News from the Egyptian Stock Market,” IMF Working Paper No. 07/179 (Washington: International Monetary Fund).
Billmeier, A. and I. Massa,, “What Drives Stock Market Development in the Middle East and Central Asia—Institutions, Remittances, or Natural Resources?” IMF Working Paper No. 07/157 (Washington: International Monetary Fund).
Favero, C.A, 2001, Applied Macroeconometrics (Oxford: Oxford University Press).
Mishkin, F.S., 1995, “Symposium on the Monetary Transmission Mechanism,” Journal of Economic Perspectives, Vol. 9(4), pp. 3– 10.
Moursi, T. A., M. E. Mossallamy, and E. Zakareya , 2007, “Effect of Some Recent Changes in Egyptian Monetary Policy: Measurement and Evaluation,” ECES Working Paper No. 122 (Cairo: Egyptian Center for Economic Studies).
Rabanal, P., 2005, “Exchange Rate Pass-Through” in: Arab Republic of Egypt: Selected Issues, IMF Staff Country Report 05/179 (Washington: International Monetary Fund)
Prepared by Andreas Billmeier (MCD). This chapter is based on the forthcoming IMF working paper by Al-Mashat and Billmeier of the same title (henceforth AMB) which includes a more detailed description of the historical record.)
Of course, central banks can also intervene directly on the foreign currency market to steer the exchange rate in a specific direction.)
Between March 2003 and February 2006, the CASE 30 index increased to about 12-fold [12-fold needs an object]; see Billmeier and Massa (2007a) for a more thorough investigation of recent developments on the Egyptian stock market. Billmeier and Massa (2007b) investigate to what extent remittances, the quality of institutions, and hydrocarbon wealth have had an impact on stock market development in a sample of 17 economies in the Middle East and Central Asia.
See, e.g., Mishkin (1995) and other contributions to the fall 1995 symposium in the Journal of Economic Perspectives.
The maximum number of observations for any given model is 114, but some of the series start later, reducing the number of observations slightly in selected models.
The measures of economic activity and the monetary stance are taken from Moursi, Mossallamy, and Zakareya (2007)—MMZ henceforth—, who construct the latter measure to overcome the lack of a consistent policy interest rate for the sample period. In a model of bank reserves a la Bernanke and Mihov (1998), the measure of the monetary policy stance corresponds to the unpredictable residual to nonborrowed bank reserves, which are not explained by shocks to total and borrowed reserves. See MMZ (2007) and AMB (2007) for a discussion of alternative measures of the monetary policy stance. The WPI is used instead of the CPI due to the weak statistical properties of the latter; see Rabanal (2005) and AMB (2007) for more details. Two exogenous variables (the federal funds rate and the oil price) are also included to avoid well-known empirical anomalies such as the price puzzle; see Favero (2001).
The response to the type of GDP distribution method (Litterman/Chow-Lin), the choice of price level measure (CPI/WPI), and the type of exchange rate (NEER, REER, and bilateral LE-U.S. dollar) is robust.
See AMB for a graphical representation.
See Baqir (2002).
In addition to the NEER used in the baseline scenario, AMB employs the REER and the bilateral exchange rate against the U.S. dollar.
For ease of comparison, the lower charts in Figure IV.3 present the inverse of the impulse response to a regular interest rate shock (which would correspond to a monetary tightening).
See AMB, Appendix I, Baseline VAR, bottom row, third chart. Given the definition of the effective exchange rates, an initially negative impulse response corresponds to a depreciation. The appreciation of the NEER over the medium term in response to a monetary easing displayed in the same chart also explains why the response of the WPI to the MP measure dies out much more quickly when the exchange rate channel is alive (top-left panel in Figure IV.3).
In this specification, we have used one lag as indicated by the Schwarz and Hannan-Quinn information criteria. The results are robust to ordering the stock market index before the monetary policy stance, consistent with the assumption that the CBE considers stock market developments as one factor in making (same period) monetary policy decisions.
Credit aggregates are deflated with the WPI and seasonally adjusted (X-12 filter).
See AMB for a more detailed discussion including charts.
Causality tests not reproduced here; see AMB. Due to the limited amount of observations, it is not possible to estimate a VAR based on the overnight interest rate.
